LUMP OF DEBT

Global debts have been breaking records over the past few years. Amid all sorts of crises, wars and, finally, pandemics, countries find solutions to economic problems in building up external borrowing. They borrow from each other, from foundations and international financial institutions by means of loans or issuing securities: the debt avalanche swells like a balloon that is about to burst. That’s when the world will face a series of bankruptcies of entire states.

However, the process has already begun. The world media and experts say that Russia is facing the first major default in its history in the last century. It looks more like a technical default, but it doesn’t change the essence of the situation. Sri Lanka has already declared debt bankruptcy.

The Russian debt crisis may urge other governments to reconsider their external borrowing policies and take a downsizing course. This has long been Azerbaijan's position, which started to minimise its debts long before the pandemic and the Ukraine crisis.

Sanctions default

The Russian Ministry of Finance failed to pay off its bonds in foreign currency for the first time on April 4. To meet its obligations to creditors, the ministry transferred funds ($649.2m in roubles) for coupon payments and Eurobond repayments to the National Settlement Depository.

Fitch Ratings downgraded Russia's long-term foreign currency issuer default rating from BBB to B. Moody's downgraded Russia's credit rating by six points at once, from Baa3 to B3. S&P Global Ratings downgraded Russia's foreign currency rating from pre-default C to SD (selective default). At the same time, the country's solvency in roubles is assessed as ‘vulnerable’ (CC). This means that analysts consider a default to be almost inevitable.

How bad is it for the country? Declaring default by the government lowers its credit rating, making it difficult or impossible for the country to attract new loans. As a consequence, the limited inflow of external capital hampers economic development. Russia has been through something similar once before in its recent history: on August 17, 1998 there was a technical default on Russia's obligations. It was not announced officially, but in fact it was a default on the country's domestic debt. The last default on Russia's foreign debt was back in 1917.

By the end of 2021, the foreign debt of Russia and its companies will reach $150bn, which is a problem for the country, with the Western sanctions having $350bn of its foreign reserves (about 60%) frozen.

Russia was already on the verge of default on March 16, when the country was due to make a coupon payment in dollars. Although many factors pointed to Russia defaulting on that date, it was able to make the currency payments thanks to an exemption from the US sanctions, which was effective until May 25.

But the US Treasury later decided to close this loophole and prohibited Russia from making dollar payments on state debt from the accounts of Russian institutions in the US banks.

"Is this a default or not? We are fulfilling our obligations, but the countries that have essentially defaulted on their obligations by freezing gold and foreign exchange reserves are making it difficult for us to fulfil our obligations. Therefore, we continue to fulfil our obligations from the point of view of the Russian Federation. The issue is writing off these funds from our currency accounts, which are not in our jurisdictions. Western countries have taken decision to suspend operations with these accounts," Russian Finance Minister Anton Siluanov commented on the situation.

However, not only Russian but also foreign experts explain the relaxed position of the Russian government on the issue by the fact that it will not change anything for the Russian economy now. Foreign debt markets are already closed for the country, while sanctions logically lead to a drastic drop in GDP, inflation, depreciation of the real exchange rate of the rouble, etc.

According to Bluebay Asset Management strategist Tim Ashe, there will no longer be a quick economic recovery in Russia because of the number of sanctions. No one will want to do business there. "Russia will be in default for perhaps a decade. This means no access to international capital markets, very high borrowing costs even from the Chinese, no investment, no growth, low living standards," the expert summarised.

Cycling debt

However, Russia is not the only country in debt crisis today.

The Sri Lankan government has also halted external debt payments to save resources to pay for food and fuel imports. It now intends to prepare a debt restructuring plan with the support of the International Monetary Fund. According to Bloomberg, Sri Lanka is due to make coupon payments of $36m in Eurobonds maturing in 2023 and pay an additional $42.2m on securities maturing in 2028 on April 18.

The Sri Lankan Ministry of Finance stated that the effects of COVID-19, as well as developments around Ukraine, have drained the budgetary resources of the country so much that it has become unable to continue servicing the country's foreign debt.

In other words, contrary to Russia’s default artificially triggered by sanctions, there are deep economic problems in Sri Lanka that make the debt repayment impossible. And this is not the first alarm bell related to exorbitant debt burdens of underdeveloped (and not only) states. Let us recall Greece, which in 2012 defaulted twice, in February and December, for a total of $177bn. The Greek authorities asked for help from the EU, and the EU leaders had to meet their demand halfway to avoid the whole zone being affected.

