What are the consequences of Russia's default on foreign debt

What are the consequences of Russia's default on foreign debt

What are the consequences of Russia's default on external debt

  What are the consequences of Russia's default on external debt

Russian default on external debt will further alienate the country from the global financial system after the sanctions imposed in connection with the Russian invasion of Ukraine

Russian default on external debt will further alienate the country from the global financial system after the sanctions imposed in connection with the Russian invasion of Ukraine

On June 26, the deadline for paying another $100 million by Russia expired. Russia was late in the payment, not meeting the 30-day grace period for interest payments (originally they should have been paid by May 27). However, it may take time to confirm the default.

“While there is a possibility that some magic could happen” and Russia will receive money through financial institutions, despite the sanctions, “no one is betting on this,” said Jay S. Auslander, lead sovereign debt lawyer at the firm Wilk Auslander (Wilk Auslander) in New York. “The overwhelming likelihood that they will not be able to do this, because no bank is going to transfer money,” the expert said.

Last month, the US Treasury deprived Russia of the ability to pay off its multi-billion dollar debt to international investors through US banks. In response, the RF Ministry of Finance stated that it would pay off dollar debts in rubles and offer “the possibility of subsequent conversion into the original currency.”

Russia calls any default artificial because it has money to pay off debts, but notes that, as a result of the sanctions, its foreign exchange reserves held abroad have been frozen.

“There is money, there is a willingness to pay,” Russian Finance Minister Anton Siluanov said last month. “This situation, artificially created by an unfriendly country, will not affect the quality of life of Russians in any way.”

Tim Ash, Senior Emerging Markets Analyst at BlueBay Asset Management, tweeted that the default is “obviously not” outside Russia's control and that the sanctions prevent it from paying its debts because it invaded Ukraine.

How much Russia owes

Russia owes approximately $40 billion in foreign bonds, about half of which is owned by foreigners. Before the war, Russia had about $640 billion in foreign exchange and gold reserves, most of which was abroad and is now frozen.

Russia has not defaulted on its international debt 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 debt in the late 1990s, but was able to recover from this default with the help of international assistance.

Investors have been expecting a default in Russia for months now. In insurance contracts covering Russian debt, the probability of default within a few weeks is estimated at 80%. Rating agencies, in particular, Standard & Poor's and Moody's have put the country's debt in junk territory.

How to know if a country is in default

Rating agencies can downgrade to default, or the issue can be decided by the court. Bondholders who have credit default swaps—contracts that act as insurance policies against default—can ask a committee of financial firm representatives to decide in which case default on debt is not yet a formal declaration of default.

The Credit Default Determination Committee, an industry group for banks and investment funds, ruled on June 7 that Russia had not paid the required additional interest on the bond after the April 4 deadline. However, the committee delayed further action due to uncertainty about how the sanctions could affect any settlement of the issue.

What investors can do

The formal way to default is if 25% or more of the bondholders say they haven't received their money. Once this happens, all other Russian foreign bonds will also be defaulted, and bondholders can go to court to enforce payment.

Under normal circumstances, investors and a defaulting government usually agree on a settlement in which bondholders are issued new bonds that cost less but at least give them some partial compensation.

The sanctions prohibit doing business with the Russian Ministry of Finance. No one knows when the war will end or how much defaulted bonds might cost.

In this case, defaulting and suing “may not be the wisest choice,” Auslander said. It is impossible to reach an agreement with Russia, and there are a lot of unknowns, so creditors may decide to “postpone”.

Investors who wanted to get rid of Russian debt are likely to have already headed for the exit, leaving those who may have bought the bonds at discounted prices hoping to profit from the settlement in the long run. And they might want to stay in the background for a while so they don't get involved with the war.

Once a country defaults, it may be cut off from borrowing in the bond market until the default is settled and investors regain confidence in the government's ability and willingness to pay. But Russia is already cut off from Western capital markets, so a return to borrowing is a long way off anyway.

The Kremlin can still borrow rubles domestically, where it relies heavily on Russian banks to buy its bonds .

The consequences of the Russian default

Western sanctions imposed in connection with the Russian invasion of Ukraine forced foreign companies to leave Russia and cut off trade and financial ties countries with the rest of the world. A default would be another sign of this isolation and economic destruction.

Investment analysts are cautious that a default in Russia will not have the same impact on global financial markets and institutions as the earlier default in 1998. At that time, Russia's default on domestic ruble bonds forced the US government to intervene and force banks to bail out the large US hedge fund Long-Term Capital Management, whose collapse, as was feared, could shake the financial and banking system as a whole.

Holders bonds — for example, funds investing in emerging market bonds — can suffer serious losses. However, Russia played only a small role in emerging market bond indices, limiting investor losses.

While the war itself is devastating in terms of human suffering and rising food and energy prices around the world, government defaults bonds will certainly not be systemically important, said Kristalina Georgieva, Managing Director of the International Monetary Fund.