Sanctions threat brings foreign share of Russian debt to lowest level in 6 years


Foreign investors’ holdings in Russian government debt fell below 20% for the first time in six years at the end of March, according to official data from Russia’s National Settlement Depository.

International investors have been sale their holdings in Russian public debt since the start of the year, fearing to be caught in a possible toughening of sanctions against Russia in retaliation for the poisoning and imprisonment of Kremlin critic Alexei Navalny.

The outflow among foreign residents of holdings in so-called OFZ – Russian government bonds – reached more than 120 billion rubles ($ 1.6 billion) in March. It was the largest monthly sale since April 2020 and brought the overall share of foreign holdings down to 19.7%, according to analysts at the state-controlled Sberbank’s investment banking arm.

“The exits are driven, in our view, by concerns about rising benchmark yields, growing geopolitical risks, a weakened ruble and still high investments, ”Sberbank analyst Alisa Zakirova said in a research note on Tuesday.

Quarter-end cash outflows likely also played a role, VTB Capital strategist Maxim Korovin said, with much of the March sale taking place in the last few days. Analysts suspect many investment firms have downgraded their positions in Russia’s foreign debt to “underweight” – a sign of market pessimism as traders limit their exposure to assets they deem too risky or not offering enough value.

At the start of the pandemic, foreigners held more than a third of Russia’s public debt.

The Russian government quickly accelerated borrowing last year to help pay the costs of the coronavirus and fill the fiscal hole created by falling oil export revenues. State-controlled banks stepped in to buy back public debt in large numbers, which also lowered the share of foreign assets.

Despite their declining share, the holdings of foreign investors have remained relatively stable over the past 12 months in ruble terms, according to the Institute of International Finance (IIF) noted, calculating the total holdings to be around $ 43 billion. Foreign holdings have actually tripled in value since 2014, when the international community first imposed sanctions on Russia for annexing Crimea.

But investors now fear that the United States will opt for the “nuclear option” of punishments – an outright ban on US-based financial institutions that hold and trade Russian government debt.

Under various laws against the use of chemical weapons, which could be used in response to the poison attack on Navalny, the US administration has this option. It’s a move Washington has hesitated to consider, but calls from die-hard senators for the Biden administration to take a tougher stance against Russia in response to Navalny’s imprisonment have intensified since the start of the year.

Still, analysts are not convinced how damaging this step would be to the Russian economy and the government’s ability to take on debt.

“The Central Bank has the option of providing liquidity to banks to buy OFZs or the national social protection fund could be used to buy government bonds directly and at a significant discount,” noted Elina Ribakov, chief economist. deputy of the IIR.

The scale of Russia international reserves offers plenty of opportunities to recover from even a full sell-off among international public debt holders, experts say, with Russia’s National Social Welfare Fund – a war chest made up of oil profits in the years leading up to the pandemic – over $ 180 billion. In addition, a financial system dominated by state-controlled lenders also offers many potential domestic buyers.

“A total ban on transactions involving Russian foreign debt (…) will only result in serious losses for Western financial institutions as a result of the sale”, economist Vladislav Inozemtsev noted recently.

“The Russian authorities will restructure their liabilities – making huge savings on debt service. Therefore, by striking a blow against Russian sovereign debt, Western politicians will not inflict much damage on Russia’s finances.

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