(Bloomberg) -- The big question now facing Russian debt owners is whether they ever get their money back.
The government is paying its bond coupons for now, but with the war in Ukraine raging and foreign reserves frozen, it's unclear how or when investors will receive their cash. Even though the central bank called the ban on transferring coupon payments temporary, the financial meltdown has been so severe that no one knows how it will be repaired or whether Russia would even have any motivation to service debt.
With decades of integration into the global financial system snuffed out in days, Russia is now at risk of its first debt default since 1998. Then, shockwaves from the Asian debt crisis and tumbling oil prices compelled Boris Yeltsin's government to renege on about $40 billion of local bonds.
“All bets are off now,” said Guido Chamorro, co-head of emerging-market hard currency debt at Pictet Asset Management Ltd. in London. “The conflict with Ukraine has changed everything,” he said, putting the risk of default above 50%.
Fitch Ratings cut Russia's sovereign credit ratings six levels to single B -- deep into junk status -- on Wednesday. Moody's Investors Service followed on Thursday, with a similar downgrade to a junk B3 rating. Meanwhile, MSCI Inc. and FTSE Russell are removing Russian equities from their widely-tracked indexes.
“We assume U.S. sanctions prohibiting transactions with the Ministry of Finance will not impede the servicing of Russia's sovereign debt,” Fitch said in its statement. “But this is unclear and the risk of such a severe measure has increased markedly.”
Read More: A $9 Billion Bond Problem Is Coming for Russian Issuers
Russia's access to reserves, willingness to pay and the mechanisms for making coupon payments will all come into play. As of the start of February, investors held almost 3 trillion rubles ($30 billion) of local Russian bonds, known as OFZs.
Barring any announcement from the central bank or government, it may be weeks before investors or ratings agencies can say for certain that Russia has defaulted. Most bond agreements come with a 30-day grace period to give borrowers some wiggle room. It's unclear where OFZ bonds carry the same provision.
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Several analysts, lawyers and bond investors interviewed by Bloomberg said they didn't know if Russia's case -- when a coupon is paid into accounts that investors can't access -- would count as a default.
Others have speculated that ratings agencies may call it a technical default, meaning Russia didn't fulfill the terms of the bond agreement. Moody's and S&P declined to comment when contacted by Bloomberg.
Read More: How Sanctions Create a Risky Tangle for Russian Bonds: QuickTake
The world's biggest clearing houses -- Euroclear and Clearstream -- no longer settle Russian assets and some of the country's largest banks are shut off from the global banking system. Capital controls imposed by the central bank mean that even though the Finance Ministry transferred a planned bond payment on Wednesday, investors can't get to the money.
“A default is a default -- whether it's technical or official, you don't get paid,” said Edwin Gutierrez, head of emerging-market sovereign debt at abrdn in London.
Russia isn't entirely cut off from global markets, but Moscow's ties to China may be of little assurance for holders of its sovereign debt.
Russia may be able to use its assets held in yuan in combination with China's own cross-border payment system to counter the impact of Western sanctions, according to analysts at Australia & New Zealand Banking Group. Russia's central bank and sovereign wealth fund probably own a combined $140 billion of Chinese bonds, they estimated.
China's central bank has a multi-billion dollar currency swap with its Russian counterpart, allowing the two countries to provide liquidity to businesses. The country has also signed Russian banks onto its homegrown payments settlement system, seen as an alternative to SWIFT.
©2022 Bloomberg L.P.
With assistance from Bloomberg
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