Let’s imagine a situation: You have borrowed a hundred rupees from your friend, and when the time comes to pay it back, you are willing to pay it back in ten-rupee notes. But your friend refuses to take it and asks that you pay back only in fifty-rupee notes. Now, you do not have any fifty-rupee notes. And then your friend accuses you of not paying back the money. Sounds like being in a tight spot with no solution ahead? But you haven't actually borrowed any money from your friend, so relax!
It’s Russia who needs to worry. On June 27, Russia is reported to have defaulted on its foreign debts. And this is the first time something like this happened to the country in a century. Let’s look at what the situation is all about.
What has happened to Russia?
Russia has defaulted on its foreign-currency sovereign debt for the first time in a century. Russia owes foreign debtors $100 million of interest payments, which were due on May 27, 2022. Russia says the money was sent to Euroclear, a bank that would then distribute the payment to investors. A 30-day window from the due date had been set, and according to Bloomberg News, the creditors have not yet received their payment. The payment has been stuck, and the 30-day period has expired, ending on the evening of June 26, Sunday. The period, when missed, leads to a situation of default.
Additionally, it has been reported that the transcontinental country owes $40 billion in sovereign debt which is held in dollars and euros and about $20 billion of it is owed to foreigners, held outside the country. Bloomberg News states that this situation of default “is a grim marker in the country’s rapid transformation into an economic, financial and political outcast”.
Before moving on, what is meant by 'default'?
In finance, the word default means the failure to meet the legal obligations (or conditions) of a loan. A default situation arises when debtors have been passed behind the payment deadline on a debt whose payment was due. A situation of national or sovereign default arises when there is the failure or refusal of a government to repay its national debt.
The national debt refers to a country's gross government debt and is also called public debt, or sovereign debt. It is the financial liabilities of the government sector. A country borrows to meet its government’s deficits. A deficit occurs when a government's expenditures exceed its revenues. Government debt may be owed to domestic residents, as well as to foreign residents.
Now, how did Russia land in this situation?
The Kremlin’s invasion of Ukraine is the sole reason. This led to tough Western sanctions on Russia, subsequently leading to the shutting down of payment routes to its overseas creditors. Bloomberg reports, “The nation’s Eurobonds have traded at distressed levels since the start of March, the central bank’s foreign reserves remain frozen, and the biggest banks are severed from the global financial system."
For months, Russia found ways to snake around these sanctions and penalties and managed its overseas payments. However, the US Treasury decided not to renew the special exemption in sanctions rules allowing investors to receive interest payments from Russia, after it expired on May 25 this year. Kremlin had avoided a default all this time and succeeded. But now, a default is impending and even Kremlin has been forced to accept its inevitability. All the same, the Russian government is highly displeased with the situation.
A formal declaration of default usually comes from rating firms, but the global rating firms have withdrawn ratings on Russian entities due to the European sanctions. Now the bondholders can themselves declare a default, as per the rules, if 25% of the owners of the outstanding bonds agree that an “Event of Default” has occurred.
Has Russia defaulted in the past?
Yes, twice. The last time such a sovereign debt situation occurred was in 1918, during the Bolshevik Revolution when communist leader Vladimir Lenin refused to pay the debts of the Russian Empire. And Russia's last debt default of any kind was in 1998 when the country suffered due to the rouble crisis during the end of Boris Yeltsin's regime. At the time Moscow had failed to keep up payments on its domestic bonds but managed not to default on its overseas debt.
What does the Russian government say now?
Finance Minister Anton Siluanov admitted foreign investors would "not be able to receive" the payments, according to the RIA Novosti news agency. However, he has also reiterated that the country had sufficient money in its coffers and had both the means and the will to pay. So, the situation is not a genuine default that occurs when a country refuses to pay or is unable to do it. “Anyone can declare whatever they like,” Siluanov said. “But anyone who understands what’s going on knows that this is in no way a default,” as per Bloomberg news. The Finance Minister dismissed the situation as a “farce”. Along with this, Russia has also criticised it, calling it a “force-majeure” (unforeseeable circumstances that prevent someone from fulfilling a contract) situation, it said that it was artificially manufactured by the West.
As to the next step that the creditors were likely to take, according to Siluanov, “it makes little sense for creditors to seek a declaration of default through the courts because Russia hasn’t waived its sovereign immunity, and no foreign court would have jurisdiction,” as reported by Bloomberg.
“If we ultimately get to the point where diplomatic assets are claimed, then this is tantamount to severing diplomatic ties and entering into direct conflict. And this would put us in a different world with completely different rules. We would have to react differently in this case - and not through legal channels,” the Minister stated further.
So, what will the creditors do?
“Most bondholders (the foreign creditors) will keep the wait-and-see approach,” said Takahide Kiuchi, an economist at Nomura Research Institute in Tokyo. The fact is, these investors do not need to act immediately. They can choose to monitor the progress of the war, and eventually, the war sanctions may be lifted or at least softened. Also, time may be on their side, as the claims become void three years on from the payment date, according to the bond document, as mentioned in the Bloomberg report.
After the expired exemption was not renewed by US Treasury, President Vladimir Putin introduced new regulations which state that Russia’s obligations on foreign-currency bonds are fulfilled once the appropriate amount in rubles has been transferred to the local paying agent. The Finance Ministry made its latest interest payments, equivalent to about $400 million, under those rules last week. However, none of the underlying bonds have terms that allow for settlement in the local currency.
However, it is still unclear if investors will use the new tool and whether the existing sanctions would even allow them to repatriate the money. On the other hand, investors who wanted out of Russian debt have probably already headed for the exits, leaving those who may have bought bonds at knocked-down prices in hopes of profiting from a settlement in the long run. And they might want to keep a low profile for a while to avoid being associated with the war, ABC News reports.
What will be the impact of this looming default?
Analysts are cautiously reckoning that the default would not have the kind of impact on global financial markets and institutions that came from an earlier default in 1998, as per the Associated Press.
As an immediate practical consequence, Russia won’t be able to borrow any more money. But the country is reportedly earning around a billion dollars a day from fossil fuel exports, and Minister Siluanov had said in April that the country had no plans to borrow more.
