FILE – Treasury Secretary Janet Yellen meets with Irish Finance Minister Pascal Donohoe at the Treasury Department Thursday, June 2, 2022 in Washington.
Highlight
- Russia has defaulted on its foreign debt for the first time since the Bolshevik Revolution.
- Moscow owes $100 million in interest on one bond denominated in dollars and one bond denominated in euros.
- Rating agency company Moody’s on Monday declared the country as default.
Russia has defaulted on its foreign debt for the first time since the Bolshevik Revolution more than a century ago, after sanctions imposed on its war in Ukraine isolated the country from the global financial system. Moscow is owed $100 million in interest on one bond denominated in dollars and one bond denominated in euros, originally due on May 27. The 30-day grace period ended on Sunday. Rating agency company Moody’s on Monday declared the country as default.
Last month, the US Treasury Department ended Russia’s ability to pay off billions of its debt to international investors through US banks. In response, the Russian Ministry of Finance said it would pay the dollar-denominated loan in rubles and provide “an opportunity for subsequent conversion to the base currency”. Before Moody’s announcement, it was largely believed that Russia was in default.
“For all practical purposes, Russia is in default,” said JS Auslander, a sovereign debt attorney at Wilk Auslander’s firm in New York. “The 30-day grace period is over. Bondholders don’t have their money.” Russia says it has money to pay off its debt but Western sanctions have created “artificial barriers” by freezing its foreign exchange reserves held abroad.
Kremlin spokesman Dmitry Peskov told reporters on Monday that “there is no basis for calling this situation a default,” adding that Russia has paid but cannot be processed because of sanctions.
The other side argues that “it happened because of the sanctions, but the sanctions were completely under your control,” Auslander said. “It was all under your control, because you didn’t just have to invade Ukraine.”
Here are important things to know about the Russian default:
How much does Russia owe?
Of about $40 billion in foreign currency bonds, about half were sold to foreign buyers. 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.
Since the Bolshevik Revolution, when the Russian Empire collapsed and the Soviet Union was created, Russia has not defaulted on its international debts. Russia defaulted on its domestic debt in the late 1990s, but was able to recover from that default with the help of international aid.
In the eyes of bond investors, Russia has effectively been in default for months, said Liam Peach, an economist specializing in emerging European markets at Capital Economics.
Insurance contracts covering Russian debt have an 80% chance of default for weeks, and rating agencies such as Standard & Poor’s and Moody’s have pushed the country’s debt into junk territory.
How do you know if a country is in default?
Rating agencies are usually the entities that will declare a default in Western financial markets, which happened on Monday. A court can also decide on this issue. Bondholders who have credit default swaps — contracts that act like insurance policies against default — can ask a committee of financial firm representatives to decide whether a failure to pay the loan should trigger a payment. , which is still not a formal declaration of default.
Peach said the Credit Derivatives Determination Committees — an industry conglomerate of banks and investment funds — will mark a “credit event.” Auslander agreed that the panel would “declare Russia as default in due course.”
It ruled on June 7 that Russia had failed to pay the required additional interest after making payments on the bonds after the April 4 due date. But the committee deferred further action due to uncertainty about how the sanctions might affect an agreement.
What can investors do?
The formal way to declare a default is if 25% or more of bondholders say they did not receive their money. Once that happens, the provisions say that all other foreign bonds in Russia are also in default, and bondholders can seek a court decision to enforce the payment.
Under normal circumstances, the investor and the defaulting government typically negotiate an agreement in which bondholders are given new bonds that are worth less but at least give them some partial compensation.
But the sanctions put a stop to Russia’s dealings with the Ministry of Finance. And no one knows when the war will end or how many defaulted bonds may expire. In this case, declaring default and suing “may not be the wisest option,” Auslander said. It’s not possible to negotiate with Russia and there are too many unknowns, so creditors may decide to “hang tight for now.”
Investors who wanted to get out of Russian debt are probably already headed for exits, having bought bonds at knock-down prices in hopes of profiting from settlement in the long run. 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 deducted from bond-market borrowings until the default is resolved and investors have confidence in the government’s ability and willingness to pay. But Russia is already cut off from Western capital markets, so any return on borrowing is far from over anyway.
The Kremlin can still borrow the ruble at home, where it relies mostly on Russian banks to buy its bonds.
What will be the effect of Russia’s mistake?
Western sanctions on the war have sent foreign companies fleeing Russia and disrupted the country’s trade and financial ties with the rest of the world. The default would be another symptom of that isolation and disruption.
A default won’t affect the Russian economy right now because the country hasn’t borrowed internationally in years amid sanctions and is making a lot of money from exports of commodities like oil and natural gas, said Chris Weifer, a consultant at consulting firm Macro. Experienced Russian Economy Analyst- Advice.
But in the long term, when the war is resolved and Russia tries to rebuild its economy, “this is where the legacy of default will be a problem. It’s something like if someone or a company has bad credit.” If you get the score, it takes years to recover from that,” he said.
Investment analysts are cautiously assuming that Russia’s default will not have the same impact on global financial markets and institutions as the earlier default in 1998. Subsequently, Russia’s default on domestic ruble bonds prompted the US government to step in and acquire banks. To salvage long-term capital management, a large US hedge fund feared to collapse could shake the broader financial and banking system.
Holders of bonds — for example, funds that invest in emerging market bonds — can incur serious losses. However, Russia played only a minor role in the emerging market bond index, limiting losses for fund investors.
“Spoilover to the rest of the world should be limited,” Peach said.
But a Russian default could have a ripple effect by adding pressure to global debt markets and making investors more risk-averse and less willing to move the money, which “could very well lead to further defaults in other emerging markets.” It is,” Weifer said.