The situation with the constant deepening of the global debt hole has long been the subject of criticism from economists around the world. They believe the inflated global financial system, multi-level web of debt interdependence and other factors are very dangerous for all countries.

According to a study by the British management company Janus Henderson, the volume of public debt worldwide will increase by 9.5% in 2022, reaching a record high of $71.6 trillion. In 2021, global public debt rose by 7.8% to $65.4 trillion, with rising borrowing in all countries covered in the study.

Meanwhile, total debt service costs have fallen to $1.01 trillion, an actual rate of just 1.6%, CNBC reported. In 2022, the global cost of servicing public debt is expected to jump 14.5% to $1.16 trillion.

Interestingly enough, it is not the third world countries, but... Europe that is responsible for the increase in the global debt. Janus Henderson's analysts think that the UK will be hit harder than any other country due to rising interest rates at the Bank of England and a large amount of government debt with floating rates linked to inflation. At the same time, the UK's debt constitutes 144% of GDP.

European countries will also actively engage in placing government bonds because of the need to sharply increase public defence spending in light of developments in Ukraine.

It is not surprising, as almost the third of the world debt belongs to the strongest economy in the world, the US. It is understandable, as the US government debt is denominated in a currency issued under Washington’s direct control. If necessary, the Fed is always ready to turn on the printing press to buy the debt. No other country in the world can do this. Therefore, the US can continue to safely increase its already astronomical debt: the US federal government debt to creditors has already reached $30 trillion. In 2020, the ratio of public debt to GDP was already 127%.

Next on the list of leading debtors are Japan (with the highest public debt in the world reaching 234% of the country's GDP), China, Germany and Italy.

Thus the combined public debt of all the countries in the world is 105% of their total GDP. In short, the world is borrowing more than it is producing. It is clear that the situation is not normal, but the worst thing is that there is no light at the end of the tunnel because of global diseases, crises and wars.

Azerbaijan’s target: 10% of GDP

Amid this global chaos, Azerbaijan is one of the very rare countries where the size of the external public debt is not increasing, but decreasing. Azerbaijani President Ilham Aliyev stated at a meeting on the economic results of the first quarter that the country’s foreign state debt now makes only 12.5% of the country's GDP, while in April last year it was at the level of 18%. That is, during the passing year Azerbaijan has managed to reduce external debt by more than $600 million. But this is not the limit. The government has been instructed to reduce debt obligations to 10% of GDP.

"Previously, I’ve instructed the government to be very cautious when borrowing. At the same time, various state-run companies used to borrow without asking anyone. And when they could not repay the loans, the state had to pay them. There was a very non-transparent picture. It is over now. Now no government institution can borrow a single manat without getting permission from the government. Every loan is approved by the government. We should attract loans only for important projects with a high-tech component and for projects implemented on the liberated lands. There is no need to give loans for other projects. That is why we have reduced the external public debt both in absolute numbers and as a ratio to GDP," Mr. Aliyev said.

Ilham Aliyev stated earlier that since Azerbaijan's foreign debt is at a very low level - only $7.4 billion, the country can in fact nullify it overnight.

But today there is no need for that. Long-term favourable loans have always been considered the best option for financing large projects, and they are rather good for the economy.

For example, Azerbaijan’s Finance Minister Samir Sharifov announced that the EU was ready to provide €2 billion from two sources: the European Bank for Reconstruction and Development and the European Investment Bank. The World Bank and the Asian Bank are also ready to provide significant funding for this purpose. "The ball is in our court; we can choose projects for financing," Mr. Sharifov said.

However, Azerbaijan's current priorities are known - the reconstruction of the liberated territories, the creation of the necessary infrastructure and economic environment for the speedy return of IDPs to their homeland. But whatever the urgency of the projects, the government is instructed not to deviate from the goal of 10%. in other words, the terms of borrowing, amount of loans and their further servicing should not be a burden for the national economy. In this way, Azerbaijan will permanently preserve its image of financial stability and further increase its investment attractiveness.

MEMO. A government default occurs when it fails to meet obligations to domestic or foreign creditors on time. Sovereign debt restructuring has no standardised procedure - an individual repayment programme is drawn up for each individual country, most often extending over several years and not guaranteeing creditors full repayment from the borrower.

A technical default is the inability to settle obligations now with the possibility of meeting
them in the future. Thus, when the government fails to fulfil its obligations during the time-limited technical default, it is followed by a normal or simple default.