In case you haven’t been following the Eurobond markets closely this year, there’s an interesting development: Ukrainian bonds are now outperforming Russian bonds. Despite being invaded by Russia and quickly downgraded by the ratings agencies, Ukraine has been making its international bond payments on time and has actually raised over $700 million in three successful war bond auctions. Turns out some investors have decided that the underdog is a safer bet than Russia.
Before and especially during the invasion, investors sold Ukrainian bonds heavily. But then Biden’s allied sanctions hit, Putin’s tanks bogged down in the mud, and suddenly everyone realized that Russia might be forced into default. In March, Russia scrambled to find ways to pay international bondholders to avoid default, but on Monday the US Treasury tightened the screws again, announcing that US banks like JP Morgan would no longer facilitate any Russian interest payments.
Sanctions technically allow Russia to make debt-servicing interest payments, but they can neither use western banks to send payments nor use their frozen assets. Russia has dollars saved at home and still earns foreign currency, so forcing them into technical default is not simple. But the Biden administration & allies are continuing to up the pressure.
Bankers have been reading the fine print of their bond contracts to see which bonds allow repayment in rubles, what are the precise criteria that would trigger a default, and whether or not they can cover their losses with Credit Default Swap (CDS) insurance. The CDS charts illustrate the default risk even more clearly.
Here’s the cost to insure Ukrainian bonds against default.
And here’s the same chart for Russian bonds. (Hint, it’s worse).
Now, to be clear, Russia isn’t a huge borrower internationally. So far, they’ve been able to earn foreign currency easily by selling fossil fuels and minerals. They normally fund overseas deals with bank credits or shareholder agreements, which are more opaque and under Kremlin control. But default would be more than embarrassing; it would limit their ability to conduct business internationally until it reached agreements to repay bondholders for their losses, and it would damage the ruble. Boris Yeltsin once defaulted on domestic bonds, but Russia hasn’t defaulted on international bonds since 1917’s Bolshevik Revolution repudiated the Tsar’s debts.
So far, Russia has been protecting the ruble and domestic investors, while alternately trying to threaten and assuage international investors. For example, they have been paying high interest to domestic bondholders and preventing foreign bondholders from collecting those same rubles—(kind of like when you get banned from a bar and then loudly declare that you won’t be doing business with them anymore). They’ve also been telling foreign investors that they’ll get their interest payments, eventually, probably, but in rubles. Which isn’t how international bond markets work. They might as well offer repayment in potatoes, delivered by babushkas, maybe next Tuesday.
The ratings agencies have been quickly downgrading both Ukrainian & Russian bonds, skipping the usual incremental +/- and letter adjustments and dropping straight to “distressed”. While Russia has so far avoided technical default by finding new payment routes and buying back some bonds, they’ve been late making payments and are into the 30-day grace period this month. Many Russian corporate bond payments are also late. But all that may be moot, since the EU will ban any firms that rate Russian securities. The ratings agencies have announced that they are ceasing all Russian operations by April 15th. And nobody—not the Chinese nor the Indians nor the Arabs—buys unrated bonds.
Like most financial firms, my broker and former employer no longer allows buying or selling Russian securities, ETF’s & Mutual Funds either no longer include Russian securities or are suspended, and residents of Russia can no longer make deposits or buy anything in their accounts. There are three million Russian-Americans here, but all those I’ve read about or know oppose the war. A few classmates who had businesses in Russia have all returned to the US after closing up shop there. The sanctions are cutting Russia’s economic ties with the world.
Many recent articles about the Russian ruble’s “recovery” miss the point. Russians can no longer sell rubles for foreign currency, Russian companies are now required to convert most foreign currency into rubles, and foreigners have had their ruble assets frozen. The ruble is no longer a free-floating currency, so, like the manipulated Russian stock market, it’s really a Potemkin currency. Nobody knows what it's really worth, which makes using the ruble to pay Russia’s debts problematic.
The next stage of the game is over natural gas contracts. Putin wants G7 customers to start paying in rubles to prop up his currency. That’s likely to backfire, especially when Putin’s war atrocities are increasing pressure for even harsher sanctions, and Europe is trying to hit aggressive renewable energy targets. And Congress has now voted to strip Russia of favored trading status and to back Biden’s ban on Russian oil, coal & natural gas.
Perhaps the greatest risks are those associated with Putin's natural gas ploy. As mentioned earlier, the natural gas contracts that buyers have signed with Russia all say that payment will be made in euros, dollars or other foreign currencies. Putin can't just cross out "dollars" or "euros" and write in "rubles" where those contracts stipulate how to pay. He has to renegotiate the terms of those contracts. And if he does so, it's likely that those countries will drastically reduce the amount of natural gas they buy from Russia.
Russia is the world's biggest producer of natural gas, as well as the biggest exporter, but it's not the only source out there, and buyers of Russian gas could pivot to new suppliers. … The countries that buy large amounts of Russian gas probably couldn't all wean themselves off it overnight, but if Russia insists on making this move, it risks turning one of its biggest revenue streams into a trickle. In short, the problem with creating a facade, as Russia has done with its currency, is not just that it might collapse — it might also collapse on you.
— NPR