WASHINGTON — Russia is heading for a major default on its foreign debt, a grim step it hasn’t seen since the Bolshevik Revolution more than a century ago and one that hints at years of legal wrangling and a hunt world by active bondholders for Russia.
The impending default is the result of sanctions that have tied up about half of Russia’s $640 billion in foreign exchange reserves, straining the country’s ability to make bond repayments in the currency in which the debt is owed. was issued – the dollar. Fearing a default, Russia has already preemptively dismissed it as an “artificial” result of sanctions imposed by the United States and its allies, and threatened to challenge such an outcome in court.
The upcoming fight, which would likely pit Russia against major investors around the world, raises murky questions about who decides whether a nation has actually defaulted in the rare cases where sanctions have limited a country’s ability to pay its debts. debts.
Russia does not seem likely to take the declaration of default lightly. If that happened, it would increase Russia’s cost of borrowing for years to come and effectively shut it out of international capital markets, weighing on an economy that is already expected to contract sharply this year. It would also be a stain on President Vladimir V. Putin’s economic stewardship that would underscore the costs Russia incurs from its invasion of Ukraine.
At stake for Russia, which has already suffered the abrupt severance of decades of crucial trade ties with the United States, Europe and other countries, is one of the foundations of economic growth: the ability to smoothly borrow money outside its borders.
Given that Russia’s predicament is so unusual, the question remains open as to who is the ultimate arbiter of a sovereign debt default.
“This underscores the spongy and disparate nature of sovereign debt markets,” said Tim Samples, a professor of legal studies at the University of Georgia’s Terry College of Business and a sovereign debt expert. “I think this is about to be convoluted and challenged for a variety of reasons.”
Mr Samples suggested there could be a “cascade” of events that would bring Russia into default.
The most direct verdict could come from the major rating agencies, which have already signaled that Russia’s creditworthiness is eroding and that a default could be on the horizon.
Last week, Moody’s warned that Russia’s payment of about $650 million of ruble-denominated dollar debt on April 4 could be deemed a default if it does not change course and pay in dollars. by May 4, when a 30-day grace period ends. . This followed a similar warning issued earlier in the week by S&P Global, which placed Russia on a “selective default” rating.
But it’s unclear exactly how the rating agencies will intervene if Russia fails to make its payments after its grace periods expire due to European Union sanctions that have prevented the agencies from rating Russia. Spokespersons for Moody’s and S&P had no comment. A Fitch spokesman said he could not comment on Russia’s solvency in light of the sanctions.
The Biden administration put additional pressure on Russia earlier this month when the Treasury Department began blocking Russia from making debt payments using dollars held in US banks. This new restriction was intended to force Russia to choose between depleting the remaining dollar reserves it has in Russia or using new revenues (from natural gas payments, for example) to make bond payments and avoid defaulting on its debt.
Russia can still make payments on Russian sovereign debt as long as it does not attempt to use funds from Russian government accounts held at US financial institutions.
After the grace period on foreign currency obligation payments expires on May 4, the next key moment will be May 25. That’s when US bondholders will no longer be able to accept Russian debt payments under a temporary exemption authorized by the Treasury Department.
Although the rating agencies’ verdict carries significant weight, bondholders will determine the consequences if Russia fails to make payments that were due or violate the terms of its contracts. Bondholders could take a wait-and-see approach or declare that bonds are immediately due and payable, which could cause other bonds with “cross-default” provisions to default as well.
Another potential default arbiter is the Credit Derivatives Determination Committee, which is a panel of investors in the market for default insurance or credit default swaps. The committee is deliberating on whether Russia’s payments in rubles constitute a “payment default,” which would kick-start insurance payments. The panel has already ruled that state-owned Russian Railways JSC was in default for missing a bond interest payment.
For some analysts, this decision and the payments in rubles mean that Russia is already technically in default.
“If Russia doesn’t pay on time, doesn’t pay in contract currency, that’s a default – that’s crystal clear,” said Timothy Ash, senior sovereign strategist at BlueBay Asset Management. “For all intents and purposes, Russia is already in default.”
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The defaults have already been upheld in court. Argentina notably defaulted in 2014 after negotiations failed with hedge funds that refused to accept reduced payments and a federal judge in the United States ruled that it could not make its regular bond payments. without also paying the recalcitrant hedge funds. The United States Supreme Court declined to hear Argentina’s appeal in this case.
Russia’s case is unique because of the sanctions, and it is expected to argue that its ability to make payments in the currencies of its bond contracts has been limited because it cannot access all his reservations.
Mr Ash hinted that it would be difficult for Russia to find a court favorable to Russia’s position.
“A US court will never rule against OFAC,” Ash said, referring to the US Treasury Department’s Office of Foreign Assets Control, which administers the sanctions.
But Mr Samples suggested that, given Russia’s status as a global pariah, creditors may find it difficult to pursue Russian assets even if they win a favorable judgment in court.
He predicted that Russia would seek creative ways to avoid acknowledging default, such as pointing to obscure language in bond contracts that could be interpreted to allow payments in other currencies or seeking amicable jurisdiction, perhaps to be in Russia.
“I expect them to stick to their own alternative facts,” Mr. Samples said.
Despite the symbolism of a default, the economic implications for Russia and the world could be relatively small.
Economists estimate Russia’s total external public debt to be around $75 billion, while Russia’s annual energy sales are around $200 billion. Investors have been anticipating a default since late February, and policymakers have suggested that a default does not pose a threat to the stability of the financial system.
Ultimately, the market will determine whether Russia is creditworthy, and its actions in Ukraine and future sanctions will determine the fate of its economy.
“It feels like a garnish and a band-aid on top of a very ugly and deep set of circumstances,” said Anna Gelpern, a Georgetown law professor who specializes in sovereign debt. “They’re drinking from a fire hose when it comes to energy revenue, so why do they need to borrow?”