Paris Club creditors adamant to Russia's requests for debt discount

Russia is requesting for a 0.5 percent discount, but the request is likely to be denied

Looks like Russia will have to give up on its plans to receive a 10 percent discount on early redemption of its debt to the Paris Club creditors. Even a meager 0.5 percent discount is out of the question, according to German financial authorities. Germany is Russia's biggest creditor. Moreover, Germany will reportedly demand a 500 million euro ($648 million) premium on early redemption of 5 billion euros owed by Russia. Experts believe that Russia may lose much more in case it disagrees to those terms since the debt value is steadily rising after the change of investment rating. A possibility for Russia to pay back 20 percent more on top of its debt value can not be ruled out.

On Monday this week Welt am Sonntag, a German newspaper, quoted an internal Finance Ministry document as saying that Germany should demand between 105 percent and 110 percent of the nominal value of the outstanding debt. “Existing practices do not particularly welcome an early debt repayment,” an anonymous German expert was quoted as saying while explaining those apparently steep demands to the newspaper.

The document could deliver a heavy blow to Russia with regard to its plans to pay the debt as soon as possible. During his state visit to Hamburg in December last year, President Vladimir Putin said that Russian intended to repay its debt to the Paris Club (Germany is a member state) within the next three years.

Germany is Russia's biggest creditor among the Paris Club of creditor nations. Russia owes more than $20 billion to Germany. Until recently Russian negotiators has expressed hope that Germany along with Italy and France would favor Russia's early debt redemption. The above countries needed the money to deal with their high budget deficits. Forecast indicate that year-end budget deficit rate may reach 2.9 percent of GDP in Germany.

Now the plans of Russia seem to have fallen through. According to Welt am Sonntag, today Russia is requesting for a 0.5 percent discount, but the request is likely to be denied. Experts point to two factors involved in the situation. First off, on March 21st  the nations of the euro zone agreed to amend the Stability Pact which stipulates macroeconomic obligations of the EU members. Now the EU members will have the right to exceed the limit of a budget deficit  provided that additional expenditure relating to important structural reforms affects the budget. The budget deficit limit previously stood at 3% of GDP. In other words, Germany and other countries do not need the money badly at the moment to fill the deficit gap.

Secondly, Standard & Poor's changed Russia's rating to a third “investment grade” earlier this year. The move resulted in a higher credit rating of Russia. The value of its debt rose subsequently. “Russia has actually run into a credit trap due to the latest developments. The higher its credit standing, the higher costs Russia has to pay for its current debt servicing,” says Dmitry Dudkin, an analyst with Uralsib.

Experts also speculate about the effect of the so-called prepayment risks. Any creditor will face those risks during an early debt repayment. “Once the Germans get back the funds owed by Russia, they should immediately place on the market and the placement terms should be the same or even better” says Mr. Dudkin. However, it will be a tough job to do. In the past the borrowing terms for Russia were extremely unfavorable. And the credit interest rates have fallen dramatically in the market over the last few years. “Germany will simply fail to find the securities with the same yield on the market,” says Mr. Dudkin. Therefore, it is small wonder that the Germans are trying to minimize the prepayment risks by demanding a premium on the early redemption of Russian debt.

Svetlana Borozdina