Russian Bonds: An atypical default


Status: 06/27/2022 5:10 p.m

According to the logic of the financial markets, Russia is experiencing a default. The Kremlin denies this. In fact, the blockade by the West plays a crucial role.

By Detlev Landmesser,

Russia faces its first default on foreign debt in more than 100 years. A 30-day period expired last night within which interest due on two government bonds in dollars and euros had to be paid. It’s about $100 million in total. Yesterday evening, several Taiwanese investors complained that they had not yet received any of the agreed interest payments. That would be the first default on Russia’s foreign debt since 1918.

Failure in the technical sense

The fact that this is no ordinary default is proven by the Russian Ministry of Finance’s assurance that the installment in question had already been transferred on May 20, five days before the transaction ban on Russian payments issued by the USA came into force. Finance Minister Anton Siluanov therefore called the impending default a “farce”.

Kremlin spokesman Dmitry Peskov added today that the payments were made “in foreign currency”. Allegations of insolvency are “unjustified”. If transactions were blocked by the clearing house Euroclear because of Western sanctions against Russia, that was “not our problem”.

Apart from the small legal vagueness as to whether the payment deadline may not expire until tonight, experts assume that the payment default is just occurring – in a technical sense, so to speak.

Not a high debt ratio

However, the current situation cannot be compared with historic state bankruptcies, such as the Russian state bankruptcy in 1998, when bonds held by residents were no longer repaid. Russia is not “insolvent” in the strict sense. It has significant financial resources at home and abroad. The entire – partly blocked – foreign exchange reserves by the Russian central bank are currently given as almost 600 billion dollars. In addition, the country is not heavily indebted by international comparison: At around 20 percent of economic output, the debt ratio is significantly lower than in many western industrialized countries.

Even the term “default” is controversial, even if Russia’s position is largely isolated. Last week, Russia’s Finance Minister Anton Siluanov said that anyone who understands what’s going on knows that this is not a default.

The experts of the major rating agencies Standard & Poor’s, Moody’s and Fitch are silent on this – the sanctions of the European Union prohibit them in this case from assessing the financial situation. There is also the international investor committee CDDC, which consists of large banks. In the event of payment problems, it decides whether credit default insurance (CDS) is due and whether the buyers of such protection are compensated. Such a case would at least come close to a default and thus a state bankruptcy.

The US government is certain that there is a default: “This morning’s news of Russia’s default finding – the first in more than a century – shows the strength of the measures being taken by the US, along with its allies and partners,” said a US government representative on the sidelines of the G7 summit in Elmau. The consequences for the Russian economy are “dramatic”.

What is certain is that Russia’s problems servicing its foreign debt are in line with Western efforts to weaken the country’s economic and financial strength. Accordingly, Moscow accuses the West of wanting to drive the country into an artificially induced insolvency.

Doubts about willingness to pay

In fact, it is in every state’s own interest to service its debts. Russia, too, has repeatedly affirmed that it is willing to do so.

Russia has recently continued to make interest payments on government bonds, albeit in rubles – which, according to the creditors, can actually be classified as default. The country has set up a new procedure for this via its NSD payment office. That money could be exchanged for dollars as soon as the Russian Federation regained access to its foreign exchange accounts frozen by the West, the Ministry of Finance said.

Last Wednesday, Kremlin ruler Vladimir Putin issued a decree that in future payments could only be made in rubles. The next day, the Ministry of Finance in Moscow announced that it had paid interest on two euro bonds due in 2027 and 2047. The interest amounting to the equivalent of 235 million dollars was sent to the NSD. The payment is thus completed.

It remains unclear whether the Kremlin is willing to draw on its directly controlled domestic foreign exchange reserves for bond payments. Russia’s failure a few weeks ago to pay $1.9 million in interest in arrears raises doubts about Moscow’s willingness to fully service its creditors, particularly from countries classified as “hostile.” In any case, Russia can always refer to the extensive blockade of its payment channels in the event of problems.

What consequences can be expected

Since the payment default is not the result of an acute lack of money on the part of the Russian government, the short-term consequences are manageable. Neither a drastic devaluation of the ruble nor the collapse of the banking system is to be expected.

However, if a rating agency or at least 25 percent of the creditors declared default, according to Western legal opinion, the creditors could demand that Russia repay all of its debts, including those that are not actually due. The volume in question is comparatively small. International creditors currently hold a total of 15 Russian Federation bonds with a face value of around $40 billion. Possibly, however, the property of Russian state-owned companies abroad is threatened. Plaintiffs could sue in court for that possession in exchange for lost interest payments.

In any case, Russia has already been prevented from issuing new bonds on Western financial markets. But if the country regained access to financial markets, it would not be able to borrow fresh money there until its creditors are fully satisfied and any litigation resulting from the default is resolved.

In addition, the isolation of Moscow from the global financial market initiated by the sanctions would be strengthened. The Russian Federation would probably have to pay higher risk premiums, i.e. interest, on new bonds for years to come.