The ABCs of Russia’s Debt Downgrade
A country would not call a “B” a good grade. The grade is a credit rating that relates to a loan. Called investment grade, AAA or even BBB- usually mean not to worry. On the other hand, lower grades say you might not get paid back.
Russia’s debt just plunged from investment grade to junk.
Russian Debt Downgrade
Russian debt has been downgraded to junk by the three major ratings agencies–S&P Global, Fitch, and Moody’s. Sinking as much as six notches, it plunged to a substandard CCC- for local currency and dollar debt. You can see below that the new rating is just above a probable default:
One reason for the grade plunge is the financial sanctions that will prevent Russia from paying interest. The response? The price of Russian dollar-denominated bonds has sunk massively. Last week, its $7 billion bond maturing in 2047 halved in price to 33 cents on the dollar. That means its interest rate–the return to investors–is way up.
When a loan is speculative grade, then its price–its interest rate–goes up. Why? Typically, remaining constant, an interest payment is determined when a bond is issued. As a result (oversimplifying), when the price of the bond goes down because of less demand, the return–the interest rate–goes up. For some investors, the higher return makes the risk acceptable.
However, even if you wanted to hold Russian debt, the cost of protecting against default has soared You can see below that it is close to 50 percent:
Our Bottom Line: Credit Rating Primer
A credit rating grade sends a message. It tells investors what to expect when they buy a bond. Because a bond is a loan to a country, buyers want to know the likelihood of being paid back in full and on time. The credit rating is the standardized signal that tells them what to expect. It is an opinion about the risk of loaning a country some money.
Through their credit worthiness ratings, the major agencies help governments (and states, cities, towns, government agencies, corporations, and other entities) raise money by telling investors what they need to know. Essentially, bonds fall into an investment grade or speculative bucket. Certain financial institutions and municipalities would be limited to investment grade purchases.
Below, you could think of Russia as an issuer while the investor might be a bank. The intermediaries, like investment banks, connect issuers to investors:
We can assume that the higher return from Russia’s debt downgrade will not create comfort for investors like the French, Italian, and Austrian banks that hold its debt.
Originally published at https://econlife.com on March 7, 2022.