Long term consequences. What does Russia's default mean?

Long term consequences. What does Russia's default mean?

Long-term consequences. What does Russia's default mean

Moscow has no technical capability pay off debts due to Western sanctions that have frozen most of the gold and foreign exchange reserves and foreign exchange transactions. Despite the fact that the default is technical, the consequences will be felt for years.

Russia has defaulted on foreign-currency sovereign debt for the first time since 1918, Bloomberg reported. On June 27, the thirty-day “grace period” bonds due May 27. The end of this grace period is a default event.

There will be no official announcement of default. This is usually done by international rating agencies, but they have all suspended their activities in Russia, Bloomberg points out. The Kremlin denies that they have fulfilled their obligations, but the bondholders have not received a payment. Reporter.net details.

Default in Russia for the first time since 1998

On the night of June 27, Russia defaulted on its foreign debt for the first time since 1918, as the grace period for paying about $100 million in overdue payments on government bonds expired, Bloomberg reports in Monday.

Default – is the default of the debtor to pay the debt. A government default lowers its credit ratings – it becomes difficult or impossible for the country to attract new loans, as a result, the limited infusion of external capital hinders the development of the economy.

A default will not be officially declared, since international rating agencies, which usually do this, have suspended their activities in Russia, notes edition.

At the same time, bondholders could make such an announcement, but they are busy assessing the chances of returning all or at least part of their money, the agency writes. For creditors to default, a quarter of bondholders would need to agree.

Investors will likely prefer to watch the war in the hope that sanctions will eventually be eased, the Guardian writes. Time is on their side: they have the right to demand payment for another three years.

The last time Russia faced default was in 1998, when it suffered a ruble crisis during the chaotic end of Boris Yeltsin's rule. Then she was unable to pay off government short-term bonds – this was mainly domestic debt in rubles.

The default of 2022 is different in that now Russia has not been able to meet its obligations to external investors on debt in foreign currency. This, according to Bloomberg, last happened in 1918 – then the Bolsheviks did not pay the debts of tsarist Russia.

The 1998 default was a serious blow to the economy. By the time the default was announced, crisis phenomena were already growing in Russia, but the default itself became an event that actually launched the obvious stage of the crisis: the ruble began to fall rapidly, stores had to revise price tags several times a day, and banks began to have problems.

Economists explained that the default largely influenced the further economic policy of Russian officials: they tried to get rid of debts, did not increase budget spending, and generally pursued a very conservative policy. Some economists have criticized this policy for hindering economic growth.

Why Russia defaulted

We are talking about Russia-2026 and Russia-2036 dollar bonds, according to which investors must 71.25 million dollars and 26.5 million euros were received, respectively, the balance of which was to be repaid by 552 million dollars on April 4.

However, then the United States blocked Russia from paying its debts from frozen reserves, and the RF Ministry of Finance initiated the fulfillment of the obligation in rubles.

Western market participants prepared to default on these bonds, citing an uncoordinated change in the currency of payment, however, at the end of April, the Russian Federation managed to bring funds in dollars to foreign investors. According to Bloomberg, the unencumbered dollar accounts of the mortgage corporation Dom.RF were used for this.

On May 11, the former holders of these bonds, who received the payment of principal by May 2, filed a notice of Russian default with the Euroclear clearing system, citing the fact that they did not receive additional interest accrued for the period from April 4 to the date of the bonds' actual redemption.

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When paying off the principal at the end of April, Russia did not include this additional interest in its payment, they claim. “Following the demand of the holders of securities, Russia never paid this percentage”, – creditors indicated.

In April, the US banned Russia from servicing foreign debt by failing to renew a license that allowed holders of Russian sovereign bonds to receive payments. This license expired on May 25.

Citibank of London then refused to perform the functions of a payment agency for Russian dollar issues, and the Ministry of Finance of the Russian Federation transferred these functions to the National Settlement Depository. In early June, NSD also came under EU sanctions.

The Kremlin called this decision an attempt by Brussels to push Russia towards “artificial default”. On June 22, Russian ruler Vladimir Putin signed a decree on the temporary procedure for fulfilling obligations on Russia's external debt in foreign currency, which implies making such payments in rubles.

On June 27, commenting on a Bloomberg report, Putin's spokesman Dmitry Peskov said that the Kremlin does not agree with the allegations of a default in Russia on foreign-currency debt.

According to him, “the allegations of a default are absolutely unjustified”, because Russia made the necessary payments in foreign currency back in May. “The fact that Euroclear withheld this money – it's not our problem anymore”, – said the Kremlin speaker.

What will be the consequences of Russia's default

Will the default of 2022 have the same consequences as the default of 1998? Probably not. Under normal conditions, a default could provoke an outflow of investors, a fall in the ruble and stock exchanges, undermining confidence in the economy and, as a result of all this, a decrease in its growth potential. But all this was already done by Russia's war against Ukraine.

“It is a very, very rare situation where another government forces a country to default when it would otherwise have the funds to pay”, – Bloomberg, Senior Sovereign Analyst at Loomis Sayles & Company LP Hassan Malik.

Bloomberg calls “the default event” rather symbolic for the Russian economy and Russians, “experiencing double-digit inflation and the worst economic downturn in recent years”.

“This is a grim marker of the country's rapid transformation into an economic, financial and political pariah”, – the agency states.

But the reputational loss from the default, writes the Financial Times, if sanctions are lifted will complicate the issuance of new bonds and the Russian government will have to offer higher yields on them.

The default will not affect Russia in the short term, says Chris Weafer, chief executive of Macro Advisory, a Moscow-based consulting firm. This is because Russia does not need to raise money internationally, since it derives its income from expensive commodities like oil.

But he agrees that this will create a “hereditary” problem. “These are actions that will hang over the economy and make recovery much more difficult once we get to this point”, – said the expert.

The default will lead to the need to repay a large amount of Russian debt. About $40 billion of Russia's debts are denominated in dollars or euros, with about half of the – out of the country.”Some portions of this debt will now be automatically redeemable, as all debt instruments have a prepayment clause, so if you fail to meet one, it usually causes an immediate demand to pay other debts, so Russia certainly may face immediate debt repayment, at this stage about $20 billion”, – he said on the BBC Today programme.