Russia Defaults on Bond Payments After US Blocks Funds

April 12, 2022

The Russian government has defaulted on its sovereign debt for the first time in more than a century, according to S&P Global, the ratings firm that tracks the creditworthiness of governments and major businesses around the world.

The news comes days after the Russian government, unable to access U.S.-dollar reserves in foreign banks, made an April 4 payment of $649 million in Russian rubles.

Russia’s failure to make payments to its bondholders was a result of the various sanctions that have been put in place to punish the country’s government for the ongoing conflict in Ukraine. Last week, on the day that the payments were due, the U.S. Treasury announced that it would tighten restrictions on Russia’s foreign reserve assets held in U.S. banks.

Despite the sanctions imposed in the days after February 24 when Russia began the latest conflict, American banks had been allowed to process certain Russian government payments, including those to bondholders.

As a result of the Treasury's change of position, JPMorgan Chase, the bank where Russia holds large deposits of U.S. dollars, was unable to process the payment due on April 4.

Rubles no substitute

The move by the U.S. left Russia the option of paying its bondholders using hard currency held by the country’s central bank. But on that same day, Russia instead transferred what it said was an equivalent amount of Russian rubles to accounts set up for bondholders from “unfriendly nations” and declared the payments to have been made in full.

On Monday, S&P Global confirmed that the transfer of rubles did not constitute a payment of Russia’s debt because the contract specifically required that payment be made in dollars.

Technically, there is a 30-day grace period, which gives Russia until early May to make the payment and avoid default. However, S&P Global said in a statement it does not expect the country to be able to make the payment at all.

“Sanctions on Russia are likely to be further increased in the coming weeks, hampering Russia’s willingness and technical abilities to honor the terms and conditions of its obligations to foreign debt holders,” the company said.

Russia protests

In an interview with the pro-Kremlin Izvestia newspaper published Monday, Russian Finance Minister Anton Siluanov described the default as artificial because Russia has the means to make its payments but is being prevented from doing so.

“Russia tried in good faith to pay off external creditors,” he told the newspaper. “Nevertheless, the deliberate policy of Western countries is to artificially create a man-made default by all means.”

Siluanov said the Kremlin will take legal action in an effort to reverse the effects of the default.

“Of course we will sue, because we have taken all the necessary steps to ensure that investors receive their payments,” he said. However, he predicted that the process would be long and difficult.

Circumstances uncommon

While sovereign defaults are not unheard of, the circumstances around Russia’s failure to make its dollar-denominated payments are somewhat unusual, said Anna Gelpern, a law professor at Georgetown University and a fellow at the Peterson Institute for International Economics.

In the past, sanctions have resulted in countries defaulting, usually because they contribute to the economic destruction of the countries subject to them, draining them of the money they need to make payments. Russia is not really short of cash, given its large foreign reserves and its continued receipt of income from the sale of oil and natural gas.

“It’s not unusual in that the payment system is a point of pressure,” Gelpern told VOA. “It is unusual in that the point of pressure is not economic or financial but political."

A bit of ‘theater’

“In a way, it’s all theater, right?” Nicolas Veron, a senior fellow with Bruegel, the Brussels-based economic think tank, told VOA.

“There's no economic driver for this. It’s entirely political, depending on what the U.S. allows, or doesn’t, with the exception that Russia has no appetite for getting their limited amounts of hard currency out of the country,” Veron said.

He pointed out that as a practical matter, the default will change little for Russia in the near term.

“The fundamental equation of Russia at this point is that they have a current account surplus, because of all the oil and gas that they sell and the high prices, thereof,” Veron said. “They get more money from the rest of the world than they have to spend there, especially as the economy is collapsing, and therefore imports are going down and not up.”

Future impact likely small

For most countries, a sovereign debt default might trigger a cascade of financial calamities, most notably making it extremely difficult to borrow on good terms in the future. But according to Gelpern, Russia has damaged itself to a point at which normal decisions about creditworthiness won’t be at the top of investors’ minds going forward.

“In the markets, waging genocidal war and getting sanctioned seems to be somewhat distinct from the sorts of things we think of going into your market reputation for repaying your debts,” she said. “So, to the extent that this episode reveals anything, it tells investors … that they can't count on Russia to be a member in good standing of the global economic system, in the eyes of the governments that have the power within that system.”

Additionally, she noted that the brutality of the assault on Ukraine and its people virtually guarantees that the Russian Federation will be the subject of a large number of court claims in the coming years, and that they will likely tie up Russian Federation assets that were stranded abroad after sanctions began to take hold.

“There are so many different pots of assets strewn about the world,” Gelpern said, “because they were evidently not prepared for the breadth of the sanctions.”