What does it mean for Russia to default on its foreign debt?

Russia is heading towards a default on its foreign debt payments, threatening to plunge its economy further into crisis.

Default is murky territory in the global economy, and Russia’s situation is complicated by its growing isolation under unprecedented sanctions imposed by Western powers.

For those of us who fell asleep during Intro to Macroeconomics class in college, let’s unpack exactly what we mean when we talk about this historic (and still potential) Russian default.

First of all: what is “default”?

To put it simply, governments, like ordinary people, borrow to finance large projects, and these loans must be repaid on a schedule. A “default” happens when a borrower cannot pay the interest or principal on its debt when it comes due.

Governments lend money by issuing bonds. Investors, both at home and abroad, buy these bonds, effectively lending money to the government with the promise of being paid back with interest.

Failure to pay results in a “default”, or, in good Portuguese, default or default. This can have dire consequences, which is why governments typically do everything they can to prevent them.

Russia has not defaulted on foreign debt obligations since the Bolshevik revolution of 1917.

Why can’t Russia pay its bills?

To clarify, Russia has the money. She just can’t access it.

Since 2014, the last time the West sanctioned Russia for annexing Crimea, the Kremlin has amassed some $640 billion in foreign reserves. About half of those funds are now frozen under Western sanctions imposed after the invasion of Ukraine.

As a result, Moscow has said it plans to pay creditors of “hostile countries” in rubles rather than dollars or euros until sanctions are lifted, Russian Finance Minister Anton Siluanov said earlier this week.

But the nongovernmental agencies that determine credit quality are likely to consider such payments a cause of default. Since Russia’s invasion of Ukraine last month, all three of the major ratings firms – Fitch, S&P and Moody’s – have downgraded Russian debt from investment grade to what’s known as “junk” (which is exactly as bad as it seems).

What happened to Russia’s first debt payment?

Last Wednesday (16), a bill of US$ 117 million expired. This represents the total interest payment you owe on two US dollar-denominated securities.

It was unclear whether a payment was made, although the US Treasury said it would allow the transaction to go through.

For example, we won’t even know if Russia has made any payments until investors confirm they have received the funds. Russia’s finance minister said on Wednesday that Moscow had paid its bill and that it was up to US officials to decide whether it would be accepted.

(Previously, the finance minister had said that the payment would be made in rubles instead of dollars, which would violate the terms of the refund and trigger a default anyway.)

Investors who spoke anonymously to Reuters and The Wall Street Journal on Wednesday said they had yet to see the funds arrive.

“The thing about defaults is they are never clear, and this is no exception,” Guido Chamorro, portfolio manager for emerging markets, told Reuters.

Also muddying the situation is a 30-day grace period for the two bonds, meaning Russia would technically not default for another month. A lot can happen in that time.

What happens if Russia goes into default?

“A default is a disaster for Russia,” said Timothy Ash, senior sovereign strategist at BlueBay Asset Management.

The country’s attack on Ukraine has left it with few friends in the international community, and a default would likely cut off access to foreign funding for years.

Russia’s economy is already bleeding. Since the start of the war, the ruble has fallen to record lows, critical revenue is declining as oil traders shun Russian oil, dozens of international corporations have suspended operations, and sanctions have frozen more than $300 billion in oil reserves. foreign currency.

The pain of a default will be felt largely in Russia.

International Monetary Fund managing director Kristalina Georgieva said a financial crisis beyond Russian borders is unlikely to develop “for now”, saying the exposure of Western banks is “not systemically relevant”.

For anyone with flashbacks to the 2010 European sovereign debt crisis, now is a good time to take a deep breath. Systemic risk appears to be low.

But a default would also come at a time of great uncertainty in global markets. Analysts at Capital Economics have warned that if a financial institution is particularly exposed to Russian debt, it could trigger wider contagion. That means we won’t really know how bad this is until it happens.

— Julia Horowitz and Charles Riley of CNN Business contributed reporting.