Russia Warns on Default Aftermath as Sweden Girds for Disruption

Russia joined China in warning that countries may intensify their search for alternative reserve currencies as the U.S. struggles to avert non-payment on Treasury bonds, with Sweden bracing itself for a default.

A U.S. failure to service its debt would threaten the low-risk status of Treasuries as collateral used around the world, Russian central bank Chairman Elvira Nabiullina said in an e-mailed response to questions from Bloomberg. Endangering the dollar’s standing “seems completely insane,” Swedish Finance Minister Anders Borg said today, adding that his country will ensure its financial system has access to U.S currency in the event markets are disrupted

“The more the situation is prolonged, the more far-reaching the consequences,” Nabiullina said. “Such events result not only in short-term jumps in volatility, but also an erosion of trust in the dollar as a reserve currency and the American financial system as a whole.”

The U.S. Congress has yet to strike an agreement to increase the nation’s debt ceiling a day before the government has said it will run short of funds to honor its obligations. In an English-language commentary published Oct. 13, Liu Chang, a writer with China’s official Xinhua News Agency, called for a new international reserve currency to replace the dollar “so that the international community could permanently stay away from the spillover of the intensifying domestic political turmoil” in the U.S.

‘Completely Insane’

“As it is an enormous advantage to be a reserve currency it seems completely insane to even contemplate creating insecurity around that status,” Borg said.

China is the biggest foreign holder of Treasuries, with $1.28 trillion at the end of July. Russia, which as accumulated the world’s fourth-largest international reserves, has reduced its holdings of U.S. government debt by 25 percent from a record high on Oct. 31, 2010, to $131.6 billion in July, according to data compiled by Bloomberg.

“We’ve never been in an equivalent situation before and it’s therefore very difficult to judge what impact it will have,” Borg said in an interview with state broadcaster SVT. “It’s essentially about fear and psychological factors.”

Rates on Treasury bills due tomorrow surged 12 basis points, or 0.12 percentage point, yesterday to 0.32 percent as investors fret over the risk of non-payment.

Diversifying Reserves

While Russia’s central bank isn’t currently reducing its investments in Treasuries, it will consider a wider range of securities for its reserve holdings, central bank First Deputy Chairman Ksenia Yudaeva told reporters today in Moscow. Bank Rossii, which has added Canadian and Australian dollars to its currency allocation, raised the U.S. dollar’s share to 45.8 percent as of Jan. 1 from 45.5 percent a year earlier, central bank data show.

In Sweden, the government has repeatedly urged banks to wean themselves off their reliance on short-term dollar funds and warned the industry it may need to help pay for central bank reserves dedicated to backstopping foreign currency risks.

“We have of course, together with the Swedish Financial Supervisory Authority and the Riksbank, worked through what counter measures are required if such an incident occurs,” Borg said. The stalemate in the U.S. “is significant and very serious but exactly how it will affect us is very hard to tell,” he said.

Dollar Funding

Sweden’s central bank said in December it was adding 100 billion kronor ($15.4 billion) to its foreign reserves to build a buffer against risks stemming from bank industry reliance on dollar funding. The nation’s four biggest lenders have assets that are more than four times its gross domestic product, prompting Sweden to impose more rigorous regulatory standards to protect taxpayers from bank industry losses.

In neighboring Denmark, the central bank said today it is ready to add dollar liquidity to the nation’s banks should the need arise.

“In the event that the U.S. debt ceiling, contrary to expectations, isn’t raised, the broader consequences are difficult to predict,” central bank spokesman Karsten Biltoft said in an e-mailed reply to questions. “Both for the financial markets and the global economy.” He said Denmark can draw on its “considerable currency reserves” to protect its financial system from shocks.

U.S. Treasury Secretary Jacob J. Lew told Congress last week that the extraordinary measures being used to avoid breaching the debt ceiling “will be exhausted no later than Oct. 17” and the department will have about $30 billion to pay obligations if Congress fails to reach an agreement to lift the cap.

‘Very Seriously’

“We’re taking this very seriously,” Swedish Prime Minister Fredrik Reinfeldt said. “It’s a serious situation that they can’t reach an agreement and we must track this very carefully and also raise our preparedness to be able to deal with this if it continues without a proper solution in place.”

Russia’s central bank considers it “highly unlikely” that the deadlock in the U.S. will reach a “critical” point, according to Yudaeva. Russian stocks and the ruble would come under pressure in the aftermath of a U.S. default, even as the country’s market has few direct links to the Treasuries market, Nabiullina said.

“During the past five years, outbursts of volatility for various reasons have become almost a regular event,” Nabiullina said. “During that time, Bank Rossii has developed a whole system of instruments to support liquidity and smooth out fluctuations, which we can deploy again this time. We are constantly monitoring the situation to be able to react to it if necessary.”

Fiscal Deal

House Speaker John Boehner will allow a vote on a Senate agreement to end the government shutdown and extend U.S. borrowing authority, said Representative Kevin Brady of Texas, a senior House Republican.

House leaders haven’t decided whether they will vote before the Senate, said a Republican aide who spoke on conditions of anonymity. For procedural reasons, if the House goes first, the bill could reach President Barack Obama’s desk more quickly.

Russia hopes U.S. policy makers will show “prudence” in overcoming the impasse, Nabiullina said.

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