The Russian-Ukrainian conflict has been raging for more than 50 days, continuously raising concerns about the risk of Russia’s sovereign debt default, which would impact the internal and external environment of China’s economy.
Default risks exist, but should be deemed differently
The financial sanctions imposed by many Western economies have led to a sharp rise in the risk facing Russia’s sovereign debt, which is under pressure to default. After Russian President Vladimir Putin signed a presidential decree in early March, announcing that rubles would be used to repay foreign currency debts of “unfriendly countries”, the Russian sovereign CDS index showed the probability of sovereign debt default had risen to 80 percent, reflecting the broad concern about the possibility of a default.
To cope with the risk of cash shortages and stabilize exchange rate fluctuations, Russia’s central bank took several measures on Feb 28, including raising the benchmark interest rate by 1,050 basis points to 20 percent, and demanding traders use 80 percent of export revenue for foreign exchange settlement.
Such moves, though they can help mitigate risks triggered by the shrinking balance sheet of Russia’s financial system, will add to expectations that Russian and Western credit systems will mutually damage each other’s creditworthiness, and squeeze confidence of foreign investors in Russia in the next few years.
In addition, the sanctions have increased the risk of Russia failing to meet external repayment obligations, which may also result in more risks of a Russian sovereign debt default. As some 40 percent of Russia’s foreign reserves deposited overseas have been frozen, the country’s ability to repay its foreign debts has been weakened to a certain extent. Meanwhile, Western countries’ sanctions, together with the countermeasures by the Russian authorities, have restricted the payment channels of foreign currency debts, creating “human-factor default risks” for the repayment of Russia’s sovereign and corporate debts.
Truly, be it directly or indirectly, the conflict is leading to risks of sovereign debt default in Russia, but there are some certain particularities on this issue.
First, after foreign reserves were frozen, although the guarantor role of the Bank of Russia as the final advancer has been weakened, the country’s central bank still has the ability to repay short-term foreign debt.
From the perspective of the composition of Russia’s foreign reserves, the latest data (as of end-September 2021) showed that gold reserves in the underground warehouse of Russia’s central bank account for some 21.7 percent and renminbi assets 13.8 percent－all still effective for exchange－and their coverage ratio of foreign debt due by the end of 2022 (about $53 billion) is as high as four times, and that of overall foreign debt 40 percent. In addition, Russia didn’t suspend its main external energy supply flow, which will continue to supplement its foreign currency holdings and provide a buffer for the repayment of short-term foreign currency debt.
Second, from the perspective of the scale and maturity structure of Russia’s sovereign debt, the short-term repayment pressure of its sovereign debt is relatively controllable. Russia’s external debt or foreign currency debt does not account for much relative to its economy－24 percent of GDP－with most from nonfinancial institutions rather than the government. The scale of short-term maturities is not large as well.
Third, Western sanctions and Russia’s countermeasures are both imposing more restrictions on the repayment of foreign currency debt, so the possibility of default due to artificial constraints is greater. That is to say, the viability of servicing Russia’s foreign debt depends on regulatory rules in the United States, the United Kingdom and the European Union.
So far as we know, though Russia’s ability to repay its foreign debt has been weakened, the country still has the ability and willingness to repay its sovereign foreign debt. However, due to sanctions, principal and interest payments may still be subject to “human-factor default risks”, which is different from those due to declines in solvency or unwillingness to pay.
Therefore, in the short term only, its impact on the liquidity of the global financial market is still limited and controllable. However, in the face of such disruptions, China does need to take sensible and smart measures to maintain its own growth momentum.