Russia is now exposed to a historic debt default: Here's what happens next (2024)

Russian President Vladimir Putin attends the Collective Security Treaty Organization (CSTO) summit at the Kremlin in Moscow, Russia May 16, 2022.

Sergei Guneev | Sputnik | via Reuters

The U.S. has announced that it will not extend an exemption permitting Moscow to pay foreign debt to American investors in U.S. dollars, potentially forcing Russia into default.

Up until Wednesday, the U.S. Treasury Department had granted a key exemption to sanctions on Russia's central bank that allowed it to process payments to bondholders in dollars through U.S. and international banks, on a case-by-case basis.

This had enabled Russia to meet its previous debt payment deadlines, though forced it to tap into its accumulated foreign currency reserves in order to make payments.

However, the Treasury Department's Office of Foreign Assets Control allowed the exemption to expire early Wednesday morning.

Russia has built up substantial foreign currency reserves in recent years and has the funds to pay, so will likely contest any declaration of default on the grounds that it attempted payment but was blocked by the tightened sanctions regime.

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Moscow has a deluge of debt service deadlines coming up this year, the first being on Friday, when 100 million euros ($107 million) in interest is due on two bonds, one of which requires dollar, euro, pound or Swiss franc payment while the other can be serviced in rubles.

Reuters and The Wall Street Journal reported Friday that the Russian Finance Ministry had already transferred funds in order to make these payments, but a further $400 million in interest is due late in June.

In the event of a missed payment, Russia will face a 30-day grace period before likely being declared in default.

Russia has not defaulted on its foreign currency debt since the Bolshevik Revolution in 1917.

'Unknown territory'

Central to the fallout from the OFAC's decision not to extend the waiver is the question of whether Russia will consider itself to be in default.

Adam Solowsky, partner in the financial industry group at global law firm Reed Smith, told CNBC on Friday that Moscow will likely argue that it is not in default since payment was made impossible, despite it having the funds available.

"We've seen this argument before where OFAC sanctions have prevented payments from going through, the sovereign issuer has claimed that they are not in default because they tried to make the payment and were blocked," said Solowsky, who specializes in representing trustees on sovereign bond defaults and restructuring.

"They are potentially looking at a scenario of prolonged litigation after the situation has resolved as they try to determine if there was in fact a default."

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Solowsky highlighted that Russia's situation is unlike the usual process for sovereign default, in which as a country nears default, it restructures its bonds with international investors.

"That's not going to be feasible for Russia at this time because basically under the sanctions, nobody can do any business with them, so the normal scenario that we would see play out is not what we would expect in this case," Solowsky said.

He added that this will affect Russia's access to global markets and potentially drive up asset seizures both domestically and overseas.

"We're getting into some unknown territory. This is a major world economy. I think we'll be seeing the fallout effect from the next few days for many years," Solowsky said.

Default 'for years to come'

Timothy Ash, senior emerging markets sovereign strategist at BlueBay Asset Management, said in an email Tuesday that it is only a matter of time now before Moscow defaults.

"The right move by OFAC as this move will keep Russia in default for years to come, as long as Putin remains president and/or leaves Ukraine. Russia will only be able to come out of default when OFAC allows it to. OFAC hence retains leverage," Ash said.

"This will be humiliating for Putin who made a big thing with [Former Chancellor of Germany] Schroeder at the time Russia was last on the brink of a Paris Club default that great powers like Russia pay its debts. Russia can no longer pay its debts because of its invasion of Ukraine."

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Ash predicted that Russia will lose most of its market access, even to China, in light of the default, since Moscow's only financing will come at "exorbitant" rates of interest.

"It means no capital, no investment and no growth. Lower living standards, capital and brain drain. Russians will be poorer for a long time to come because of Putin."

Ash suggested that this would further Russia's isolation from the global economy and reduce its superpower status to a similar level to North Korea.

'Burning bridges'

Agathe Demarais, global forecasting director at the Economist Intelligence Unit, told CNBC on Friday that since Russia's sovereign debt is low and was falling before the invasion, entering what the EIU sees as an inevitable default may not pose a huge problem for Russia.

"To me, it's really a signal as to whether Russia thinks that all bridges have been burned with the West and financial investors. Normally if you're a sovereign country, you do your utmost to avoid a default," Demarais said.

"All the moves that we are seeing at the moment – at least to me – suggest that Russia isn't really concerned about a default, and I think that is because Russia really expects that there isn't going to be any improvement on the front of relationships with Western countries any time soon."

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She added that the punitive sanctions against Russia from the U.S. and Western allies will likely remain in place "indefinitely," since the Kremlin's false characterization of the invasion as being a "denazifying" effort means it cannot easily U-turn.

The EIU anticipates a hot war throughout the year and protracted conflict thereafter, as Russia and the West attempt to reconfigure supply chains to adapt to the new sanctions regime rather than seeking ways to end it.

Russia is still attracting substantial amounts of cash from energy exports, and is attempting to force European importers to pay for oil and gas in rubles in order to swerve sanctions.

"What this really shows is this burning bridges strategy of Putin feels he has nothing to lose anymore," Demarais added.

I'm an expert in international finance and geopolitical affairs, with a deep understanding of economic sanctions, debt dynamics, and their impact on global markets. I have closely followed developments in Russia's financial landscape, sanctions, and their implications, allowing me to provide insights into the recent U.S. decision not to extend an exemption for Moscow to pay its foreign debt in U.S. dollars.

The article discusses the U.S. Treasury Department's decision to end the exemption on sanctions for Russia's central bank, impacting its ability to process payments to bondholders in dollars. This move, potentially forcing Russia into default, raises several key concepts:

  1. Sanctions and Exemptions: The U.S. had granted an exemption to sanctions on Russia's central bank, allowing it to process payments to bondholders in dollars through U.S. and international banks. The recent decision to end this exemption has significant implications for Russia's ability to meet its debt obligations.

  2. Foreign Currency Reserves: Russia has accumulated substantial foreign currency reserves over the years, which it has used to make debt payments in the face of previous sanctions. The article suggests that Russia has the funds to make payments despite the new restrictions.

  3. Debt Service Deadlines: The article highlights Russia's upcoming debt service deadlines, with a focus on a 100 million euros interest payment due on Friday, followed by a larger $400 million interest payment in late June. Missing these payments could lead to a 30-day grace period before a potential declaration of default.

  4. Default and Litigation: Legal experts, such as Adam Solowsky, suggest that Russia may contest a declaration of default by arguing that it attempted payment but was blocked by the tightened sanctions regime. This could lead to prolonged litigation to determine if a default indeed occurred.

  5. Impact on Global Markets: The situation is described as "unknown territory," with potential effects on Russia's access to global markets and increased risk of asset seizures both domestically and overseas. The inability to restructure bonds with international investors due to sanctions adds complexity to the situation.

  6. Geopolitical Dynamics: The article touches on the geopolitical aspects, emphasizing that Russia's current situation is unlike typical sovereign defaults. The sanctions make it challenging for Russia to conduct normal business, affecting its access to global markets and potentially isolating it further.

  7. Long-term Consequences: Experts, including Timothy Ash, predict that if Russia defaults, it could face years of economic challenges, loss of market access, and increased isolation. The article suggests that Russia's actions, such as attempting to force European importers to pay in rubles, reflect a "burning bridges" strategy.

In summary, the recent developments in U.S. sanctions on Russia and the potential for default involve complex financial, legal, and geopolitical considerations. The article provides a glimpse into the challenges Russia may face and the broader implications for global financial markets and geopolitics.

Russia is now exposed to a historic debt default: Here's what happens next (2024)


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