A large volume of scheduled external debt repayments has led to speculation that Russia could experience a financial crisis in the near future. However, these financial vulnerabilities are not as worrying to Russian policy-makers as they might appear. A significant share of Russia’s external debt is owed not to Western banks, but instead to other Russian parent or holding companies registered abroad. This ‘intra-group’ debt is easily rescheduled, which means that Russia is unlikely to suffer a currency crisis – though other indicators, such as foreign direct investment, are more worrying for the health of the economy.
The dynamics behind falling reserves
The dramatic depreciation of the rouble over the winter, along with a decline in Russia’s international reserves, vividly illustrated Russia’s economic weaknesses and vulnerability to declining oil prices.
However, one of the principal causes of the rouble’s poor performance in the final quarter of 2014 was not directly related to the falling price of oil. Instead, a spike in external debt repayments also created downward pressure on the rouble. Because of financial sanctions imposed by Western states, access to Western capital markets was effectively closed to a large number of Russian corporations, and not just those directly targeted by sanctions.
Unable to refinance existing debt, Russian firms were forced to repay their debts on schedule. As a result, Russia’s total external debt fell from around $728 billion in January 2014 to $597 billion at the end of 2014. This sharp reduction of over $130 billion in the stock of external debt was due to a combination of repayments (primarily to Western banks) and a reduction in the dollar value of rouble-denominated debt.
The surge in net private capital outflows that attracted much excitement at the end of 2014 – estimated to have reached $154 billion in 2014 -- was at least partially driven by these forced external debt repayments. This in turn contributed to the reduction in Russia’s foreign exchange reserves as roubles were exchanged for foreign currency to service external debt obligations. Over the course of 2014, Russia’s international reserves dwindled from $510 billion at the beginning of the year to $388 billion at the end of the year. Today, they stand at $356 billion.
Some, such as the Atlantic Council’s Anders Aslund, have suggested that this cocktail of declining reserves and high external debt threatens the financial stability of Russia. This is, he suggests, because (a) Russia’s international reserves might not be liquid enough to be used to meet external financial obligations; and (b) Russia’s foreign debt obligations in the near future exceed the readily available stock of reserves. However, both claims are exaggerated.
First, Russia’s international reserves are liquid, as clearly documented by Ben Aris in a recent BNE article.
Second, and less widely documented, is the fact that Russia’s foreign debt obligations over the next two years are not as imposing as might first appear. According to data publically available on the Bank of Russia website, a little under $75 billion of external debt repayments are scheduled to be repaid over 2015 (a further $45 billion was scheduled for repayment between January and May 2015), and $68 billion over 2016. That means that between now and the end of 2016, over $140 billion is currently scheduled to be repaid. Set against around $350 billion in international reserves, this looks like a substantial and worrying amount.
However, much of Russia’s scheduled external debt repayments consist of obligations to banks or other corporate entities that either own or are linked with the Russian debtors. In other words, there is significant ‘intra-group’ debt, where Russian firms borrow from closely-linked entities registered offshore for the purpose of ‘tax efficiency’, for example. Such debt can be easily rescheduled and does not constitute a ‘hard’ debt obligation.
Just how much of Russia’s external debt does intra-group debt account for? Overall, it accounts for around a quarter of total external debt. But even more importantly, it accounts for around half of the repayments that are scheduled for 2015 and 2016. This means that the total ‘hard’ external debt repayments over the next 18 months amounts to a figure nearer $70 billion than $140 billion. Given Russia’s still substantial international reserves, and the fact that many firms continue to generate large volumes of foreign currency revenues, this amount will not worry policy-makers in Russia.
Looking to the future, because much of Russia’s external debt will likely be rescheduled, we should expect to see the total stock of external debt decline quite slowly, and the share of intra-group debt to rise. This should mean that the headline short-term debt figure will grow and perhaps appear disconcertingly high. But, as this note shows, a careful reading of the data should lead to a less alarming conclusion.
Threat of declining investment
Does this mean that the Russian economy is safe? Well, it does mean that the likelihood of a financial crisis is quite low. Of course, another sudden and sustained decline in the price of oil would cause problems. But in a relatively benign baseline scenario of stable oil prices, it is unlikely that onerous external debt repayments will cause a dramatic financial crisis like the one Russia suffered in August 1998.
Unfortunately for Russia, other economic indicators look more worrying. For example, inflows of foreign direct investment (IFDI) in Russia have fallen to worrying levels. In the second half of 2014, IFDI was negative. While this is not unprecedented, the fact that it accompanied a wider contraction in investment indicates that the prospects for investment in Russia appear bleak.
This is of tremendous importance because IFDI is a crucial source of technology and knowhow. If this trend persists, the effectiveness of Russia’s aggregate investment will decline, productivity growth will slow, Russia’s international competitiveness will slump further, and ultimately living standards will fall.
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