As Russia nears a debt default, talk now turns to global contagion

Russia is on the brink of defaulting on its debt, according to ratings agencies and international bodies, but economists do not yet see a global contagion effect on the horizon.

International Monetary Fund Managing Director Kristalina Georgieva said Sunday that sanctions imposed by western governments on Russia in response to its invasion of Ukraine would trigger a sharp recession this year. She added that the IMF no longer sees Russian sovereign debt default as an “improbable event.”

Her warning followed that of World Bank Chief Economist Carmen Reinhart, who cautioned last week that Russia and ally Belarus were “mightily close” to defaulting on debt repayments.

Despite the high risk of default, however, the IMF’s Georgieva told CBS that a wider financial crisis in the event of a Russian default was unlikely for now, deeming global banks’ $120 billion exposure to Russia “not systematically relevant.”

However, some banks and investment houses could be disproportionately affected. U.S. fund manager Pimco started the year with $1.1 billion of exposure to credit default swaps — a type of debt derivative — on Russian debt, the Financial Times reported last week. A spokesperson for Pimco wasn’t immediately available for comment when contacted by CNBC.

The Russian state has a host of key payment dates coming up, the first of which is a $117 million payment of some U.S. dollar-denominated eurobond coupons on Wednesday.

Credit ratings agency Fitch last week downgraded Russian sovereign debt to a “C” rating, indicating that “a sovereign default is imminent.”

S&P Global Ratings also downgraded Russia’s foreign and local currency sovereign credit ratings to “CCC-” on the basis that the measures taken by Moscow to mitigate the unprecedented barrage of sanctions imposed by the U.S. and allies “will likely substantially increase the risk of default.”WATCH NOWVIDEO03:41Moody’s downgrades Russia’s credit rating in an ‘unprecedented’ way

“Russia’s military conflict with Ukraine has prompted a new round of G7 government sanctions, including ones targeting the foreign exchange reserves of The Central Bank of Russia (CBR); this has rendered a large part of these reserves inaccessible, undermining the CBR’s ability to act as a lender of last resort and impairing what had been – until recently – Russia’s standout credit strength: its net external liquidity position,” S&P said.

Moody’s also slashed Russia’s credit rating earlier this month to its second-lowest tier, citing the same central bank capital controls likely to hinder payments in foreign currencies, resulting in defaults.

Moscow moved to strengthen its financial position following a suite of western sanctions imposed in 2014, in response to its annexation of Crimea. The government ran consistent budget surpluses and sought to scale back both its debts and its reliance on the U.S. dollar.WATCH NOWVIDEO02:10Scholar discusses China’s position on U.S. and EU sanctions on Russia

The accumulation of substantial foreign exchange reserves was intended to mitigate against the depreciation of local assets, but reserves of dollars and euros have been effectively frozen by recent sanctions. Meanwhile, the Russian ruble has plunged to all-time lows.

“To mitigate the resulting high exchange rate and financial market volatility, and to preserve remaining foreign currency buffers, Russia’s authorities have – among other steps – introduced capital-control measures that we understand could constrain nonresident government bondholders from receiving interest and principal payments on time,” S&P added.

Grace periods

Russian Finance Minister Anton Siluanov said Monday that Russia will use its reserves of Chinese yuan to pay Wednesday’s coupon on a sovereign eurobond issue in foreign currency.

Alternatively, Siluanov suggested the payment could be made in rubles if the payment request is rebuffed by western banks, a move Moscow would view as fulfilling its foreign debt obligations.

Although any defaults on upcoming payments would be symbolic – since Russia has not defaulted since 1998 – Deutsche Bank economists noted that nonpayments will likely begin a 30-day grace period granted to issuers before defaults are officially triggered.WATCH NOWVIDEO05:53We could be heading for World War III if Russia joins forces with China, investor says

“Thirty days still gives time for there to be a negotiated end to the war and therefore this probably isn’t yet the moment where we see where the full stresses in the financial system might reside,” Jim Reid, Deutsche Bank’s global head of credit strategy, said in an email Monday.

