(Bloomberg) — With all the focus on the risk of default by Russia, an even more spectacular collapse has gone largely unnoticed right next door: There’s a bond crisis brewing in Belarus, which has the world’s worst-performing government debt this year.
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Notes from the key Russian ally, which shares Ukraine’s northern border, have slumped to levels that suggest investors see little hope of getting repaid. Belarus dollar-denominated debt due in 2027 was quoted as low as 6.5 cents on the dollar on March 7, down from 88 cents just days before Russia’s invasion of Ukraine last month, data compiled by Bloomberg show. They were last quoted at 11.7 cents, an 87% decline from right before the war.
Belarus — whose leader maintained control in a disputed 2020 election — is a bond-market minnow, with $3.3 billion in foreign obligations and its next dollar payment due in June. And its economy, at around $60 billion as of 2020, was a sliver of Russia’s. But its size and economic dependence on Russia are at the heart of bondholders’ problems — with less reserves and oil exports, the impact of sanctions is only magnified, and default is seen as all but certain.
“Default is very likely, even inevitable,” said Stuart Culverhouse, who has spent 16 years covering sovereign debt restructurings at research firm Tellimer Ltd. “They have been dependent on Russia since the disputed election in August 2020, and that dependence has just increased since the war. It’s a client state of Moscow now.”
Investors started ditching Belarus bonds in mid-February as tension around Ukraine escalated. While President Alexander Lukashenko has denied Russia asked Belarus to join the conflict, Russian troops used it as a staging post for the invasion. Ukraine’s border guard also said some shelling has come from Belarus.
Some of the sanctions applied to Russia have also been extended to Belarus, a nation of about 9 million people that relied on Russia and Ukraine for more than half of its trade in 2019, according to World Bank data. Analysts predict a severe toll on the economy, which is expected to contract about 6% this year, according to the average of five forecasts compiled by Bloomberg this month.
Venla Sipila-Rosen, associate director of economics at S&P Global Market Intelligence, said the nation’s economy could contract by 10.5% this year due to the confluence of war, financial and sanction shocks.
“Belarus’s economy is so connected with the Russian economy,” she said, explaining that a default would only strengthen that dependence. “It would make it even clearer that they would not have any means of borrowing in any international markets, and make them even more eager to increase their financial linkages with Russia.”
Against that backdrop, Belarus dollar bonds have slumped 86% this year on average, the steepest decline across all global government debt, data compiled by Bloomberg show. By comparison, Russian bonds are down 75%, and Ukraine’s have fallen 54%.
Holders of Belarus obligations include some of the biggest investors in emerging markets, such as Franklin Resources Inc., Fidelity Investments parent FMR LLC and Capital Group, according to data compiled by Bloomberg, based on the investors’ most recent disclosures.
The data include holdings of passive funds, which have little choice in what they buy or sell, and don’t necessarily encompass investors that aren’t required to disclose debt transactions; holders tracked by Bloomberg own about 4% of total debt outstanding.
Belarus debt represents less than a fraction of 0.1% of Capital Group’s total assets under management, Tom Joyce, a spokesperson, said via email. In the portfolios that hold it, the positions aren’t material, he said. Fidelity and Franklin Resources didn’t reply to emailed requests for comment.
Belarus’s dependence on borrowing was evident at year-end, when its total debt load amounted to about 45% of its gross domestic product, while Russia’s was around 20%, according to Fitch Ratings data. Belarus’s foreign reserves were just $3.9 billion by the end of January, a “temporary buffer” that will likely be exhausted rapidly, Moody’s Investors Service analysts wrote in a statement. Russia’s totaled about $630 billion before the invasion.
Belarus “is economically far more vulnerable than Russia, even in a scenario where we see a resolution of the war,” said Jens Nystedt, a senior money manager at Emso Asset Management. For the smaller country, “upside is more limited, while the downside is probably even higher if it directly joins the war.”
After breaking away from the Soviet Union, Belarus stayed aligned with Russia, unlike some of its neighbors. Lukashenko has led the country since its first presidential election as an independent republic, in 1994. He maintained control in 2020 despite protests after key challengers were detained or kept off the ballot.
This month, Lukashenko took a page from Russian President Vladimir Putin’s playbook by signing a decree to let the government repay foreign-currency debt in the local currency, also called the ruble. That step requires the consent of the Council of Ministers and can be applied when “unfriendly” countries impose restrictions on Belarus, the finance ministry said.
Failure to pay the bonds — or payment in a different currency — would put Belarus in default, said Timothy Ash, a sovereign debt analyst at BlueBay Asset Management.
Smaller countries in the developing world typically turn to the International Monetary Fund when they default, seeking loans often with the condition that they’ll enact economic policies aimed at improving their outlook. That path seems unlikely for Belarus given the U.S. stance on the war. The U.S. has the largest share of voting power in the IMF’s board of directors, which has to approve the lender’s programs before disbursement of funds.
The extra yield investors demand to hold Belarus sovereign bonds over U.S. Treasuries has skyrocketed to almost 12,000 basis points, according to JPMorgan Chase & Co. data, far above the level of 1,000 basis points for debt to be considered in distress.
S&P Global Ratings says the nation could default within a year if things don’t improve soon. A default is also “increasingly likely” in the view of Moody’s.
(Updates pricing, adds economists’ comments in seventh paragraph.)