What will happen if Russia defaults on its debt?

WASHINGTON – Russia is seeking a massive default on its foreign debt, a grim milestone not seen since the Bolshevik Revolution more than a century ago and potentially raising the prospect of years of legal debate and global stalking by bondholders for Russia. origins.

The looming default is the result of sanctions that have frozen about half of Russia’s $640 billion in foreign currency reserves, straining the country’s ability to repay bonds in the currency in which the debt was issued – in dollars. Specifically for a default, it has already preemptively dismissed it as an “artificial” consequence of sanctions imposed by the United States and its allies, and has threatened to challenge such an outcome in court.

The upcoming battle, which will likely pit Russia against large investors from around the world, raises murky questions about who will decide whether a country has actually defaulted in the rare case that sanctions have limited a country’s ability to repay its debts.

Russia does not seem likely to take the default announcement lightly. If that happens, it will increase the cost of Russia’s 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 disgrace to President Vladimir Putin’s economic management that would underscore the costs to Russia of its invasion of Ukraine.

At stake for Russia, which has already suffered the sudden rupture of decades of crucial trade relations with the United States, Europe and other countries, is one of the pillars of economic growth: the ability to seamlessly borrow money from outside its borders.

As Russia’s predicament is so unusual, it remains a somewhat open question who will be the final verdict of sovereign default.

“This points to the volatile and moral nature of sovereign debt markets,” said Tim Siemens, professor of legal studies at the University of Georgia’s Terry School of Business and an expert on sovereign debt. “I think this is set to be complex and contested for a number of reasons.”

Mr. Science suggested there could be a “chain” of events driving Russia into default.

The most direct verdict could come from major credit rating agencies, which have already indicated that Russia’s creditworthiness is eroding and defaults may be looming.

Last week, Moody’s warned that Russia’s repayment of about $650 million in ruble-denominated debt on April 4 could be considered a default if it does not reverse course and pay in dollars by May 4, when the 30-day grace period expires. . It followed a similar warning earlier in the week by S&P Global, which placed Russia under a “selective default” rating.

But it is not clear how the rating agencies will affect if Russia fails to make the payments after the grace periods run out due to EU sanctions that have restricted the agencies in rating Russia. Moody’s and Standard & Poor’s spokesmen did not comment. A spokesperson for Fitch said he could not make any comments about Russia’s creditworthiness in light of the sanctions.

The Biden administration put additional pressure on Russia earlier this month when the Treasury Department began preventing Russia from making debt payments using dollars held in US banks. This new restriction was intended to force Russia to choose between depleting its remaining dollar reserves in Russia or using new revenue (from natural gas payments, for example) to make bond payments and avoid defaulting on its debt.

Russia can still make payments on Russia’s sovereign debt as long as it does not attempt to use money from Russian government accounts held in US financial institutions.

After the grace period on foreign currency bond payments expires on May 4, the next key moment will be May 25. US bondholders would then be unable to accept Russian debt payments under a temporary relief allowed by the Treasury.

While the rating agencies’ judgment carries significant weight, bondholders will determine the consequences of Russia’s failure to make payments that were owed or that violate the terms of its contracts. Bondholders can take a wait-and-see approach or declare the bonds payable and payable immediately, which may also cause other bonds with “cross-default” provisions to default.

Another potential default ruling is the Credit Derivatives Determination Committee, which is a committee of market investors to insure against default, or default swaps. The commission is studying whether payments to Russia in rubles constitute a “payment failure”, which would trigger insurance payments. The commission has already ruled that the state-owned Russian Railways has defaulted on an interest payment on the bonds.

For some analysts, this decision and payments in rubles mean that Russia is already technically in default.

“If Russia doesn’t pay on time, and doesn’t pay in the contract currency, that’s a default — it’s pretty clear,” said Timothy Ash, chief sovereign strategist at BlueBay Asset Management. “For all intents and purposes, Russia is already in default.”

Assumptions have been restricted in courts before. Argentina faltered notably in 2014 after negotiations with hedge funds that refused to accept discounted payments broke down, and a US federal judge ruled that it could not make its regular bond payments without also making hedge fund money. The US Supreme Court refused to hear Argentina’s appeal in the case.

Russia’s case is unique due to the sanctions, and it is expected to argue that its ability to make currency payments in its bond contracts is restricted because it does not have access to all of its reserves.

Mr. Ash noted that it would be difficult for Russia to find a court sympathetic to Russia’s position.

“A US court will never rule against OFAC,” Mr. Ash said, referring to the US Treasury’s Office of Foreign Assets Control, which administers sanctions.

But Mr Siemens noted that, given Russia’s global pariah status, creditors could struggle to pursue Russian assets even if they win a favorable ruling in court.

He predicted that Russia would look for creative ways to avoid recognition of default, such as referring to vague language in bond contracts that could be interpreted to allow payments in other currencies or by seeking an amicable court, possibly in Russia.

“I expect them to stick to their alternative realities,” Mr. Siemens said.

Despite the symbolism of default, the economic effects on Russia and the world may be relatively small.

Economists estimate that Russia’s total external public debt is about $75 billion, while Russia’s annual energy sales are around $200 billion. Investors have been anticipating defaults since late February, and policymakers have suggested that defaults do 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 an embellishment on top of a very ugly and deep set of circumstances,” said Anna Gilburn, a Georgetown University law professor who specializes in sovereign debt. “They drink from a fire hose relative to the energy revenue, so why do they need to borrow?”

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