“There has already been a huge mark to market loss anyway with news coming through or write downs. However, this is clearly an important story to watch.”

Russian assets pricing in defaults

Trading in Russian debt has largely shut down since the web of sanctions on central banks and financial institutions was imposed, with government restrictions and actions taken by investors and clearing exchanges freezing most positions.

Ashok Bhatia, deputy chief investment officer for fixed income at Neuberger Berman, said in a recent note that investors will be unable to access any liquidity in Russian assets for some time. Bhatia added that prices for Russian government securities are now pricing in a default scenario, which Neuberger Berman strategists think is a likely outcome.

“It’s unclear why Russia would want to use hard currency to repay these securities at the moment, and we expect much of this debt to enter ‘grace periods’ over the coming month,” he said.WATCH NOWVIDEO04:38Russia’s economy will limp on without much deeper dislocation, strategist says

“Russian hard currency sovereign securities are indicated at 10 – 30 cents on the dollar and will likely remain there.”

Bhatia suggested that the key macroeconomic risk arising from the conflict in Ukraine is energy prices, but the spillover pressure to global credit markets will be “relatively muted” with recent volatility across asset classes continuing.

“But given that Russian securities have been repriced to default levels, we believe those immediate impacts are largely over,” he said.

China’s ‘Silicon Valley’ manufacturing hub orders production halts to control a Covid spike

China’s ‘Silicon Valley’ manufacturing hub orders production halts to control a Covid spike

PUBLISHED MON, MAR 14 202212:31 AM EDT

BEIJING — Mainland China is facing its worst Covid-19 outbreak since the country clamped down on the pandemic in 2020, with major cities rushing to limit business activity.

Shenzhen, the biggest city in the manufacturing hub of Guangdong province, told all businesses not involved with essential public services to suspend production or have employees work from home for a week starting Monday. The production halts reportedly include Apple supplier Foxconn, which did not immediately respond to a CNBC request for comment.

The city, sometimes called China’s “Silicon Valley,” has shut public transportation and begun a third city-wide round of testing. Shenzhen has reported more than 400 confirmed cases since late February.

Those numbers and case counts across China pale in comparison with other countries. But the rapid increase in cases in the last few days has local authorities rushing to control the outbreak as China seeks to maintain its zero-Covid strategy.

Shanghai, the coastal metropolis home to many foreign businesses and financial firms in China, has reverted schools to online classes. Some neighborhoods have entered lockdown and conducted mass testing, and residents typically cannot leave until results come back negative.

The city on Saturday told residents not to leave Shanghai unless absolutely necessary. More than 600 confirmed cases have been found since late February.WATCH NOWVIDEO03:08Two years into the pandemic, will we need a fourth shot?

Jilin province in northern China reported an overnight surge this past weekend of over 1,000 new locally transmitted coronavirus cases, for a total of more than 2,900 cases this month as of Sunday.

In all, mainland China reported 1,437 new confirmed cases as of Sunday — with only 100 attributed to travelers from overseas — for a total of 8,531 domestically transmitted active cases. That’s the most since March 2020. No new deaths have been reported.

Hong Kong, a special administrative region just across the border from Shenzhen, has fought a resurgence of Covid cases in the last few weeks. The region has the highest number globally of new Covid-related deaths per million people, according to Our World in Data.

Hong Kong’s outbreak stems from the highly transmissible omicron variant, which has since spread to the mainland.

Beijing city on alert

The capital city of Beijing said Sunday it identified six sources of transmission for the latest handful of municipal cases, mostly reported around the downtown and eastern parts of the city. Local authorities said anyone returning to Beijing must not attend gatherings for seven days following arrival.

For months the capital has had one of the strictest Covid control policies in the country. Travelers must show a negative Covid test taken 48 hours before entering Beijing, and take another test within 72 hours of arrival. If their 14-day travel history shows they visited a locale with a confirmed case, they are not allowed into the city.

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After the emergence of Covid-19 in Wuhan in late 2019, mainland China shut down more than half the country in February 2020 to control the outbreak. Domestically, the virus came under control within weeks, but Covid had spread overseas in a global pandemic.

