Russia defaults on loans for first time in a century as sanctions complicate next steps

Russian President Vladimir Putin gestures as he addresses a plenary session of the St Petersburg International Economic Forum in St Petersburg, Russia, Friday, June 17, 2022. AP Photo/Dmitri Lovetsky

Russia has defaulted on its external sovereign bonds for the first time in a century, the culmination of ever-tougher Western sanctions that have closed payment channels to foreign creditors.

For months, Russia had found ways to circumvent sanctions imposed after the Kremlin invaded Ukraine. But at the end of the day on Sunday, the grace period on about $100 million in frozen interest payments due May 27 expired, a deadline considered an “event of default” if missed.

The road to this point has been far from normal, as Russia has the resources to pay its bills – and has tried to do so – but has been blocked by sanctions. These restrictions also mean that there is huge uncertainty about what’s next and how investors can go about getting their money.

“With Russia benefiting from the high price of its energy exports, it clearly has both the means and the will to pay its external debt,” said Giles Coghlan, chief analyst at HYCM Group. It’s a “defect in a technical sense, so many investors may be willing to wait.”

Given the damage already done to the economy and markets, the default is also mostly symbolic for now, and matters little to Russians facing double-digit inflation and the worst economic contraction in years. But it’s still a grim marker of the country’s rapid transformation into an economic, financial and political pariah. The country’s Eurobonds have been trading at distressed levels since early March, central bank foreign exchange reserves remain frozen and the biggest banks are separated from the global financial system.

Russia has pushed back on the default designation, saying it has the funds to cover all bills and has been pressured into not paying.

As it tried to get out of it, it announced last week that it would switch to servicing its $40 billion of ruble-denominated sovereign debt, criticizing a ‘force majeure’ situation which it said had been artificially manufactured by the West.

Russia’s last sovereign default occurred in 1998, when the country’s financial collapse and devaluation of the rouble.

At the time, Russia avoided defaulting on its foreign Eurobonds, although President Boris Yeltsin’s government rolled back $40 billion in ruble-denominated debt, and also missed payments on dollar banknotes. issued by the state bank Vnesheconombank.

While these bonds were issued after an agreement with the so-called London Club in 1997 to restructure Soviet-era debt held by Western banks, they were technically Vnesheconombank bonds rather than Russian Federation bonds. , according to an article published by the International Monetary Fund. . In May 1999, the government also defaulted on a Soviet-era dollar bond, known as MinFin III, issued domestically but largely held by foreign investors.

According to Lee Buchheit and Elena Daly, sovereign debt lawyers who advised Russia during its 1990s restructuring, when the country restructured some of its debt at the time, which did not include its Eurobonds at the time. “The MinFins, although denominated in dollars, were governed by Russian law and could therefore be considered an internal debt,” they said.

The last time Russia fell into direct default with its foreign creditors was more than a century ago, when the Bolsheviks under Vladimir Lenin repudiated the nation’s huge indebtedness to the tsarist era in 1918.

By some metrics, it approached a trillion dollars in today’s money, according to Hassan Malik, senior sovereign analyst at Loomis Sayles & Company LP.

By comparison, foreigners held nearly $20 billion worth of Russian Eurobonds in early April.

A formal declaration of default would typically come from rating agencies, but European sanctions have caused them to withdraw ratings of Russian entities. According to the bond documents, holders can call one themselves if the owners of 25% of the outstanding bonds agree that an “event of default” has occurred.

Finance Minister Anton Siluanov on Thursday called the situation a “farce”.

He also said it made little sense for creditors to seek 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 amounts to severing diplomatic relations and entering into direct conflict,” he said. “And that would put us in a different world with completely different rules. We would have to react differently in this case – and not through legal channels. »

The 30-day grace period was triggered when investors failed to receive payment for coupons due on dollar and euro-denominated bonds on May 27. Bondholders have time to assess the situation: claims do not expire until three years after the date of payment, according to the surety documents.

With payments blocked, Vladimir Putin introduced new regulations that Russia’s obligations on foreign currency bonds are fulfilled once the appropriate amount in rubles has been transferred to the local paying agent.

The Department of Finance made its final interest payments, equivalent to about $400 million, under those rules on Thursday and Friday. However, none of the underlying bonds have terms that allow settlement in local currency.

So far, it is unclear whether investors will use the new tool and whether the existing sanctions would even allow them to repatriate the money.

“Is it a valid excuse to say, ‘Well, the sanctions prevented me from making the payments, so it’s not my fault’?” said Malik, who is also the author of “Bankers and Bolsheviks: International Finance and the Russian Revolution.”

“The larger problem is that the sanctions were themselves a response to action by the sovereign entity,” he said, referring to the invasion of Ukraine. “And I think history will judge that in that last light.”

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