The Turkish lira has fallen by 18% this year. Photo: iStock
The Turkish lira has plunged in value. Photo: iStock

Geopolitical instability, sanctions, supply-chain bottlenecks, inflation, and quantitative tapering, together with a restrictive monetary policy, are creating a perfect storm that could trigger corporate bankruptcies and sovereign defaults.

An increase in Eurozone government bond yields reflects investors’ fears about the future of the bloc’s economy. Considering the level of indebtedness of Greece, Italy and some other southern European countries, there is a high risk that the European debt crisis will be repeated once again. At the current interest rate, without the European Central Bank (ECB) printing press, it will be impossible to service this debt for a long time.

https://www.oecd-ilibrary.org/economics/oecd-economic-outlook/volume-2022/issue-1_62d0ca31-en

The situation in emerging markets is no better. According to the World Bank, over the next 12 months, as many as a dozen developing economies could prove unable to pay back their debt. Despite the fact that it would not constitute a systemic global debt crisis, it would still be significant – the largest spate of debt crises in developing economies in a generation.

Two countries inching toward a debt default are Turkey and Russia. In the first case, the dollar-lira exchange rate recently surpassed 17. The country’s regulator has almost no resources left to stabilize the national currency because of the depletion of reserves. In the meantime, the cost of ensuring exposure to Turkey’s sovereign debt continues to grow while Turkey’s dollar-denominated bond prices fall.

In the second case, after the US barred Russia from using frozen central bank reserves held in US banks, it has become much more difficult to pay bondholders. Nor does the fact that the US Treasury blocked US correspondent banks from managing dollar payments from Russia add to the optimism of the situation. Does this mean that a default is imminent?

Considering the fact that Russia has already missed a US$1.9 million payment in accrued interest on a dollar bond, the probability is very high. A Credit Derivatives Determinations Committee (CDDC) overseeing Europe, whose members are banks and asset managers, voted “yes” to a question on whether a “failure to pay credit event” had occurred with respect to Russia.

The good news is that the non-payment of $1.9 million is not enough to cause a cross-default on other instruments. The minimum threshold for such an event would be at least $75 million. The bad news is that despite the fact that the country has to pay less than $2 billion on its external debt until the end of the year, default is still “highly likely” unless the country finds a legal way to make these payments.

Igor Kuchma is a financial adviser who is passionate about economy and the capital markets in general. He has experience working with Russian, Spanish and American financial institutions. He helped to compile a course for the Series 7 exam, while some companies he has prepared investment portfolios and macro and microeconomic models in Excel, and has studied trends and historical data.