Credit default risk… Russia's invasion of Ukraine led to extensive financial and economic sanctions. Russia's credit ratings were downgraded to junk level. In response, credit default swaps on Russia's short-term government debt rose to record highs.

 

Financial impact… The Central Bank of Russia, which created approximately $630 billion in reserves prior to the invasion of Ukraine, currently cannot access most of its reserves. The sanctions also hamper Russia's ability to intervene in currency markets to bolster the depreciating ruble against the US dollar. A sharp depreciation of the ruble will make it difficult to repay debts in this currency and increase Russia's default risk.

 

Global creditors… Since the Russian Central Bank has announced that coupon payments will not be made to foreign investors, the risk dimension has become important. Data show that most of the country's external debt is held by Western European countries. As the spread widens as credit risk rises, the rally likely indicates that investors are wary of the potential financial effects of the war. Data from the Bank for International Settlements (BIS) shows that the French and Italian banking systems each have a total exposure to Russia of approximately $25 billion at the end of the third quarter of 2021. and households may suffer in case of repayment of loans.

 

The $14.7 billion exposure American banks face to Russia equates to less than 0.1% of US banking system assets. While the Russian invasion of Ukraine will certainly result in higher financial market volatility, for Russian debt lenders the impact will be more palpable in Europe than in the United States.

 

Consolidated positions of global creditors in Russia - Amounts in circulation at the end of September 2021 (Million USD)… Source: BIS

 

Conclusion? The Russian economy is probably in its toughest conditions since debt default and the financial crisis of 1998. The sanctions imposed on Russia by Western countries could potentially lead to another financial crisis in the economy. Russia's debt (about $350 billion) was in foreign currencies such as US dollars and euros. The sharp depreciation of the Russian ruble, which lost nearly 30% against both the US dollar and the euro last week, will make it harder for Russian households, businesses and government to pay off debts in this currency. The Russian economy has never been very strong as it has always been in policy turmoil, but sanctions and restricted financing opportunities mean that conditions can be even more challenging and expose global creditors to risk.

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