Russia’s Finance Ministry said that it has sent payment orders for the interest on its dollar bonds to its correspondent bank, giving incremental details on a debt settlement that has come to exemplify how Moscow plans to handle its future relations with creditors. 

In a statement Thursday, the Finance Ministry said it had sent the order for a US$117 million interest payment on March 14 to a correspondent bank that it didn’t identify, adding that it would issue a separate comment about whether the paying agent, Citibank’s London branch, has received the payment. The bank declined a request for comment. The ministry has said it would first try to make the payments in dollars and then use rubles if that fails. So far, bondholders in Europe have received no sign of the funds.

So far, European bondholders of Russia’s sovereign debt have received no sign of the funds, although growing optimism that the bonds may be settled is spurring prices higher across maturities.

What happens next is unclear, but if Russia’s creditors don’t get the cash in dollars within the 30-day grace period that starts on Thursday, it would be the first time the nation defaulted on foreign-currency bonds since the Bolsheviks repudiated the czar’s debts in 1918. Bondholders could still declare default if Russia pays in rubles, according to Fitch Ratings. Kremlin spokesman Dmitry Peskov said the nation has all the resources it needs to avoid a default.

If, however, it doesn’t meet its debt obligations, the outcome could reinforce Russia’s exclusion from global capital markets and raise its borrowing costs. The government and firms including Gazprom and Lukoil have about US$150 billion of foreign-currency debt. Such amounts and the broader financial squeeze may not be enough to threaten a global financial crisis, but the strains are rippling through emerging markets and could deal shocks to a world economy undergoing a seismic transformation in the wake of the invasion of Ukraine.

“The Russian debt deterioration was very sudden and in a country where the fundamentals were strong, so it will definitely be more significant than, say, Argentina’s default,” Anthony Kettle, a senior portfolio manager at BlueBay Asset Management Plc, said. “It may lead to some further diversification of international reserves, with possibly more of a role for CNY, as the U.S. has used sanctions and the dollar reserve asset status so effectively in this case.”

SIGNS OF STRESS

As for the impact on Russia itself, while its economy has been devastated by measures such as freezing much of the central bank’s US$640 billion in reserves, the country’s large current account surplus means it doesn’t necessarily need bond market access. 

That said, there have also been signs of strains among some Russian corporate borrowers. Internet search engine Yandex, social-media network VK Co Ltd. and Ozon Holdings have already initiated talks with creditors. Also, payments due from EuroChem hadn’t been processed as of Wednesday evening, according to people familiar with the matter, and Severstal said it had “grounds to believe” its settlement wouldn’t be processed either. Citigroup is the paying agent for both bonds. The bank declined to comment on all of the interest payments.

“The biggest hit will obviously be on the flow of capital,” said Simon Harvey, head of FX analysis at Monex Europe, who expects money managers to become much more cautious around emerging-market credit. “Investors have now been woken up to the perils of investing in higher-yielding sovereign debt.”

In 1998, Moscow’s default on its domestic debt and moratorium on payment to foreign creditors rippled across the global economy, contributing to the collapse and subsequent rescue of hedge fund Long-Term Capital Management, an event cited by the World Bank’s chief economist in an interview on Tuesday.

“Remember LTCM? That wasn’t necessarily on anyone’s radar screen at the outset of the Russian default in August 1998,” said World Bank Chief Economist Carmen Reinhart. “Those things start to surface. Exposures are opaque.”

Reminder of New Rules

• In a decree issued on March 7, President Vladimir Putin set out new rules for debt settlements and divided foreign creditors into two categories: those from “countries that engage in hostile activities” can only be paid interest and principal payments in rubles.
• The new procedure involves opening so-called Type C accounts, which can be done automatically without the consent or involvement of a foreign creditor, Morgan Lewis partner Grigory Marinichev said. For investors based in unfriendly nations, receiving transfers into Type Cs is “equivalent to paying into a blocked account,” Marinichev said. “You can’t repatriate those rubles.”
• Any such payment would likely kick off a bout of legal wrangling between Russia and its bondholders over what constitutes a legitimate settlement of the debt. That matters not just for bondholders but for the investors holding US$40 billion worth of credit default swaps linked to Russian debt.