As of Monday, South Korea followed by Germany have the highest 28-day new case counts at 5.2 million and 4.8 million, respectively, according to Johns Hopkins data. The U.S. has recorded the most deaths, at more than 967,000 as of Monday morning Beijing time.

Zero-Covid isn’t going away

Mainland China has maintained a strict “zero-Covid” policy for the last two years. The travel restrictions and potential for swift lockdowns have weighed on domestic tourism and services businesses, dragging down consumer spending.

An annual parliamentary meeting that wrapped up Friday gave no signs that the central government plans to loosen its Covid control policy, although official statements in recent months have added terms such as “dynamic.”

Vice Premier Sun Chunlan said at a government meeting for epidemic control Saturday that the country should keep following the “dynamic” zero-Covid policy and that all measures should be taken to prevent a large-scale virus resurgence.

Her remarks, as published by state media, ended with a call to prepare the way for a top meeting of the ruling Chinese Communist Party later this year. Chinese President Xi Jinping is expected to receive an unprecedented third term at the meeting.

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Abandoning zero-Covid “now could be perceived as conceding that the strategy did not work in the first place,” Nomura’s chief China economist Ting Lu said in a note Friday.

“The next 12 months are a crucial time for the one-in-a-decade leadership change, which is pushing top leaders to stick to the status quo in order to avoid making policy mistakes,” he said. “Pictures of many Hong Kong Covid patients treated outside overwhelmed hospitals have further convinced Chinese officials and the masses that ZCS is China’s only viable solution to the coronavirus.”

China’s Center for Disease Control and Prevention published a study in November that said shifting to the coexistence strategy of other countries would likely result in hundreds of thousands of new daily cases and devastate the national medical system.

But, Lu said, the economic costs of the zero-Covid strategy are rising, while the benefits are diminishing.

“Amid rounds of lockdowns and travel bans across China,” he said, “more individuals are feeling the pinch, becoming worn out, unemployed or underemployed, and have drained their savings to a level at which they have to reduce spending.”

Investors will continue to monitor developments around the Russia-Ukraine war and Covid wave in China, both of which threaten to further disrupt global supply chains.

SINGAPORE — Shares in Asia-Pacific were mixed in Monday morning trade as investors monitor a Covid wave in China. Meanwhile, oil prices continued to be volatile amid the Russia-Ukraine war.

Hong Kong’s Hang Seng index dropped 2.77% in morning trade as shares of Chinese tech heavyweight Tencent fell 3.43%. Mainland Chinese stocks were also lower, with the Shanghai composite down 1.5% while the Shenzhen component shed 1.46%.

In Japan, the Nikkei 225 climbed 1.03% while the Topix index advanced 0.97%. The S&P/ASX 200 in Australia gained 1.07%.

South Korea’s Kospi lagged, dipping 0.54%.

MSCI’s broadest index of Asia-Pacific shares outside Japan traded 0.99% lower.

Investors continued watching developments on the Russia-Ukraine war, which is disrupting shipping and air freight. Elsewhere, markets also monitored a recent wave of Covid infections in China — including the major city of Shenzhen.

Oil prices fall 3%

Oil prices fell in the morning of Asia trading hours, with international benchmark Brent crude futures down 3.03% to $109.26 per barrel. U.S. crude futures shed 3.16% to $105.87 per barrel.

Oil prices during the Russia-Ukraine conflict have spiked to record levels but fell back in the past week on supply hopes, before rising again to close out the week. Over in Asia, China, India, Japan and South Korea are all major importers of oil, according to 2020 data from the International Energy Agency.

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The U.S. Federal Reserve is widely expected to announce a rate hike later this week, the first such move since 2018.

In Asia, the Bank of Japan is also set to announce its monetary policy decision later in the week.

Currencies

The U.S. dollar index, which tracks the greenback against a basket of its peers, was at 99.049 after its recent bounce from below 98.

The Japanese yen traded at 117.66 per dollar after last week’s weakening from below 116 against the greenback. The Australian dollar was at $0.7275 after slipping from above $0.732 late last week.