(Bloomberg) – Russia is defaulting on its sovereign debt in foreign currency for the first time in a century, culminating in increasingly harsh Western sanctions that closed the avenues of payment to foreign creditors.
For months, the country found ways around the sanctions imposed after the Kremlin’s invasion of Ukraine. But at the end of the day on Sunday, the grace period of about $ 100 million in interest payments pasted on May 27 expired, a term considered a default event if lost.
It is a sad sign of the country’s rapid transformation into an economic, financial and political outcry. The country’s Eurobonds have been trading at distressed levels since early March, the central bank’s foreign reserves remain frozen and the largest banks are separated from the global financial system.
But given the damage that has already been done to the economy and markets, the default is also mostly symbolic for now and it doesn’t matter to Russians suffering from double-digit inflation and the worst economic contraction in recent years.
Russia has rejected the default designation, saying it has the funds to cover any bills and has been forced not to pay. While trying to twist its exit, last week it announced it would switch to serving its $ 40 billion outstanding sovereign debt in rubles, criticizing a “force majeure” situation that it said was artificially fabricated by the West.
“It’s a very, very rare thing where a government that otherwise has the means is forced by an outside government to default,” said Hassan Malik, senior sovereign analyst at Loomis Sayles & Company LP. “It will be one of the great defaults in history.”
Normally, a formal statement came from the rating companies, but European sanctions led them to withdraw the ratings from the Russian entities. According to the documents in the notes whose grace period expired on Sunday, holders can call them themselves if the owners of 25% of the outstanding bonds accept that a “Breach Event” has occurred.
When the deadline has passed, the focus is on what investors are doing next.
They do not need to act immediately, and may choose to monitor the progress of the war in the hope that sanctions will eventually soften. Time may be on your side: claims only become void three years from the date of payment, according to bail documents.
“Most bondholders will keep the focus on wait and see,” said Takahide Kiuchi, an economist at the Nomura Research Institute in Tokyo.
Russia’s default struggle with bondholders is just beginning
During Russia’s financial crisis and the collapse of the 1998 ruble, the government of President Boris Yeltsin defaulted on $ 40 billion of its local debt.
The last time Russia defaulted on its foreign creditors was more than a century ago, when the Bolsheviks under Vladimir Lenin repudiated the nation’s tsarist-era debt in 1918.
By some measures it was approaching the trillion dollars in money today, according to Malik of Loomis Sayles, who is also the author of “Bankers and Bolsheviks: International Finance and the Russian Revolution.”
By comparison, foreigners had the equivalent of nearly $ 20 billion of Russian Eurobonds in early April.
Russia’s debt kept abroad below 50%, first time since 2018: chart
“Is it a justified excuse to say, ‘Well, the sanctions prevented me from making the payments, so it’s not my fault’?” said Malik.
“The broader issue is that the sanctions were in themselves a response to an action by the sovereign entity,” he said, referring to the invasion of Ukraine. “And I think history will judge him in that last light.”
Finance Minister Anton Siluanov on Thursday dismissed the situation as a “farce.”
With billions of dollars a week still pouring into the state coffers from energy exports, despite the stressful conflict in eastern Ukraine, he reiterated that the country has the means and the will to pay .
“Anyone can declare whatever they want,” Siluanov said. “But anyone who understands what’s going on knows that this is by no means a default.”
His comments were motivated by the grace period that ended Sunday. The 30-day period was activated when investors did not receive coupon payments to be paid in dollar- and euro-denominated bonds on May 27th.
The cash was trapped after the U.S. Treasury let a sanctions breach expire, removing an exemption that had allowed U.S. bondholders to receive payments from the Russian sovereign. One week later, Russia’s paying agent, the National Settlement Depository, was also sanctioned by the European Union.
In response, Vladimir Putin introduced new regulations that say that Russia’s obligations on foreign currency bonds are met once the appropriate amount in rubles has been transferred to the local paying agent.
The finance ministry made its final interest payments, equivalent to about $ 400 million, according to those rules Thursday and Friday. However, none of the underlying bonds has terms that allow for settlement in local currency.
So far, it is unclear whether investors will use the new tool and whether existing sanctions would allow them to even repatriate the money.
According to Siluanov, it makes little sense for creditors to request a declaration of default through the courts because Russia has not waived its sovereign immunity and no foreign court would have jurisdiction.
“If we finally get to the point where diplomatic assets are claimed, that is tantamount to breaking diplomatic ties and entering into direct conflict,” he said. “And that would put us in a different world with completely different rules. We should react differently in this case, and not through legal channels.”
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