WASHINGTON – Russia is striving for a major default on its foreign debt, a grim cornerstone it has not seen since the Bolshevik revolution more than a century ago, which raises the prospect of years of litigation and global hunting by Russian asset bondholders.
The impending bankruptcy is the result of sanctions that have immobilized about half of Russia’s $ 640 billion foreign exchange reserves, straining the country’s ability to make bond payments in the currency in which the debt was issued, the dollar. Assuming non-compliance, Russia has already preemptively dismissed it as an “artificial” result of sanctions imposed by the United States and its allies, and has threatened to challenge such a result in court.
The upcoming battle, which is likely to pit Russia against major investors around the world, raises vague questions about who should decide whether a nation has indeed failed in the rare case where sanctions limit a country’s ability to pay its debts.
It seems that Russia will not take the declaration of bankruptcy lightly. If that happens, it will raise the price of Russia’s loans for years to come and effectively block it from international capital markets, which will weigh on an economy that is already expected to shrink sharply this year. It will also be a stain on President Vladimir Putin’s economic governance, highlighting the costs Russia has incurred since invading Ukraine.
The pledge for Russia, which has already suffered decades of disrupting important business ties with the United States, Europe and other nations, is one of the cornerstones of economic growth: the ability to borrow money abroad without any problems.
Because Russia’s difficulty is so unusual, it remains a kind of open question who is the ultimate arbiter in the event of default.
“This points to the fragility and perfection of sovereign debt markets,” said Tim Samples, a professor of law at Terry Business College at the University of Georgia and a public debt expert. “I think this will be complicated and contested for various reasons.”
Mr Samples suggested there could be a “cascade” of events leading to Russia’s bankruptcy.
The most direct verdict could come from major credit rating agencies, which have already signaled that Russia’s creditworthiness is deteriorating and that default may be on the horizon.
Last week, Moody’s warned that Russia’s payment of about $ 650 million in dollar-denominated ruble debt on April 4 could be considered default if it does not reverse and pay in dollars by May 4, when the 30-day grace period ends. period. . This was followed by a similar warning earlier this week from S&P Global, which ranked Russia as a “selective default”.
But it is unclear how the rating agencies will weigh if Russia fails to make payments after the grace periods expire due to European Union sanctions, which have restricted the agencies from rating Russia. Speakers at Moody’s and S&P did not comment. A Fitch spokesman said he could not comment on Russia’s creditworthiness 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 draining the remaining dollar reserves it has in Russia or using new revenues (from natural gas payments, for example) to make bond payments and avoid default. .
Russia can still make payments on Russian government debt as long as it does not try to use funds from Russian government accounts held in US financial institutions.
After the expiration of the grace period for payments on foreign currency bonds on May 4, the next key moment will be May 25. Then the holders of American bonds will no longer be able to accept payments on Russian debt with a temporary exception, which the Ministry of Finance has allowed.
Although the verdict of the rating agencies carries considerable weight, bondholders will determine the consequences of Russia not making due payments or violating the terms of its agreements. Bondholders may take a wait-and-see approach or declare that the bonds are immediately callable and callable, which may lead to the default of other bonds with “cross-default” provisions.
Another potential arbiter in the event of default is the Credit Derivatives Determination Committee, which is a group of investors in the default insurance market or credit default swaps. The committee is discussing whether ruble payments to Russia constitute a “non-payment” that will boost insurance payments. The court has already ruled that the state-owned Russian Railways AD is in arrears due to missed interest on bonds.
For some analysts, this decision and payments in rubles mean that Russia is already technically in default.
“If Russia does not pay on time, does not pay in the currency of the contract, this is a default – this is crystal clear,” said Timothy Ash, senior sovereign strategist at BlueBay Asset Management. “For all its intentions and goals, Russia is already in default.
The Russia-Ukraine war and the global economy
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Lack of base metals. The price of palladium, used in car exhaust systems and mobile phones, is rising amid fears that Russia, the world’s largest metal exporter, could be cut off from world markets. The price of nickel, another key Russian export, is also rising.
Financial turmoil. Global banks are preparing for the effects of sanctions designed to limit Russia’s access to foreign capital and limit its ability to process payments in dollars, euros and other currencies that are crucial to trade. Banks are also on the lookout for retaliatory cyber attacks from Russia.
The defaults have been linked in court before. Argentina failed in 2014 after negotiations with hedge funds that refused to accept reduced payments failed and a federal judge in the United States ruled that it could not make its regular bond payments without paying the arrears. of hedge funds. The US Supreme Court has refused to consider Argentina’s appeal in the case.
Russia’s case is unique because of the sanctions, and it is expected that its ability to make foreign currency payments in its bond contracts has been limited as it is unable to gain access to all its reserves.
Mr Ash suggested that it would be difficult for Russia to find a court that was sympathetic to Russia’s position.
“The US court will never rule against OFAC,” Mr Ash said, referring to the US Treasury Department’s Office of Foreign Assets Control, which administers sanctions.
But Mr Samples suggested that given Russia’s global pariah status, creditors could struggle to pursue Russian assets, even if they win a favorable ruling in court.
He predicts that Russia will look for creative ways to avoid admitting default, such as stating a mysterious language in bond contracts that could be interpreted as allowing payments in other currencies or by seeking friendly jurisdiction in the courts, perhaps in Russia.
“I expect them to stick to their own alternative facts,” Mr Samples said.
Despite the symbolism of bankruptcy, the economic consequences for Russia and the world may be relatively small.
Economists estimate that Russia’s total foreign debt is about $ 75 billion, while Russia’s annual energy sales are about $ 200 billion. Investors expect bankruptcy from the end of February, and politicians suggest that bankruptcy does not pose a threat to the stability of the financial system.
Ultimately, the market will determine whether Russia is worthy of credit, and its actions in Ukraine and future sanctions will determine the fate of its economy.
“It feels like a garnish and a bandage over a very ugly and deep set of circumstances,” said Anna Gelpern, a law professor at Georgetown who specializes in government debt. “They drink from a fire hose when it comes to energy revenue, so why should they borrow?”
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