Could there be Russia Debt Default Contagion?

As sanctions on Russia begin to bite, concern is rising about potential domino effects on other countries with shaky public finances.

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When and why?

Russia is scheduled to make a $117M payment on some of its debt on Wednesday. However, the restrictions from sanctions might make it impossible for the country to meet its obligations. There is a 30-day grace period following a no payment, so Russia will probably not fall into default until next month, even if it misses Wednesday's payment.

Russia has relatively little foreign sovereign debt, totalling about $40B. Where the concern is with private debt, with Russian corporations owing $480B to foreign investors. Almost a third of that, or $135B is due over the coming 12 months.

What it could mean

Typically, when there is a sovereign default, it raises concerns about the creditworthiness of other countries in a similar situation. However, Russia would potentially be unable to meet credit obligations because of sanctions, which isn't a common problem among other emerging markets.

Hedge funds have snapped up a lot of Russian debt in prior years eager to cash in on higher interest rates. While bank assets are generally more transparent, it's harder to get an insight into private high-risk funds' portfolios. Banks and insurers have relatively low exposure, but hedge funds have much more.

How much?

Reportedly, Blackrock had $18B invested in Russian assets. But, that's relatively small compared to their $9.5T in funds under management. Another hedge fund that has substantial exposure to Russia is Pimco, at $1.5B compared to $2.2T in assets.

The exposure isn't enough to push these firms into insolvency. However, they will likely have to write down a substantial amount due to Russian debt being cut to junk. And that could mean there is less capital interested in higher-risk assets, which typically supports emerging markets stocks.

MSCI to remain under pressure

The iShares Emerging Markets index ETF saw a major breakdown in 2022, sliding below the 38.2% Fibonacci retracement level, which has been support in late 2021. The price slumped right below the 50% Fibonacci level before bouncing and the level acted as resistance.

The next potential downside target is the 61.8% Fibonacci level at around 4100, with the 4000 round number sitting just below.

Source: Spreadex trading platform

Key takeaways

Regardless of whether Russia falls into default or not, the iShares EM index is likely to remain under pressure while the war continues. Investors must keep an eye on whether Russia keeps its obligations though, as a miss of its Wednesday payments would be deemed bearish.

If sanctions against Russia ramp up, downside risks would transpire to the emerging markets as hedge funds are exposed to the Russian markets. Either way, investors will be more cautious around high-risk assets as we advance, which puts the longer-term upside into question, particularly while Russia is in the index.