WASHINGTON – Russia is heading for a major default on its foreign debt, a horrific milestone it hasn’t seen since the Bolshevik revolution more than a century ago, and it raises the possibility of years of legal strife and global hunting for bonds by Russians around the world.
The looming default is the result of sanctions that have depleted nearly half of Russia’s 40 640 billion foreign exchange reserves, forcing the country to repay bonds in the currency in which the debt was issued. Guarding for a default, Russia has already rejected it as an “artificial” consequence of sanctions imposed by the United States and its allies and has threatened to challenge such a result in court.
The impending war, which is likely to pit Russia against the world’s biggest investors, raises vague questions about who will decide whether the nation has actually defaulted in a rare case where sanctions have hampered a country’s ability to repay its debts.
Russia does not seem to take lightly the default declaration. If that happens, it will increase Russia’s borrowing costs for next year and effectively lock it out of the international capital market, weighing on an economy that is expected to shrink sharply earlier this year. It would also be a blot on the economic stewardship of President Vladimir V. Putin, which would underscore the costs that Russia is incurring as a result of its aggression in Ukraine.
At risk for Russia, which has already suffered the sudden severance of decades of important trade relations with the United States, Europe and other countries, is one of the foundations of economic growth: the ability to easily borrow money from outside its borders.
Since Russia’s plight is so unusual, it remains an open question as to who is the final arbiter of a sovereign debt default.
“This indicates the squishiness and patchwork nature of the sovereign debt market,” said Tim Samples, professor of legal studies and sovereign debt specialist at Terry College of Business University in Georgia. “I think it’s going to be complicated and controversial for a variety of reasons.”
Mr Samples suggested that there could be a “cascade” of events that would bring Russia into a default.
The most direct verdicts could come from major credit rating agencies, which have already indicated that Russia’s creditworthiness is declining and could be on a default horizon.
This past week, Moody’s warned that repaying Russia’s approximately $ 650 million-dollar approved loan in rubles on April 4 could be considered a default if it does not repay in dollars by May 4, the 30-day grace period ends. . This follows a similar warning from S&P Global earlier this week, which placed Russia under a “selected default” rating.
But it is not clear how rating agencies will weigh in if Russia fails to pay after the grace period expires, due to EU sanctions restricting Russian rating agencies from giving ratings. Moody’s and S&P spokesmen did not comment. A spokesman for Fitch said he could not comment on Russia’s indebtedness in light of the sanctions.
The Biden administration put additional pressure on Russia earlier this month when the Treasury Department began using dollars in American banks to prevent Russia from repaying loans. The new sanctions were intended to force Russia to choose between draining its remaining dollar reserves or using new revenues (for example, from natural gas payments) to pay off bonds and avoid defaulting on its debt.
Russia can still pay off Russian sovereign debt unless it tries to use funds from Russian government accounts in American financial institutions.
After the grace period for foreign currency bond payments ends on May 4, the next key moment will be May 25. At that time, American bondholders will no longer be able to accept payments on Russian debt, subject to temporary clearances granted by the Treasury Department.
Although the verdicts of the rating agencies carry significant weight, the bondholders will determine the consequences of Russia’s failure to pay the arrears or violate the terms of its agreement. Bondholders can wait and see or declare that the bonds are immediately outstanding and payable, which may default to other bonds, including the “cross default” provision.
Another potential arbiter of default is the Credit Derivatives Determination Committee, a panel of investors in the market for default insurance, or credit-default swaps. The committee is discussing whether Russia’s payment in rubles constitutes a “failure to pay”, which will start providing insurance. The panel has already ruled that the state-owned Russian Railways defaulted on non-payment of interest on JSC bonds.
To some analysts, that decision and the payment of the ruble means that Russia is already technically in default.
“If Russia does not pay on time, in the currency of the agreement, it is a default – it is crystal clear,” said Timothy Ash, a senior sovereign strategist at Asset Management in Blue. “For all intents and purposes, Russia is already the default.”
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He has been a defaulter in the court before. Argentina defaulted significantly after negotiations with a hedge fund in 2014 that refused to accept reduced payments, and a US federal judge ruled that the hedge fund could not make its regular payments on bonds without paying holdings. The U.S. Supreme Court has refused to hear Argentina’s appeal in the case.
Russia’s case is unique because of the sanctions, and it argues that its bond agreement limits its ability to pay in currency because it cannot access all of its reserves.
Mr Ash suggested that it would be difficult for Russia to find a court that was sympathetic to Russia’s position.
Referring to the US Treasury Department of Foreign Asset Control, which administers the sanctions, Mr Ash said “a US court will never rule against OFAC.”
But Mr Samples suggested that given Russia’s global parietal status, lenders could fight for Russian assets even if the court rules favorably.
He predicted that Russia would look for creative ways to avoid acknowledging a default, such as pointing to vulgar language in a bond agreement that could be interpreted to allow payments in other currencies, or seeking amicable court jurisdiction, possibly in Russia.
“I hope they stick to their own alternative information,” Mr Samples said.
Despite being symbolic of a default, the economic impact for Russia and the world could be relatively small.
Economists estimate that Russia’s total foreign public debt amounts to about $ 75 billion, compared to Russia’s annual energy sales of $ 200 billion. Investors are expecting a default by the end of February, and policymakers have suggested that a default does not pose a threat to financial stability.
Ultimately, the market will determine whether Russia deserves credit, and its activities in Ukraine and future sanctions will determine the fate of its economy.
“It feels like a decoration and a dressing up on a very ugly and deep situation,” said Anna Gelpern, a Georgetown law professor who specializes in sovereign debt. “As much as they get energy revenue from fire hoses, why should they borrow?”