Russia defaults on foreign debt for the first time in more than a century after sanctions forced it to miss Sunday deadline
- Moscow missed deadline to pay $100m (£81.4m) in interest on two Eurobonds
- Kremlin has been unable to send money to bondholders because of sanctions
- Russia’s efforts to avoid major default hit insurmountable roadblock in May when the US effectively blocked Moscow from making payments
Russia has defaulted on its foreign debt for the first time since the Bolshevik coup more than a century ago after crippling sanctions forced the country to miss a key payment deadline on Sunday.
Moscow missed the deadline to pay $100 million (£81.4m) in interest on two Eurobonds, one denominated in U.S. dollars and another euros, which had originally been due on May 27. The payments had a grace period of 30 days, which expired on Sunday.
Some Taiwanese holders of the Russian Eurobonds had not not received the interest payments on Monday, sources told Reuters.
The Kremlin has repeatedly said there are no grounds for Russia to default but it is unable to send money to bondholders because of sanctions, accusing the West of trying to drive it into an artificial default.
The country has struggled to keep up payments on $40 billion (£32billion) of outstanding bonds since its invasion of Ukraine on February 24, as sweeping sanctions have effectively cut the country off from the global financial system and rendered its assets untouchable to many investors.
Moscow missed the deadline to pay $100 million (£81.4m) in interest on two Eurobonds, one denominated in U.S. dollars and another euros, which had originally been due on May 27. The payments had a grace period of 30 days, which expired on Sunday. Pictured: Russia’s Eurobonds have traded at low levels since the start of March
While a formal default would be largely symbolic given Russia cannot borrow internationally at the moment and doesn’t need to thanks to plentiful oil and gas export revenues, the stigma would probably raise its borrowing costs in future
What happens when a country defaults?
When a government is unable to meet its sovereign debt repayments – by being unable or unwilling to make good on its fiscal promises or repay its bondholders – then it is said to be in ‘default’.
Russia is among countries to have defaulted in the past, doing so in 1998. Argentina and Lebanon are among the others to have done so.
What follows is usually a complete market and international collapse of confidence in the country’s economy.
The market – aware of the issues being faced by the country – sell off its currency, causing its value to plummet, as was the case with the rouble in 1998.
As when an individual cannot repay their debts, a country defaulting also makes it more difficult and expensive to borrow funds.
But the most damaging impact can be on the country’s people. When a country’s borrowers face dramatically higher payments on things such as mortgages, then they have far less disposable income.
Even without the government defaulting, this is already the case in Russia. With the value of the rouble plummeting in recent weeks, the average Russian is already seeing prices of goods skyrocket.
A debt default can also have a knock-on effect on other economies – particularly those which own much of the country’s debt.
This can prompt other countries to help bail out a defaulting country, as the United States did for Mexico in the mid-1990s, or as the EU did for Greece during the 2008 global crash.
Russia’s efforts to avoid what would be its first major default on international bonds since the Bolshevik revolution more than a century ago hit a insurmountable roadblock in late May when the U.S. Treasury Department’s Office of Foreign Assets Control (OFAC) effectively blocked Moscow from making payments.
‘Since March we thought that a Russian default is probably inevitable, and the question was just when,’ Dennis Hranitzky, head of sovereign litigation at law firm Quinn Emanuel, told Reuters. ‘OFAC has intervened to answer that question for us, and the default is now upon us.’
While a formal default would be largely symbolic given Russia cannot borrow internationally at the moment and doesn’t need to thanks to plentiful oil and gas export revenues, the stigma would probably raise its borrowing costs in future.
The payments in question are $100 million in interest on two bonds, one denominated in U.S. dollars and another in euros, Russia was due to pay on May 27. The payments had a grace period of 30 days, which expired on Sunday.
Russia’s finance ministry said it made the payments to its onshore National Settlement Depository (NSD) in euros and dollars, adding it has fulfilled obligations.
Some Taiwanese holders of the bonds had not received payments on Monday, sources told Reuters.
For many bondholders, not receiving the money owed in time into their accounts constitutes a default.
With no exact deadline specified in the prospectus, lawyers say Russia might have until the end of the following business day to pay the bondholders.
‘While there is a possibility that some magic could occur’ and Russia gets the money through financial institutions to bondholders despite sanctions, ‘nobody’s making that bet,’ said Jay S. Auslander, a top sovereign debt lawyer at the firm of Wilk Auslander in New York.
‘The overwhelming probability is they won’t be able to because no bank is going to move the money.’
Russia calls any default artificial because it has the money to pay its debts but sanctions have frozen its foreign currency reserves held abroad.
‘There is money and there is also the readiness to pay,’ Russian Finance Minister Anton Siluanov said last month. ‘This situation, artificially created by an unfriendly country, will not have any effect on Russians’ quality of life.’
Tim Ash, senior emerging market sovereign analyst at BlueBay Asset Management, tweeted that the default ‘is clearly not’ beyond Russia’s control and that sanctions are preventing it from paying its debts because it invaded Ukraine.
Russia owes about $40 billion (£32billion) in foreign bonds. Before the start of the war, Russia had around $640 billion (£519billion) in foreign currency and gold reserves, much of which was held overseas and is now frozen.
Russia has not defaulted on its international debts since the Bolshevik Revolution more than a century ago, when the Russian Empire collapsed and the Soviet Union was created.
Russia defaulted on its domestic debts in the late 1990s but was able to recover from that default with the help of international aid.
