Imminent Russian Defaults Will Lead To An Economic Crisis Worse Than In 1998

In just one week, Russian President Vladimir Putin has caused hundreds of deaths and wreaked havoc in the lives of millions. He has also begun the destruction of the Ukrainian and Russian economies. Making Russia a global economic pariah is a dubious achievement, and it will take years for the citizens of both countries to recover.

Sanctions Are an Economic Siege

Russian President Vladimir Putin’s unprovoked invasion of Ukrainian has led to global economic sanctions tantamount to an economic siege. Starting on February 21, the U.S. imposed sanctions under Executive Order 14065 “prohibiting all new investment, trade, and financing by U.S. persons to, from, or in the so-called Donetsk People’s Republic (DNR) or Luhansk People’s Republic (LNR) regions” of eastern Ukraine.” Three days later, the US imposed additional sanctions in the form of sweeping financial sanctions and stringent export controls. And on Thursday, the U.S. government imposed “blocking sanctions on Russian defense entities, export controls targeting oil refining, a key revenue source that supports Russian military, restrictions on Belarus to choke off its import of technological goods in response to its support of Putin’s war of choice,” and has banned “Russian aircraft from entering and using domestic U.S. airspace.” Thus far, thirty-five countries which include Australia, Canada, Japan, 27 countries of the European Union, New Zealand, Switzerland, Taiwan, the U.S. and the U.K. have imposed sanctions and export controls targeting Russia. Brazil, China, India, Mexico, Pakistan and South Africa have not imposed sanctions yet.

Divestments Are Quickly Rising

The private sector globally has also moved quickly to punish Russia. At the time of this writing, over 30 internationally well-known companies from every sector, including energy, and financial institutions had pulled out of Russia. This has all happened in five days. Since executives fear legal and reputational repercussions from the sanctions, many more will follow.

Downgrades Deluge

This economic siege has caused a deluge of credit ratings downgrades of Russian sovereign and corporate debt issuers. Every announcement of a downgrade and even of a negative credit watch is leading to an imminent default of sovereign, corporate, and financial institution issuers. Downgrades, not to mention defaults, raise the borrowing cost of issuers. Even under normal circumstances, increased borrowing costs makes it difficult for issuers to stay afloat. Now, this is practically impossible, since the Russian economy is under siege caused by continually increasing and intensifying sanctions and divestments.

On Friday, February 25^th, S&P Global Ratings was the first rating agency to open the flood gates of Russian downgrades. In just one week, Russia’s local and foreign currency sovereign debt rated has plummeted from investment grade BBB- to CCC-, a level showing that a default is imminent. S&P also announced that it also downgraded its “transfer and convertibility assessment to ‘CCC-‘ from ‘BBB-‘. The ratings remain on CreditWatch with negative implications.” CreditWatch Negative means that S&P could downgrade Russian debt even further.

Tuesday, the Bank of Russia banned coupon payments to foreign owners of ruble denominated bonds. The next important date to watch out for is March 16th when another Russian bond coupon payment is due.

On Wednesday, FitchRatings downgraded the Russian Sovereign from BBB to B, and this Friday, FitchRatings downgraded 100 Russian issuers including 32 banks’ local and foreign subsidiaries and six government related issuers, as well as companies in the consumer and health, homebuilding, insurance, natural resources, telecommunication, transport, and utilities sectors.

Throughout the week, Moody’s Investor Services has placed 16 financial institutions, over 50 companies, sixteen municipalities, on a review for a possible downgrade. Moody’s downgraded the Russian sovereign from investment grade Baa3 to junk status of B3 and also lowered the ratings of three Russian Mortgage Backed Securities (MBS).

AM Best has also downgraded several Russian reinsurance and insurance companies this week. Moreover, the insurance specialist rating agency warned that the global insurance industry will remain pressured in the near future due to the economic shocks from the invasion of Ukraine.

Economic Crisis will be Long and Painful

Defaults will push Russia even faster toward an economic crisis that will be far worse than the 1998 crisis. In the mid-1990s, Russia was an economy in transition from a centrally planned economy and embroiled in a costly conflict in Chechnya. The spillover from the Asian crisis and oil in the $10-25 range were the nails in the coffin for the Russian ruble. In that crisis, no government or company was closing off the Russian economy.

Putin will be remembered for squandering the financial autarky, that his administration, together with Russian companies and financial institutions had been building, since the 1998 crisis, but especially after the economic sanctions imposed due to the Russian invasion and annexation of Crimea in 2014. As Dr. Gian Maria Miles-Ferretti explained in his highly recommended Brookings Institution blog, “the breadth and scope of the sanctions imposed in the past few days—which go much beyond those adopted eight years ago—will impose very severe costs on the Russian economy.”

Putin should have learned from the multiple banking and currency crises of the 1990s that it is impossible for central banks to defeat the power of power of foreign exchange investors. With over half of its foreign exchange reserves now frozen, the Bank of Russia has almost run out of tools to support the ruble and to stop a run on Russian banks. Even with the humanitarian and economic disaster that Putin is wreaking, he is unlikely to step down soon, since as Anton Chekhov explained “any idiot can face a crisis.’ Maybe, if we are all lucky, ‘it’s this day-to-day living” that will wear him out.

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