EXPLAINER: What’s the latest in Russia’s dance with default?
Russia appeared to dodge default on its foreign debt by dipping into its scarce dollar reserves. Moscow’s debt drama is not over.
Russia’s finance ministry abandoned its proposal to use rubles instead of dollars to make overdue payments on two government bonds, saying Friday that it had transferred the money to an account at Citigroup: $564.4 million for a bond due in 2022, and $84.4 million for another due in 2042. A 30-day grace period on making the overdue payments was to expire Wednesday.
The government had claimed that U.S. sanctions freezing its massive currency reserves held abroad meant it couldn’t pay and that Russia wasn’t to blame for any default, the first on foreign debt since the 1917 Bolshevik Revolution.
Even if Russia has made the most recent payments other due are due. Plus, U.S. permission for American bondholders to accept payment on Russian bonds is set to expire May 25, so even if Russia tries to pay, investors would not legally be able to take the money.
Here’s a list of issues surrounding Russian debt.
WHY ARE PEOPLE TALKING ABOUT A POSSIBLE RUSSIAN DEADLINE?
Ratings agencies state that if bonds require payment in dollars, then payments in rubles amount to a failure of payment as promised. Russia may prefer to pay in rubles rather than its foreign currency reserves because a large portion of these have been frozen overseas. It paid Friday’s amount by accessing its limited internal reserves, which were immune to sanctions.
Russia cannot avoid default unless the money is transferred from Citigroup through the banking systems to bondholders before Wednesday’s deadline.
“Bondholders don’t get paid until Citigroup processes the payments” and pass them on to clearinghouses that distribute payment to bondholders, said Jay S. Auslander, a top sovereign debt lawyer at the firm of Wilk Auslander in New York.
Banks should be cautious about transactions with Russia. They may want to consult the U.S. or UK authorities first. Auslander stated that “I believe it’s probable that the funds will reach the bondholders in which case they will not be default this time.”
HOW MANY DOES RUSSIA OWE?
About $40 billion in foreign bonds, about half of that to foreigners. Before the start of the war, Russia had around $640 billion in foreign currency and gold reserves, much of which was held overseas and is now frozen.
HOW DO YOU KNOW IF A COUNTRY IS IN DEFAULT?
Rating agencies can lower the rating to default, or a court may decide the matter. Bondholders with credit default swaps, contracts that act as insurance policies against default, can ask a committee made up of representatives from financial firms to determine if a failure to repay debt should result in a payout. This is not a formal declaration.
The Credit Default Determination Committee — an industry group of 14 banks and investors that determines whether or not to pay on these swaps — said Friday that they “continue to monitor the situation” after Russia’s payment. After another meeting Tuesday, the committee said it would continue to monitor the situation and “defer publication of an Initial List of Deliverable Obligations.”
WHAT CAN INVESTORS DO?
The formal way to declare default is if 25% or more of bondholders say they didn’t get their money. After that, all Russian foreign bonds are in default and bondholders can seek a court order to enforce payment. In normal circumstances, investors and defaulting governments negotiate a settlement where bondholders receive new bonds with a lower value but at least partial compensation.
But sanctions prohibit dealings with Russia’s finance ministry. No one knows when the war will end, nor how much defaulted bonds might end up being worth.
In this instance, Auslander stated that declaring default and suing “mightn’t be the wisest decision.” “You cannot negotiate with Russia right away. You are entering a world with many unknowns and sanctions that are constantly changing. Creditors may decide to keep their intentions a secret and just wait for the right time. “
Popular sentiment is a consideration for investors, especially any who may have bought bonds at knocked-down prices in hopes of profiting from a settlement.
“It is not a good idea to show that you were making a profit from Russian distressed debt, Auslander stated. “Will that happen in the future?” I suspect it will.”
Once a country defaults, it can be cut off from bond-market borrowing until the default is sorted out and investors regain confidence in the government’s ability and willingness to pay. Russia is already cut off from the West capital markets so any return to borrowing will be a long way away.
The Kremlin is able to borrow rubles at home. It mainly relies on Russian banks for its bonds.
WHAT IMPACT CAN A RUSSIAN DEFAULT HAVE?
The country already feels the economic effects of Western sanctions. These have caused foreign companies to flee the country and disrupted financial ties with the rest the world. This isolation and disruption would continue to be a problem.
Investment analysts are cautiously reckoning that a Russia default would not have the kind of impact on global financial markets and institutions that came from an earlier default in 1998. The U.S. government intervened to get banks to bailout Long-Term Capital Management, an American hedge fund that was in danger of collapsing.
Holders could suffer serious losses, such as funds that invest in emerging markets bonds. Russia played a limited role in the emerging market bond indexes, which helped to limit losses for fund investors. While the war is having devastating effects on human suffering and higher energy prices around the world, default on government bonds would not be “definitely relevant” Kristalina Georgieva from the International Monetary Fund stated.
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