Unpaid default interest on a dollar bond is bringing Russia to the brink of its first default since the Russian Revolution more than a century ago. One reason is the sanctions of the European Union. She recently redlisted a payment processor that Moscow wanted to use to service its eurobonds.
Russia has repeatedly encountered financial difficulties over the past 100 years. In 1918, for example, the governing Bolsheviks refused to recognize old foreign debts from the time of the tsars. So far, the country has always been able to avert a default, but this time it could fail.
What is unusual is that Russia does not default due to a lack of funds. The country has large foreign exchange holdings and earns billions a month from oil and gas exports. So the roughly $40 billion in foreign debt outstanding — with about $2 billion in payments due by the end of the year — should be easy to handle.
However, the country has been largely cut off from international payments by Western sanctions in response to the Russian invasion of Ukraine ordered by President Vladimir Putin. In addition, part of its currency reserves are frozen. An exemption that allowed US holders of Russian government bonds to receive payments has now expired. This is bankrupting Russia by blocking the path by which payments would reach bondholders’ bank accounts.
Russia is trying to find a way out by instructing creditors to pay in Russian rubles or in hard currencies other than the dollar, bypassing the western payment infrastructure. Finance Minister Anton Siluanov suggested copying the ruble conversion payment system imposed on European gas customers. The creditors open accounts with a Russian bank and pay in currencies other than the dollar.
However, the plan would not have allowed Russia to avoid a default because US investors would not have been able to get involved. And on Friday, the European Union imposed sanctions on Russia’s National Settlement Depository, which was supposed to handle bond payments.
Russia could be considered officially insolvent at the end of June. It is questionable whether interest payments, which Russia says it ordered on May 27, will also reach the bondholders because of the sanctions. Specifically, it is about interest payments of 71.25 million US dollars and 26.5 million euros (equivalent to 28 million US dollars). In order to avert a payment default, the money must end up in the accounts within a grace period of 30 days.
Russia only repaid a bond that was due in early April shortly before the grace period expired on May 2. However, since this did not include interest on arrears of over $1.9 million, creditors had submitted the case to the CDDC Investors Committee. The committee then classified Russia as a defaulting payer. As a result, buyers of default insurance policies can assert claims against providers of these so-called credit default swaps (CDS).
Russia is already cut off from global financial markets. Aside from reputational damage, a payment default has other consequences. Creditors could go to court to confiscate Russia’s foreign assets.
In addition, a long and costly process to restructure defaulted debt looms should Russia and the West reconcile in the future. A state bankruptcy usually increases the cost of borrowing in the long term and could therefore cost Russia dearly for years to come.