An employee looks at a stock price index graph showing plunging stock prices on an electronic information screen at the headquarters of the Micex-RTS Moscow Exchange (file)
Investors have expected Russia to default for months. Insurance contracts that cover Russian debt have priced a 80 per cent likelihood of default for weeks, and rating agencies like Standard & Poor’s and Moody’s have placed the country’s debt deep into junk territory.
Once a country defaults, it can be cut off from bond-market borrowing until the default is sorted out 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 borrowing is a long way off anyway.
The Kremlin can still borrow rubles at home, where it mostly relies on Russian banks to buy its bonds.
Western sanctions over the war have sent foreign companies fleeing from Russia and interrupted the country’s trade and financial ties with the rest of the world. Default would be one more symptom of that isolation and disruption.
Investment analysts are cautiously reckoning that a Russia default would not have the kind of impact on global financial markets and institutions that came from an earlier default in 1998.
Back then, Russia’s default on domestic ruble bonds led the U.S. government to step in and get banks to bail out Long-Term Capital Management, a large U.S. hedge fund whose collapse, it was feared, could have shaken the wider financial and banking system.
Holders of the bonds – for instance, funds that invest in emerging market bonds – could take serious losses. Russia, however, played only a small role in emerging market bond indexes, limiting the losses to fund investors.
While the war itself is having devastating consequences in terms of human suffering and higher food and energy prices worldwide, default on government bonds would be ‘definitely not systemically relevant,’ International Monetary Fund Managing Director Kristalina Georgieva has said.
The Bolsheviks to Putin: a history of Russian defaults
In 1918, Soviet revolutionary Leon Trotsky told Western creditors aghast at the Bolsheviks’ repudiation of Russia’s external debt: ‘Gentlemen, you were warned.’
He reminded them that dismissal of Tsarist-era debt had been a key manifesto of the failed uprising in 1905. More than a century later, Russia stands on the brink of another default but this time there was no warning.
Few expected the Kremlin’s invasion of Ukraine to elicit such a ferocious response from the West, which has all but severed Russia from global financial and payment systems.
These are Russia’s major debt events over the past century:
Just before the 1917 revolution, Russia was the world’s largest net international debtor, having borrowed heavily to finance industrialisation and railways.
But seeing the Tsarist industrialisation drive as failing the working class, the Bolsheviks repudiated all foreign debt.
‘They said ‘we are not paying and even if we could, we wouldn’t pay.’ And that was a political statement,’ said Hassan Malik, senior sovereign analyst at Loomis Sayles and the author of the book ‘Bankers and Bolsheviks: International Finance and the Russian Revolution’.
Despite Trotsky’s reminder, the default shocked the world, especially France, whose banks and citizens suffered massive losses.
‘Investors didn’t take it seriously because they thought it would be so self-harmful,’ Malik said, estimating the debt to be worth at least $500 billion at 2020 prices and possibly more.
It took until the mid-1980s for Moscow to recognise some of that debt.
1991: USSR TO RUSSIA
Following the break-up of the USSR in 1991, Russia stopped servicing part of the overseas debt it inherited from former Soviet states.
Andrey Vavilov, Russia’s deputy finance minister between 1994 and 1997, said the Russian Federation held around $105 billion in Soviet-era debt at the end of 1992, with its own debt amounting to $2.8 billion.
For accepting the inherited debt, the Paris Club recognised Russia as a creditor nation, Vavilov wrote in his book ‘The Russian Public Debt and Financial Meltdowns’. And as Russia agreed with the group of nations to restructure $28 billion in debt in 1996, it was allowed to shift major Soviet-era debt payments to the next decade.
But with a financial crisis around the corner, it would take until 2017 to clear the Communist-era arrears.
1998: ROUBLE DEBT DEFAULT
By 1997, crashing oil prices slashed Russian export revenues. External debt, which stood near 50% of GDP in 1995, had swelled by 1998 to 77%, according to Vavilov, who blamed hefty IMF/World Bank loans for contributing to the pile.
Russia raised very little tax revenue and relied on short-term Treasury bills known as GKO to cover expenditure. But it found it harder and harder to roll these over and was soon spending ever-increasing amounts to defend the rouble.
‘The more the government insisted that it would stand by the currency and repay its debts, the more investors concluded it was time to sell,’ said Chris Miller in his book ‘Putinomics: Power and Money in Resurgent Russia’.
A month before the default, the IMF put together a $22.6 billion aid package, but ‘the market was expecting the announcement of an additional $20 billion,’ Martin Gilman, the IMF representative in Moscow at the time, wrote in his book ‘No Precedent, No Plan: Inside Russia’s 1998 Default’.
On Aug. 17, 1998, Russia threw in the towel, devaluing the rouble, announcing it could no longer pay rouble debt and introducing a three-month moratorium on some external debt.
Russian banks that had invested heavily in T-bills and had extensive foreign currency exposure soon went under.
2022: A FORCED DEFAULT
Through dire financial straits in 1998, Moscow made sure to continue Eurobond payments. Now it has plenty of cash but may not dodge default.
To sidestep sanctions, the Kremlin is suggesting foreign creditors open Russian bank accounts to receive payments in alternative currencies to the dollar.
Non-U.S. investors can in theory agree, but U.S. bondholders cannot, after a U.S. Treasury licence allowing them to accept Russian payments expired in May.
Miller, author of ‘Putinomics’, said Russia would fight tooth and nail to dodge a Eurobond default.
‘The officials on the central bank and the finance ministry have built their careers on restabilising Russia as a creditor that can be trusted in international markets,’ he said.
‘It’s built into their identity to make sure a default doesn’t happen again.’