Russia’s economy is in dire straits and on Wednesday it faces its first payment on US dollar bonds since it invaded Ukraine last month.
Moscow is due to pay $117m in interest on two dollar-denominated sovereign bonds or risk defaulting on its debt.
Russia’s attack on Ukraine has sparked international condemnation in major financial capitals.
The United States, European Union, and Allies imposed severe sanctions on Moscow. The penalties froze more than half of the central bank’s $300bn in assets and sent the rouble spiralling 35 percent against the US dollar. Hundreds of Western firms have also since pulled business out of the country.
Russian President Vladimir Putin has said that Moscow would make the payments, but in rubles as long as the sanctions don’t allow dollar settlements. Paying in local currency rather than dollars could set off a significant wave of defaults — unthinkable just weeks ago.
Russia and Russian companies owe about $150bn in foreign-currency debt.
Russia’s default on its external debt would be its first since the Bolsheviks failed to recognize the Tsar’s debt following the 1917 revolution.
What happens if Russia refuses to pay? Will this result in a larger wave of defaults? What effect will this have on the rest of the world’s economy?
Here’s the Short Answer.
What is Russia obligated to pay?
On Wednesday, Russia is due to pay $117m in interest on its dollar bonds. The coupon is the first of several. Another $615m is due later in the month.
So, what if Russia fails to make a payment?
It is granted a 30-day grace period on these particular bonds. If Moscow does not make a payment, credit rating agencies will likely consider it to be in default and bondholders will begin to negotiate. But those negotiations do not appear to be promising given Russia’s economic chokehold and growing isolation.
Why would Russia fail to make a payment?
Since the West announced its sanctions, the rouble has lost about a third of its value. Some of the bonds that Russia has issued have a clause that allows payment in rubles, but the interest payments that are due Wednesday are not eligible. Russia must pay in dollars and given the diminished value of its currency, that’s a tall order.
What happens if Russia makes the payment in rubles?
The government can try to override a contract. It’s a way of saying “we’re paying you in rubles” rather than just not paying at all.
But wait, Russia has been cut off from many financial mechanisms, can it even make the payments?
Yes, the US Office of Foreign Assets Control has authorized an exemption for transactions for US persons with regards to “the receipt of interest, dividend, or maturity payments in connection with debt or equity”.
What happens if Russia doesn’t pay at all?
A debt default could drive Russia’s few remaining foreign investors out of the country, further isolating it. If the government defaults, companies may follow.
Is this something you’ve seen before?
In terms of emerging markets, it’s comparable to what happened in Argentina in 2020, according to Gerard DiPippo, a senior economics fellow at the Center for Strategic and International Studies.
“The big difference here is it’s a shock that investors were not expecting say two or three months ago, whereas, in Argentina, you could see the problems building,” he added.
So this is unprecedented?
Pretty much. Economists can usually predict major crises.
“There are usually red flags. But not many could have predicted [this]. It’s a geostrategic event, followed by massive sanctions, a crumbling economy, and now the potential of debt default,” DiPippo explained.
Who holds the bonds?
Russia’s bonds are mostly held by institutional investors — pension funds, hedge funds, and corporations.
So what options do they have?
Bonds can still be traded on secondary markets and they are currently trading at about 20 cents on the dollar.
“The question is whether they will get their money back and whether they will be repaid in the end. The bond price reflects those expectations,” DiPippo told Al Jazeera.
Do you believe the US and its Allies considered that sanctions will make it hard for the Russians to pay their debt?
“I would assume they were aware of the implications of effectively freezing the Russian central bank’s ability to access dollars and euros and other major currencies,” DiDippo said.
What effect will debt default have on Russians?
Russians are primarily affected by the depreciation of the rouble and their plummeting purchasing power. If Russia will not pay its debt, foreign investors will become even more hesitant to do business with the country. The ruble will suffer.
Are Americans exposed to risk from Russia’s government and companies defaulting on their debt?
The exposure of pensions to emerging market debt is usually pretty small, and any reasonable fund manager, especially if one managing pensions will not be heavily invested in any one emerging market, DiPippo told Al Jazeera.
How does Russia’s debt look?
The Russian government is actually not that indebted.
Part of their “fortress Russia” strategy was to build up Moscow’s balance sheet, primarily with foreign exchange reserves and some gold, and then maintain low debt levels. Russia’s domestic debt was about 13 percent of its gross domestic product last year. The external debt is something like $150bn and only $45bn of that is actually owned by the Russian government. Most of it is owned by Russian companies and Russian banks, DiPippo told Al Jazeera.
And what about the Russian companies?
The biggest single company that owns debt is oil giant Gazprom, but Russia’s oil and gas sector has been fairly insulated from Western sanctions. Still, Russians are having a hard time selling their oil, except at a high discount because of concerns about running afoul of sanctions.