Vladimir Putin’s Russia on the Verge of Default – Who Will Be Most Affected?

Bad things always come in threes.

After the rumor of an imminent nuclear war triggered by Vladimir Putin's Russia, a new rumor is circulating. This one is financial, but it continues to fuel fear in the investment world. The rumor is that Russia is about to default. This means that Russia would not pay back all or part of its debt.

Indeed, Russia has to repay in a little more than three weeks a loan issued on the London market of two billion dollars. However, the Russian State has recently announced that it intends to repay this debt in rubles. But as the ruble has collapsed, this does not please investors. As a logical consequence of these threats, interest rates on Russian debt have soared.

The one-year interest rate on Russian government bonds has risen from 8% at the beginning of January 2021 to 24% since March 4, 2022;

At the same time, the rating agencies have downgraded the Russian debt to C, the last level before default or even bankruptcy. Of course, since the subprime crisis, during which they sadly illustrated themselves by rating AAA products infected by subprime debts and which were ultimately worthless, these agencies are completely discredited. However, as usual, they have managed to add fuel to the fire and to reinforce the risk of default by Russia.

But make no mistake, the final decision will be made by Vladimir Putin's Russia.

Russia would not be at its first default if we refer to the history books

The reason this rumor has investors so scared is that if you look at the history books, you will see that this is not Russia's first attempt at a sovereign default. Russia's first default was in 1918. This default will certainly remain as one of the biggest state hold-ups in contemporary history, notably to the detriment of French savers.

Thus, from 1822 to the beginning of the XXth century, the Russian State was going to appeal more and more to France to finance its debt, issuing several loans only to the French. Despite the risk of insolvency greater and greater, Russia will then collect almost a third of the French savings to finance its debt. It must be said that the advertising campaigns of the banks and the French media of the time were rather inciting: "To lend to Russia is to lend to France!”. That's what you can read everywhere at that time.

It will be discovered later that the Russian leaders paid insane commissions to the banks and to some newspapers to promote what was presented as a 100% guaranteed loan.

But, because there is always a but in this type of story, the new loans were only used to maintain huge operating expenses and to pay back the interests of the previous loans. A true State Madoff system even before Bernard Madoff was born. At the root of these scams? Always the same thing, the lure of gain, and therefore the exploitation of human greed. But that is another debate.

The Russian Revolution broke out, and what had to happen happened: on December 29, 1917, the Bolsheviks unilaterally repudiated all the debts contracted by Russia. More than one and a half million French people were thus harmed and often lost their entire savings that they had blindly invested in Russian loans presented as “safe”...

Ninety years later, in the summer of 1998 to be more precise, history repeats itself: the Russian public debt exceeds 130% of the GDP, the prices of raw materials are at their lowest and Russia cannot repay its debts. Russia defaults once again, dragging in its wake the LTCM (Long Term Capital Management) fund, which at the time caused a mini international financial crisis.

The situation in 2022 is different, and a Russian default could have big consequences for the Western creditors

It is therefore easy to understand why the rumor of a new default by the Russian government on its debt is taken very seriously in the markets. Will we then see this default from Russia in the coming weeks or months?

In my opinion, it is very likely. The problem is that, unlike in 1918 and 1998, the Russian default is not justified given Russia's recent financial fundamentals. Indeed, its public debt is very low: 18% of its GDP in 2021 according to the IMF, which is very different from an over-indebted country close to default, as it was for example the case during the last Greek crisis with a public debt of 170% of the GDP and which reaches today 210%.

Similarly, inflation has certainly increased in Russia, but it is not dramatic either, at least for the moment. But above all, Russia currently has several airbags to absorb the shock. First of all, it has a structural current account surplus: +95 billion dollars in 2021. Even stronger: its foreign exchange reserves reach 643 billion dollars in February 2022, which places Russia in fourth place in the world, behind China (3,400 billion dollars), Japan (1,405 billion dollars), and Switzerland (1,110 billion dollars).

It doesn't stop there, as Russia's gold reserves are close to 2,300 tons, or about $150 billion. Finally, to top it all off, the Russian sovereign wealth fund has assets of about $200 billion. In this context, Russia's organized default risks cost its international creditors much more, who hold only 23% of Russia's debt. Putin could thus present this default as a sanction for foreign investors.

On the other hand, if Russia defaults and the sanctions against it persist, the Russian State will then experience serious difficulties, first to find the path of growth and then to find new financiers for their debts. To avoid the disaster scenario, it will have to find a “white knight”. As Abu Dhabi was for Dubai in 2010 or the European Union for Greece in 2012.

Will China play this role for Russia? If so, Russia will have defaulted without serious impact on its economy, but with serious consequences for its Western creditors.

We must therefore face the facts: Russia is unfortunately very well prepared for war and economic sanctions, which is not the case for the West and in particular for Europeans. It would therefore be a serious mistake to overestimate the impact of economic sanctions on Russia and to underestimate those on Europe. Whatever happens, one thing remains certain: the sooner the war in Ukraine ends, the better it will be at all levels.