Russia's Perfect Debt Storm

Updated January 30, 2015

In light of the recent increase and drop in interest rates to 17 percent by the Central Bank of Russia (CBR) and then back to 15 percent in a desperate effort to stabilize Russia's faltering economy, I thought that a brief look at several  issues, particularly Russia's external debt, that will be impacted by higher interest rates and lower commodity prices is in order.

As most of us remember and as I posted here, Russia has already defaulted on its sovereign debt once; back in 1998, the nation saw its interest rates rise and ruble collapse which led to Moscow declaring that payments on its debt would be halted.  With that in mind, let's look at Russia's current external debt in millions of U.S. dollars:

Russia's external debt in June 2014 (the last month that firm data is available for) was $731.204 billion, up from $707.260 billion one year earlier.  

In the current situation, what is even more critical to Russia is the currency composition of Russia's debt.  Here is a table showing the breakdown of the $731.2 billion in debt by currency since 2011:

Notice that  in the second quarter of 2014, $448.8 billion or 62.6 percent of the total external debt at that time was in United States dollars and $76.5 billion (in USD) or 10.7 percent  was in euros.  Only 23.3 percent of the external debt was in rubles.  This could prove to be problematic if the ruble remains at its current depressed level for an extended period of time. Back on April 1, 2014, a U.S. dollar was worth 35.06 rubles which resulted in a U.S. dollar-denominated debt of 15.735 trillion rubles ($448.8 billion times 35.06).  On January 30, 2015, the conversion rate was 69.8 rubles to the U.S. dollar which results in a debt of 31.326 trillion rubles, nearly doubling the ruble-denominated debt in just eight months.  We can see how quickly the debt situation in Russia could get out of control based solely on the declining value of the ruble.

Here is a table showing the payment schedule for Russia's external debt:

Here is the same information in bar graph form from Russia's Ministry of Finance, showing debt by maturity converted to billions of rubles:

Note that a substantial portion of Russia's debt comes due within the next five years:

Of the $731.2 billion in debt during the second quarter of 2014, $161.6 billion or 22 percent of Russia's external debt was due within one year.  Over the following year, an additional $83.409 billion comes due.  In total, within the next two years, $245.058 billion or 33.5 percent of Russia's total outstanding debt will come due and be rolled over at much higher interest rates given the current situation.  Using the same rubles to dollars conversion rates as I used above, back in April, the debt coming due over the next two years totalled 8.592 trillion rubles; this has now grown to 16.811 trillion rubles using the current conversion rate.

Let's switch gears for a moment and look at the size of Russia's economy.  Here is a graph showing how Russia's GDP has grown since 2005 from the World Bank database:

According to Statista, in 2014, Russia's GDP is estimated to be $2.057 trillion.  According to a 2012 paper by Jack D. Sharples, the energy sector accounts for around 30 percent of Russia's GDP and almost half of the Federal Budget revenues.  In 2010 alone, Russia's revenue from fossil fuel exports exceeded $255 billion.  According to another study by Katsuya Ito at Fukuoka University,  a 1 percent increase (decrease) in oil prices leads to a 0.46 percent growth (decline) in Russia's GDP growth meaning that, as we already know, Russia's economy is particularly vulnerable to fossil fuel prices.     

Switching gears yet again, like other central banks around the world, the CBR has dramatically increased the nation's supply of money, a measure that gives us some sense of how inflation could impact the economy in the future.  At the beginning of the Great Recession, Russia's M2 money supply was 12.869 billion rubles.  By the beginning of December 2014, this had grown by 235 percent to 30.268 billion rubles.  For comparison's sake, this is what has happened to the American M2 money supply over the same timeframe:

The U.S. M2 grew from $7.43 trillion at the beginning of the Great Recession to its current level of $11.603 trillion, an increase of 56.2 percent.  Dramatic increases in the money supply seem to be the preferred method of central bankers to prod the world's economies back to health.  In Russia's case, the increase in the size of the supply of money is particularly dramatic even compared to the United States.

To summarize, Russia's economy is now entering a perfect storm with:

1.) A high level of external debt denominated in foreign currencies.

2.) A high level of external debt denominated in foreign currencies that is maturing in the next two years.

3.) A high interest rate environment that will impact the interest rates on debt that is rolling over.

4.) An economy that is highly reliant on oil and natural gas revenues and that is very vulnerable to even small changes in the price of both commodities.

5.) A decline in the size of Russia's economy as a result of recessionary pressures and an increase in indebtedness due to unfavourable currency conversion rates, Russia's debt-to-GDP ratio is likely to rise substantially.

6.) A very substantial growth rate in its M2 money supply that could prove to be a harbinger of future inflationary pressures.

As Russia's economic growth rates contract, it will be increasingly difficult for the government to achieve fiscal balance, necessitating the issuance of additional sovereign bonds at extremely high interest rates that may make it difficult to service the additional debt in the future, particularly if oil prices remain low and the value of the ruble does not rise substantially.  A scenario similar to the one that played out in 1998 is a definite possibility.