What We Lose This Time: US sanctions on Russia’s sovereign debt come into force

Yelena Ivanova, Natalia Seibil

Sanctions against Russia's sovereign debt have been discussed in the US for four years as a response to interference in the 2016 US elections and cyber attacks by Russian hackers close to the Russian state. In 2019, a ban was issued on participation in the placement of Eurobonds for American investors. The Ministry of Finance insured itself and stopped issuing bonds denominated in dollars. Now, debt obligations issued by the Central Bank, the National Treasury Fund or the Ministry of Finance have fallen under the ban. American banks and financial institutions were prohibited from lending to Russian government agencies in any currency.

Both American and Russian financial experts assess these sanctions as a kind of demonstrative gesture, when the US Treasury could not but respond to the legislative branch, therefore, chose the softest option of all. In 2018, Treasury Secretary in the Trump administration Steven Mnuchin gave an opinion on the initiative of Congress to punish Russia and extend sanctions to its national debt. Even then it was said: undesirable, look for another option.

"These are the sanctions for the initial offering. Now we have about 20% of the state debt with non-residents, of course, this is already a secondary placement. Initial purchase is prohibited. Therefore, the direct impact of these sanctions has long been played out", - says economist Igor Nikolayev.

If the sanctions were tougher, this would affect not only the Russian financial market, no one wanted to allow this. Perhaps that is why the decision on the national debt was postponed for so long.

"A complete ban on working with the Russian national debt would mean additional turbulence in the financial markets as a whole, not only for Russia. This would cause serious enough losses for American investors, amounting to billions of dollars. Who will compensate? It quietly went away, says a leading expert at the Institute of Contemporary Development", - Nikita Maslennikov.

Nevertheless, American lawmakers broke through the sanctions, and President Biden had to sign them. For players on the government bond market, the measures taken will mean only one thing - if an investor cannot buy paper at an auction, any of their partner banks can do it for him. On the way from the state to the buyer, another transaction appears, and that's it. There are no more obstacles.

The sanctions are officially directed against foreign investors, but there are not so many non-residents on the Russian bond market - a little less than 20%. This is due to the growing geopolitical uncertainty since the end of last year and the change of power in Washington. In addition, the ruble weakened significantly over the past year. The classic of the genre is that after the announcement of such sanctions, the currency of the country against which these measures are directed, as a rule, weakens. This did not happen with the ruble. President Biden signed into law and the ruble began to appreciate. There are several reasons for this.

The Russian currency, in spite of the decoupling from oil prices, continues to be "raw", writes Kommersant. The price of oil continues to significantly affect the financial system and the behavior of the national currency.

The second factor that contributed to the growth is psychological - the sanctions were expected to be much tougher than those that were adopted.

In addition, the Russian Central Bank began to raise the key refinancing rate quite sharply, which leads to an increase in the yield of government bonds, especially short-term bonds issued for 2-3 years, the most interesting for investors. Nikita Maslennikov says:

"The following mechanism is immediately triggered here: this is, of course, a benchmark, but it affects the ruble exchange rate, imports become cheaper due to the strengthening. In May, the ruble appreciated by 1.8%, since the beginning of the year - by 1.4%. Imports are getting cheaper. Those who want to replace machines, equipment, technological lines and the like can buy the necessary components. It is beneficial for them. And for the investor too. There is an opportunity to play on exchange rate differences and rates, it is very profitable".

Regardless of what Putin and Biden agree on, and whether they agree at all, the Central Bank has begun a policy of raising the rate. According to analysts, it will continue to rise. The only question is whether it will be 6% or 6.5%. Against the backdrop of tightening credit and financial policy, it is likely that non-residents will begin to return to the OFZ market, albeit a secondary one. For them, the actions of the Central Bank play a more important role than sanctions. Financial organizations are pragmatic in their approach to the framework conditions: they are not allowed to enter the primary market, we will trade in the secondary market, the main thing is that the profitability is high.

For the Russian Ministry of Finance, each subsequent placement becomes more expensive than the previous one. When debt becomes more expensive, the Ministry of Finance should increase repayment payments. It is not profitable for him, so this year debt borrowings are reduced by 800 billion rubles. This is correct, experts say. You need to curtail your appetites without trying to borrow.

One might get the impression that sanctions play no role for Russia. However, this is a misconception, warns Igor Nikolayev:

"Now they have a very small direct impact, but this is a preliminary step towards those sanctions that, if adopted, will affect the entire public debt owned by non-residents in both the primary and secondary markets. Then it will be really serious and unpleasant".

Not all investors are ready to go for the “long ruble”. When assessing the risks, they also take into account that serious sanctions have just become closer. This does not increase the investment attractiveness of Russian securities, which is not very good anyway. The effect of the current measures will affect the medium term, it will simply be postponed.