The Central Bank of Russia (CBR) has already cancelled the repayment of coupons on the state’s bonds as it starts to husband its resources after it lost half of them to sanctions on its gross international reserves on February 27. But the Ministry of Finance’s Russian Ministry of Finance ruble-denominated OFZ treasury bills are not the problem. The much bigger debt that needs to be serviced is Russia’s corporate debt.  

Russian companies vigorously deleveraged after the 2008 global financial crisis. They deleveraged further after sanctions were imposed in 2014 to reduce the danger of being targeted.  

“After years of deleveraging since Western financial sanctions were first imposed in 2014, the dollar value of Russia’s external debts has fallen by about a third and stood at just under half a trillion dollars in September of last year (or around one third of Russia’s overall GDP),” said William Jackson, the chief Emerging Markets economist with Capital Economics, in a note.

“Of this, $67bn consists of external debts of the government (two-thirds of which are foreign holdings of local currency debt), $30bn are debts of the central bank, $75bn are debts of banks, but by far the largest share belongs to the corporate sector ($310bn),” Jackson added.  

Foreigners hold about $40bn worth of OFZ, but with a current account surplus last year of $120bn and the same expected for this year the state has plenty of money in theory to cover its obligations.  

But it is the Russian corporates that account for around two-thirds of Russia’s external debt repayments over the rest of this year with a surge in payments of around $700mn in government debt repayments but $7bn of commercial payments due in just March

 

Moreover, their money is tied up in bank accounts and, as bne IntelliNews reported, there is a nasty mismatch between banks dollar liabilities and their assets: banks have $280bn in dollar liabilities but only $46bn in cash. With everyone already starting to line up at the door to the CBR for hand-outs getting hold of dollars to make these repayments has become more difficult, but is not impossible.  

Jackson argues that three factors are going into making the risk of defaults rise.  

“First, there could be unintended consequences from sanctions that make it difficult for Russian entities to make debt repayments (although we assume that the exclusion from SWIFT will allow these payments to be made),” says Jackson.  

The EU slapped SWIFT sanctions on Russia at the end of last month and Russia’s two biggest banks, VTB Bank and Sber (formerly known as Sberbank), have been singled out. However, the full list of which banks will be included has not been released and the details of what exemptions will be included to allow for energy payments, transfers of cash back of their families by ordinary people living abroad, and settling debt payments have yet to be released.  

“Second, the sanctions on the central bank and exclusion from SWIFT will hit Russia’s ability to access foreign currency (from reserves or from export revenues) to service debt,” says Jackson.  

European Union's top diplomat Josep Borrell estimated a week ago that the new sanctions on Russia’s reserves will tie up about half its money, leaving the CBR with reduced reserves of some $310bn – the same amount as the corporate external debt. Moreover, about half of Russia’s remaining reserves are in gold ($133bn as of the end of January), which is less liquid than cash holdings.  

On top of this Russia could use the threat of default as a way of retaliating against Western sanctions to inflict losses on foreign lenders.

As bne IntelliNews pointed out in a recent opinion piece, the Kremlin could take the current sanctions as an act of economic war and claim that they constitute a force majeure, so Russia is not obliged to pay. The Kremlin has not made this threat but as Russia’s economy crashes, the sanctions increase and the war in Ukraine lengthens this is a possible scenario. Russian Foreign Minister Sergei Lavrov made it clear that Russia would no longer tolerate sanctions as a tool to be used against the country last February in his new rules of the game speech that marked the start of the Kremlin new more belligerent relationship with Europe.  

Thirdly, it is not inconceivable that the authorities will simply ban foreign debt repayment as a way to preserve what resources it has. The CBR has already this week banned the OFZ coupon payments to their foreign owners as a stopgap measure, but is already tantamount to default.  

“It underscores the point that the authorities are acting with scant regard for foreigners’ holdings of Russian assets,” says Jackson.

There are some mitigating circumstances. About 40% of the corporate debt ($124bn) is actually intercompany debts owed by foreign-based companies to their Russian-based subsidiaries, which are typically rolled over when they become due and so don't need to be repaid.  

Another factor is the biggest corporate debtors are largely in the raw materials business and as the crisis is already contributing to an increase in already high commodity prices these companies are much better placed to meet their obligations on their own.  

“But these are far from normal times. Administrative measures by the Russian government could prevent companies from repaying debts. Russian firms’ access to FX has already been crimped by mandatory conversion orders. And were Western governments to decide to halt energy imports from Russia in a further escalation of sanctions, that would hit corporates’ FX incomes hard, raising default risks,” says Jackson.