Risk of Russian debt default drives S&P to downgrade country deeper into junk territory

In 1998, Moscow devalued the rouble and failed to meet its financial obligations

The Red Square in Moscow. Western sanctions have prompted rating agencies to slash Russia's credit score. AFP

S&P Global Ratings downgraded Russia's credit rating further into “junk” territory due to the country's debt being “highly vulnerable to non-payment”, the agency said.

S&P lowered its foreign and local currency sovereign credit ratings on Russia to “CC”, from “CCC-", two notches above default. It also revised downwards its transfer and convertibility assessment to “CC”, from “CCC-". The country's ratings remain on a negative credit watch.

Earlier this month, Fitch Ratings and Moody's Investors Service downgraded Russia's sovereign credit rating to non-investment grade junk status due to the wave of US and EU sanctions.

“Our ratings focus on an issuer's ability and willingness to meet its financial obligations in full and on time, as well as in accordance with the terms of the obligation, including in the agreed currencies,” S&P said in a statement late Thursday.

The rating agency said its action was prompted by its understanding that investors did not receive a coupon payment on the Russian government's US dollar-denominated 2023 and 2043 eurobonds, when payment was due on March 16, 2022, owing to technical difficulties related to international sanctions.

“Although public statements by the Russian Ministry of Finance suggest to us that the government currently still attempts to transfer the payment to the bondholders, we think that debt service payments on Russia's eurobonds due in the next few weeks may face similar technical difficulties,” S&P said.

The rating agency also cited an exemption currently granted under the US sanctions that expires on May 25, which it said could further complicate Russia's ability to make its debt service payments after that date.

US Treasury’s restrictions on dealings with Russia’s central bank and other Russian institutions do not prevent the country from making payments on its dollar debt, at least until late May, Bloomberg reported, citing a Treasury representative.

Russia's payment difficulties are a result of a series of punitive measures imposed by western countries to incapacitate Moscow economically in response for its military offensive in Ukraine.

After plummeting as much as 100 per cent to the US dollar, Russia's rouble recovered some lost ground. As of Friday, it was down 38 per cent against the greenback since the start of the year.

The country's biggest banks have been disconnected from the global financial system, markets and infrastructure and its ability to conduct cross country payments has also been impeded by sanctions.

Russia has a 30-day grace period to meet its payment obligations on the bonds. In 1998, the Russian government and the country's central bank devalued the rouble and defaulted on debt.

“If funds are not accessible for investors or if a payment is made in a currency not stipulated in the terms of the obligation and we believe that the investor does not agree to the alternative payment, we could deem this a default,” S&P said.

JP Morgan processed $117 million interest payments from Russia for two of the country’s bonds and passed them on to Citigroup, the payment agent responsible for distributing the money to investors, the Financial Times and Bloomberg reported.

S&P said it is keeping Russia's ratings on negative watch to indicate that it could lower the foreign currency issuer credit ratings to selective default “if the Russian government fails to make a debt service payment in accordance with the terms of the obligation, and if we do not expect such payment to be made within an applicable grace period".

It also said it would lower the local currency rating to selective default if it assesses that some non-resident bondholders are unable to have access to debt service payments on local Russian OFZ bonds within an applicable grace period.

Rating downgrades signal a country is undergoing financial instability or may not have adequate cash reserves relative to its needs and financial obligations, which makes it speculative and considered a high credit risk. That will make it difficult for Russia and Russian companies to raise funding globally.

The amount Russia owes to bondholders is about 18 per cent of the country's gross domestic product.

Russia, which has about $60 billion in external debt and hundreds of billions of dollars worth of gold and foreign currency reserves, has said it could pay its debt in roubles because of the complications it faces as a result of sanctions. However, that would be considered a default by rating agencies.

On Thursday, the heads of international financial institutions said the Ukraine-Russia crisis will dent global economic growth, increase inflation and disrupt supply chains.

Russia's economy is expected to shrink 7 per cent this year, according to Moody's, while the Institute of International Finance forecasts a much deeper contraction at 15 per cent.

“The entire global economy will feel the effects of the crisis through slower growth, trade disruptions and steeper inflation, harming especially the poorest and most vulnerable,” said the heads of the European Bank for Reconstruction and Development, the European Investment Bank, the Council of Europe Development Bank, the International Monetary Fund and the World Bank.

“Higher prices for commodities like food and energy will push inflation up further. Countries, particularly those neighbouring Ukraine will suffer disruptions in trade, supply chains and remittances, as well as surges in refugee flows.

“Reduced confidence and higher investor uncertainty will impact asset prices, tighten financial conditions and could even generate capital outflows from emerging markets.”

Oil prices hit a 14-year high last week, rallying to about $140 a barrel. Both key benchmarks, Brent and West Texas Intermediate, were well above $100 a barrel on Friday.

The conflict has affected a major breadbasket of the world as both Russia and Ukraine account for about 29 per cent of global wheat supplies. It has also led to soaring commodity prices globally.

“Surging prices for oil, natural gas, grains, fertilisers and industrial metals will feed through into higher producer and consumer price inflation worldwide — in advanced, emerging and lesser-developed countries,” said Stephen Dover, chief market strategist and head of the Franklin Templeton Investment Institute.

“Even in countries with large domestic supplies of energy and food resources, such as China [coal, grains] or the US [crude oil, natural gas, various agricultural products], prices are set in world markets, meaning that increases are felt universally.”

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Updated: March 18, 2022, 2:04 PM
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