In the worst moments of the U.S. debt ceiling crisis in 2011, then-Treasury Secretary Tim Geithner warned lawmakers that if markets lost confidence in the ability of the U.S. to pay its debts, the Treasury might one day have to withdraw a scheduled bond sale because of a lack of buyers. A last minute deal to lift the federal borrowing limit meant failed bond sales remained only in Geithner’s nightmares, but it’s a scenario his counterpart in Russia, Finance Minister Anton Siluanov, is now dealing with in reality.
For the seventh time in two months, according to Bloomberg, the Russian Finance Ministry was forced to withdraw its offer to sell bonds denominated in rubles on the open market. In a press release on the Ministry’s website, the reason given for the withdrawal was that “investors’ requested price target levels not reflecting adequately the credit quality of the bonds offered.”
Translated into non-jargon, that means that investors were demanding such high interest rates in order to buy Russian bonds that the government decided it wasn’t worth the cost.
Bond pricing is about as straight-up a gauge of market confidence as there is. Bond yields, meaning the interest rate bondholders receive on the money they have paid the issuer, are high when buyers see a significant risk that they won’t get their investment back. They are low when investors see little risk.
For example, U.S. Treasuries are about the closest thing the market sees to a risk-free asset. At times, the U.S. government has been able to borrow at rates below the rate of inflation, because investors see the U.S. Treasury as the ultimate safe haven.
The issue with the market’s perception of Russian bonds is a little more complicated than simple worries about repayment. The bonds are denominated in Russian rubles, and the Russian government prints rubles, so the likelihood of actual default is extremely small. The problem is that investors are worried that in five or nine years (the maturities of the two offerings withdrawn today) the rubles they get back might not be worth very much.
In January, for example, it cost about 33 rubles to buy one U.S. dollar. Since the crisis in the Ukraine began, the cost has spiked to as high as 36.6 rubles, and now sits at about 35.6. Further sanctions on Russia would likely weaken the ruble further, meaning that investors in Russian bonds might be looking at the possibility of being repaid in a currency with much less buying power than when the bond was first purchased.
The concern about the value of the ruble can be traced directly to the current situation in Ukraine. Russia has already invaded and annexed Ukraine’s Crimean peninsula. It also has tens of thousands of troops positioned just across the border from eastern Ukraine, where separatists are now in conflict with the central government in Kiev. Russian leaders have warned publicly that they may decide to intervene in eastern Ukraine — with little doubt that any such “intervention” would be, in effect, a military invasion.
Currency devaluation isn’t the only danger investors in the ruble might be concerned about. Another is the “headline risk” associated with a country that may be on the brink of war. Russian bonds purchased today might be worth significantly less on the secondary market if Russia were to invade Ukraine next week. Some investors might prefer not to be seen as supporting Russia by buying its bonds. Both factors would cause reasonable investors to, at minimum, demand a significant risk premium.
Russia has already been slapped with sanctions by the international community, particularly the United States, and has been warned that more sanctions are on the table should it try to take over more Ukrainian territory.
Wednesday’s withdrawal of two bond offerings leaves Russian President Vladimir Putin and his government in a tough spot. Access to credit is essential to any modern government, for rolling over existing debt, financing new or unexpected costs and fulfilling numerous other needs.
Russia could offer to sell bonds denominated in another currency, like the dollar or the Euro, but in addition to being embarrassing, that would expose the Russian government to foreign exchange risk that wouldn’t come with borrowing in rubles. Alternatively, Russia could dip into its sovereign wealth funds, or try to increase income from oil and gas exports.
Obviously, none of these options are as appealing for the Russian government, but getting stiff-armed by the international bond market may leave Putin and his allies little choice.
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