Russia’s likely debt default runs the risk of contaminating other emerging markets and financial institutions in ways that are hard to predict, with the example of hedge fund Long-Term Capital Management LP two decades ago serving as an example, the World Bank’s chief economist warned.
Even though Russia only accounts for 3% of global gross domestic product, it’s hard to know who has investment and exposure, Carmen Reinhart said in interview on Tuesday. While data from the Bank for International Settlements show bank exposure, they don’t show the vulnerability of non-bank institutions, Reinhart said.
To demonstrate the potential for unforeseen risks, Reinhart cited the example of LTCM, which needed to be bailed out by a group of banks in 1998, in part due to losses from Russia’s financial crisis that year. She also mentioned Pacific Investment Management Co. filings compiled by Bloomberg last week that showed Pimco built up billions of dollars of exposure to Russian debt, opening up its funds to losses.
“Remember LTCM? That wasn’t necessarily on anyone’s radar screen at the outset of the Russian default in August 1998,” Reinhart said. “Those things start to surface. Exposures are opaque.”
Russia would be in default if it doesn’t pay in US currency the coupon payments that are due on Wednesday on its dollar debt within a 30-day grace period, according to credit assessor Fitch Ratings.
Reinhart, a professor on leave from Harvard University and an expert in the history of debt and financial crises, said that in looking over a century of data on sovereign credit assessments from Moody’s Investors Service and Fitch Ratings, she hasn’t found any example of a nation being downgraded as suddenly or dramatically as Russia.
Russia’s invasion of Ukraine came at a moment when most emerging and low-income economies still have per-capita incomes below pre-pandemic levels, and the risks from higher inflation and food and energy price increases include civil unrest, Reinhart warned. The economies of northern Africa and the Middle East that are big importers from the two nations could be particularly affected, she said.
There’s also a danger that governments acting to subsidize food and gasoline for their populations will worsen already weak fiscal and debt situations, she said. And China’s lockdown of tech hub Shenzhen also will be another fresh shock for the global economy, she said.
For the global economy, “the risks are really well stacked on the downside,” she said.