Russia is about to default on its foreign debt for the first time since the Bolshevik revolution more than a century ago, further alienating the country from the global financial system following sanctions imposed over its war in Ukraine.
A 30-day grace period on interest payments originally due on May 27 expired on Sunday. But it might take time to confirm a default value.
“It appears that the banks have complied with international sanctions and withheld payment,” said Chris Weafer, a veteran Russian economics analyst at consultancy Macro-Advisory.
Last month, the US Treasury Department terminated Russia’s ability to pay its billions of debt to international investors through US banks. In response, Russia’s Finance Ministry said it would pay dollar-denominated debts in rubles and offer “the opportunity for subsequent conversion to the original currency.”
Russia says it has the money to pay its debts, but Western sanctions have created “artificial obstacles” by freezing its foreign exchange reserves.
Kremlin spokesman Dmitry Peskov told reporters in a conference call on Monday that “there is no reason to call this situation a breach,” saying Russia paid but could not be prosecuted due to sanctions.
The other party argues that “this happened because of the sanctions, but the sanctions were totally under their control,” said Jay S. Auslander, a leading sovereign debt attorney at Wilk Auslander’s firm in New York. “This was all under his control. , because all you had to do was not invade Ukraine.”
Here are key things to know about a Russian default:
HOW MUCH DOES RUSSIA OWE?
About $40 billion in foreign bonds, about half of that for foreigners. Before the start of the war, Russia had about $640 billion in foreign exchange and gold reserves, much of which was held abroad and is now frozen.
Russia has not defaulted on its international debts since the Bolshevik Revolution, when the Russian Empire collapsed and the Soviet Union was created. Russia defaulted on its internal debts in the late 1990s, but was able to recover from that default with the help of international aid.
Russia has effectively been in default for months in the eyes of bond investors, said Liam Peach, an economist specializing in European emerging markets at Capital Economics.
Insurance contracts covering Russian debt have priced an 80% probability of default for weeks, and ratings agencies such as Standard & Poor’s and Moody’s have placed the country’s debt in junk territory.
HOW TO KNOW IF A COUNTRY IS IN DEFECT?
Rating agencies can downgrade to default or a court can decide the issue but they have stopped rating Russia. Bondholders holding credit default swaps (contracts that act as insurance policies against default) can ask a committee of financial firm representatives to decide whether nonpayment of debt should trigger a payment, which would still it is not a formal declaration of default.
The Credit Derivatives Determinations Committees, an industry group for banks and mutual funds, would likely signal a “credit event,” Peach said.
The panel ruled on June 7 that Russia had not paid the required additional interest after making a payment on a bond after the April 4 maturity date. But the committee postponed further action due to uncertainty about how the sanctions could affect any deal.
The formal way to declare default is if 25% or more of bondholders say they didn’t get their money. Once that happens, the provisions say all of Russia’s other foreign bonds are also in default, and bondholders could seek a court judgment to enforce payment.
Under normal circumstances, investors and the defaulting government typically negotiate a deal in which bondholders receive new bonds that are worth less but give them at least partial compensation.
But the sanctions prevent dealings with the Russian Finance Ministry. And no one knows when the war will end or how much the defaulted bonds might end up being worth.
In this case, declaring default and suing “might not be the smartest option,” Auslander said. It is not possible to negotiate with Russia and there are so many unknowns that creditors may decide to “wait for now”.
Investors who wanted to get out of Russian debt have probably already headed for the exits, leaving those who bought bonds at cut prices hoping to benefit from a long-term deal. And they may want to keep a low profile for a while to avoid being associated with the war.
Once a country defaults, it can be suspended from borrowing in the bond market until the default is resolved and investors regain confidence in the government’s ability and willingness to pay. But Russia has already been cut off from Western capital markets, so any return to lending is a long way off anyway.
The Kremlin can still borrow rubles at home, where it relies mainly on Russian banks to buy its bonds.
WHAT WOULD BE THE IMPACT OF RUSSIA’S NON-COMPLIANCE?
Western sanctions over the war have caused foreign companies to flee Russia and severed the country’s commercial and financial ties with the rest of the world. The default would be one more symptom of that isolation and disruption.
Weafer says a default wouldn’t affect the Russian economy at the moment because the country hasn’t taken international loans in years amid sanctions and is making a lot of money exporting commodities like oil and natural gas.
But in the longer term, when the war has been resolved and Russia tries to rebuild its economy, “this is where the legacy of non-compliance will be an issue. It’s a bit like if an individual or a business gets a bad credit score, it takes years to get over it,” she said.
Investment analysts cautiously estimate that a Russian default would not have the kind of impact on global financial markets and institutions that a previous default had in 1998. Back then, Russia’s default on domestic ruble bonds led to the US government to step in and get banks to bail out Long-Term Capital Management, a large US hedge fund whose collapse, it was feared, could have shaken the broader financial and banking system.
Bondholders, for example funds that invest in emerging market bonds, could suffer serious losses. Russia, however, played only a small role in emerging market bond indices, limiting losses to fund investors.
“The spillover effects on the rest of the world should be limited,” Peach said.
But a Russian default could have a domino effect by increasing pressure on global debt markets and making investors more risk averse and less willing to advance money, which “could very well lead to more defaults in other markets.” emerging,” Weafer said.
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