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Russian bonds plunge as new sanctions spark default fears

Russian bonds tumbled on Monday as investors braced for the possibility that the latest round of Western sanctions against Russia could cause Moscow to default on its debt for the first time since 1998.

Moves by the United States and Europe over the weekend to cut Russia off from the global financial system, as Moscow ramps up its invasion of Ukraine, have raised concerns that Russia’s foreign creditors will not be able to claim interest or principal.

Sanctions on Russia’s central bank are expected to severely hamper its efforts to deploy more than $600 billion in foreign exchange reserves to bolster its finances, leading markets to speculate on the possibility of a A country that owes only 20% of its gross domestic product may fail. to repay the lender.

“A Russian default is now a real possibility,” said Tim Ash, economist at BlueBay Asset Management. “It’s amazing that the hero has fallen.”

Russia’s dollar-denominated bonds fell sharply on Monday, according to Tradeweb data, with the biggest – $7 billion in bonds maturing in 2047 – halving in price to 33 cents from dollar, a level associated with a high degree of difficulty, according to Tradeweb data.

The move comes after S&P Global downgraded Russia’s credit rating to “junk” late Friday.

The cost of buying Russian default-backed derivatives has skyrocketed. The price of Russian credit default swaps, which provide holders with insurance-like payouts if the country defaults, has risen sharply, with the 5-year CDS rising 20 percentage points to 37% on a “basis” basis. upfront,” according to traders in the derivatives market.

CDS switched to being quoted on an “upfront” basis as concerns about financial hardship increased. This is because the cost of buying default protection rises much higher than the standard running cost defined in derivatives contracts, so traders begin to quote the additional payout they pay. required at the start of the transaction.

Monday’s trading levels mean it will cost $37 million to secure $100 million of debt in default in five years, on top of $1 million a year in premiums.

A Russian default would be painful for foreign investors, already reeling from the fall in bond prices. At the beginning of the year, foreigners held 20 billion dollars of Russian foreign currency debt, as well as more than 3 billion rubles worth of domestic debt.

Some investors warned against reading too much into bond prices due to extremely tense trading conditions on Monday. One fund manager said: “I think the current price level may be reduced by forced liquidation and does not accurately reflect the probability of default.

Russia may even want to withhold debt repayments to save precious dollars, due to sanctions on the central bank, an emerging markets fund manager said. However, he added that Monday’s price drop was due to some holders being forced to sell their bonds and “did not accurately reflect the probability of default”.

While the Russian state had a strong balance sheet prior to its invasion of Ukraine, traders and investors are increasingly worried that sanctions and other measures could prevent them from paying interest. for international investors. These technical factors can still trigger payments for CDS contracts.

There is growing concern that these factors could interfere with the process used to determine payments for CDS contracts, as it requires traders to trade Russian bonds at a specified date. auction.

“In our view, risks could arise in a scenario where existing restrictions are likely to be extended to include an outright ban on secondary trading,” said credit analysts. Citigroup’s users wrote in a note to clients on Friday.

Ray Attrill, a strategist at National Australia Bank, warned that a Russian sovereign default would also spill over into the European banking system, estimating that banks in France and Italy each Banks own about $25 billion in Russian government bonds, and Austrian banks hold about $17.5 billion of Exposure.

“A default would have macroeconomic implications,” he said. “It will have important implications for banks’ balance sheets and lending capacity – as we last saw after the 2011-2012 Greek debt crisis and restructuring.”

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