Russia defaulted on its foreign currency debt for the first time in a century, culminating in increasingly tough Western sanctions blocking payment routes to foreign creditors.
For months, the country struggled with sanctions imposed after the Kremlin invaded Ukraine. But at the end of the day on Sunday, the grace period at about $100 million in tied interest payments expired on May 27, a deadline considered a default if missed.
It is a stark milestone in the country’s rapid transformation into an economic, financial, and political outcast. The country’s Eurobonds have traded at worrying levels since early March, the central bank’s foreign exchange reserves remain frozen, and the largest banks have been disconnected from the global financial system.
But given the damage already done to the economy and markets, the default is also mostly symbolic for now. It will make little difference to Russians facing double-digit inflation and the worst economic contraction in years.
Russia has opposed the default designation, saying it has the money to cover all bills and has been forced into non-payment. While trying to squeeze its way out, it announced last week that it would switch to paying off its $40 billion in ruble-denominated public debt, criticizing a “force majeure” situation it believes to be artificially created by the West. It had been manufactured.
“It’s very rare for a government that otherwise has the resources to be forced to default by an outside government,” said Hassan Malik, senior sovereign analyst at Loomis Sayles & Company LP. “It will be one of the largest defaults in history.”
A formal statement would normally come from rating agencies, but European sanctions led them to withdraw ratings from Russian entities. According to the documents for the notes whose grace period ended Sunday, holders can call one themselves if owners of 25% of the outstanding bonds agree that an “Event of Default” has occurred.
Now that the final deadline has passed, the focus is shifting to what investors do next.
They do not have to act immediately and may choose to monitor the war’s progress, hoping that sanctions will eventually be eased. Time may be on their side: According to the bond documents, the claims don’t become void until three years after the payment date.
“Most bondholders will remain cautious,” Takahide Kiuchi, an economist at the Nomura Research Institute in Tokyo.
During the Russian financial crisis and the ruble’s collapse in 1998, President Boris Yeltsin’s government defaulted on $40 billion in local debt.
The last time Russia defaulted on its foreign creditors was a century ago when the Bolsheviks under Vladimir Lenin rejected the country’s staggering debt burden in 1918.
According to Loomis Sayles’ Malik, author of “Bankers and Bolsheviks: International Finance and the Russian Revolution,” it approached a trillion dollars in current money by some measures.
By comparison, foreigners owned nearly $20 billion in Russian Eurobonds at the beginning of April.
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“Is it a legitimate excuse to say, ‘Oh well, the sanctions prevented me from making the payments, so it’s not my fault’?” said Malik.
“The broader issue is that the sanctions themselves were a response to an action on the part of the sovereign entity,” he said, referring to the invasion of Ukraine. “And I think history will judge this in the last light.”
Finance Minister Anton Siluanov called the situation a “farce” on Thursday.
While billions of dollars a week are still flowing into the state coffers from energy exports despite the protracted conflict in eastern Ukraine, he reiterated that the country has the means and will to pay.
“Everyone can say what they want,” Siluanov said. “But anyone who understands what’s going on knows this isn’t a standard in any way.”
His comments were prompted by the grace period that ended on Sunday. The 30 days were triggered when, on May 27, investors did not receive coupon payments due on the dollar and euro-denominated bonds.
The money got stuck after the US Treasury Department cleared a sanctions loophole, lifting an exemption that allowed US bondholders to receive payments from the Russian sovereign. A week later, the European Union also sanctioned the Russian paying agent, the National Settlement Depository.
In response, Vladimir Putin introduced new regulations stating that Russia’s obligations for foreign currency bonds are met once the appropriate amount in rubles has been transferred to the local paying agent.
Under those rules, the Treasury Department made its final interest payments Thursday and Friday, equivalent to about $400 million. However, none of the underlying bonds have terms allowing local currency settlement.
So far, it’s unclear whether investors will use the new tool and whether existing sanctions would even allow them to repatriate the money.
Siluanov says it makes little sense for creditors to default through the courts because Russia has not waived its sovereign immunity, and no foreign court would have jurisdiction.
“When we finally get to the point where diplomatic assets are requisitioned, it’s tantamount to cutting diplomatic ties and entering into direct conflict,” he said. Thiss would put us in a different world with completely different rules. We should react differently in this case – and not through legal channels.”