LONDON – Russia faces its first sovereign external default in over a century after it made arrangements to make an international bond repayment in roubles earlier this week, even though the payment was due in U.S. dollars.
S&P on Saturday lowered the country’s foreign currency ratings to “selective default” on increased risks that Moscow will not be able and willing to honour its commitments to foreign debtholders.
Russia has not defaulted on its external debt since the aftermath of its 1917 revolution, but its bonds have now emerged as a flashpoint in its economic tussle with Western countries. A default was unimaginable until recently, with Russia rated as investment grade in the run up to its Feb. 24 invasion of Ukraine, which Moscow calls a “special military operation”.
Here are answers to key questions:
Russia was due to make a payment of $649 million to holders of two of its sovereign bonds on Monday. But the U.S. Treasury blocked the transfer, preventing Russia from using any of its frozen foreign currency reserves for servicing its debt.
Coming up with an alternative, Russia placed the rouble equivalent of those payments for bondholders from so-called unfriendly nations in special accounts at its National Settlement Depository.
Moscow has a 30-day grace period from the payment date, which was Apr. 4.
Analysts say Russia has the means and ability to pay. The country receives billions in U.S. dollars in revenue from energy exports, and while around half its foreign exchange reserves are frozen, it has hundreds of millions that are not.
Elina Ribakova, deputy chief economist at the Institute of International Finance, said this was likely a “willingness-to-pay situation.”
The U.S. Treasury did not ban correspondence banking with Russia, subject to checks, and has granted a license to allow for payments relating to Moscow servicing sovereign debt until May 25.
All this means it looks like Russia could still make the payment, if it wanted to, according to analysts.
WHATTYPE OF DEFAULT?
At its most basic level, a default is a breach of contract, though the term can cover a variety of scenarios.
Payment default is a failure to pay principal, interest or other amounts due after the grace period has passed, according to a paper by restructuring experts file:///C:/Users/8017535/Downloads/chapter-7-sovereign-default.pdf at the International Monetary Fund.
However, there are also technical defaults due to events such as administrative errors, generally viewed by market participants as minor and swiftly remedied.
Legal experts say payment in the wrong currency, in this case roubles, constitutes a non-payment.
Russia has dismissed the notion of a default.
“In theory, a default situation could be created but this would be a purely artificial situation,” Kremlin spokesperson Dmitry Peskov said on Wednesday. “There are no grounds for a real default.”
WHOWOULDCALL A DEFAULT?
A default is a state of affairs, not a credit rating though markets often look to credit-rating agencies to declare a default has occurred.
S&P, assigning Russia a “selective default” rating, said it did not expect investors would be able to convert the rouble payments into dollars equivalent or that the government will convert those payments within a 30-day grace period.
With major ratings agencies having withdrawn ratings on Russia it is not entirely clear what manner of announcements might be made.
A default will have wider ramifications.
It could, for example, trigger credit default swaps (CDS) – an insurance policy bought by investors for such a case. A determinations committee will take a view on whether a “non-payment” event has occurred. However, such a decision is generally taken after the grace period has passed.
There are around $6 billion worth of CDS contracts outstanding on Russia.
Russia could unilaterally declare a moratorium – a temporary or permanent payment stop.
Made as an announcement or legislation separate from the missed payment, a moratorium can come before or after the payment default, according to the IMF.
A government might announce a moratorium as an interim measure to halt payments before launching a debt restructuring, as Mexico did in 1982.
The declaration of a moratorium is also one of the potential triggers for CDS contracts.
WHATHAPPENSAFTER A DEFAULT?
Debt obligations at risk of, or already in, default are often snapped up by funds specialising in distressed situations, either hoping to make money when a restructuring is eventually worked out or to litigate in courts with the aim of getting compensation or seizing a debtor’s assets instead.
However, litigation and asset seizures are lengthy and costly processes. Many previous attempts have been unsuccessful, such as when creditors tried to seize Argentina’s famous navy vessel https://www.ecb.europa.eu/pub/pdf/scpwps/ecb.wp2135.en.pdf, the ARA Libertad, in 2012 over a debt default a decade earlier or Argentine dinosaur fossils exhibited in Europe.