The clock ticks towards a Russian default

Russia is facing its first sovereign external default for over 100 years. Russia made arrangements earlier this week to repay international bonds in roubles, despite the fact that the payment was due in U.S. Dollars.

S&P reduced the country’s foreign currency rating to “selective default” Saturday due to the increased risk that Moscow may not be able or willing to honor its obligations to foreign debtholders.

Russia has not defaulted in respect of its external debts since 1917, but these bonds are now a major issue in Russia’s economic dispute with Western countries. A default was impossible until recently. Russia was rated investment grade during the period leading up to its February 24 invasion of Ukraine. Moscow called it a “special military operations”.

These are the key questions we can answer:

CAN RUSSIA PAY?!

On Monday, Russia was scheduled to pay $649 million to two holders of its sovereign bonds. The U.S. Treasury stopped the transfer and prevented Russia from using any frozen foreign currency reserves to service its debt.

Russia came up with an alternative solution. It placed the Russian rouble equivalent of these payments for bondholders coming from unfriendly countries in special accounts at its National Settlement Depository.

Moscow offers a 30-day grace period starting from Apr. 4.

Analysts believe Russia has the ability and means to pay. Russia receives billions of dollars in energy export revenue. While around half of its foreign currency reserves are frozen, hundreds upon millions are not.

Elina Ribakova (deputy chief economist at the Institute of International Finance) stated that this was likely to be a “willingness to pay situation.”

The U.S. Treasury has not banned correspondence banking with Russia. However, checks have been made and a license has been granted to allow payments to Moscow for servicing sovereign debts until May 25.

Analysts believe that Russia could still pay the money if it so desired.

WHAT TYPE IS DEFAULT?

A default can be described as a breach of contract at its most basic, but it can also refer to a range of situations.

According to restructuring experts from the International Monetary Fund, payment default refers to failure to pay principal, interest, or any other amounts due to the International Monetary Fund.

There are technical errors due to events like administrative errors. These are generally considered minor and quickly remedied by market participants.

Experts in legal matters say that payment in the wrong currency (in this case, roubles) constitutes non-payment.

Russia denies any notion of default.

Dmitry Peskov, a spokesperson for the Kremlin, stated Wednesday that a default scenario could theoretically be created. However, this would be an artificial situation. “There is no reason to create a default situation.”

Who WOULD CALL A DEFAULT

A default is a condition, not a credit rating. Markets often turn to credit-rating agents to declare that a default has taken place.

S&P gave Russia a “selective default” rating. It stated that it didn’t expect investors to be able to convert the rouble payments in dollars equivalent, or that the government would convert these payments within a 30-day grace.

It is unclear what announcements may be made after major rating agencies have withdrawn Russia ratings.

A default can have more severe consequences.

It could trigger credit default swaps (CDS), which are insurance policies that investors buy to cover such an event. A committee of determinations will decide if a “nonpayment” has occurred. This decision is usually made after the grace period expires.

Russia has approximately $6 billion in CDS contracts.

WHAT ELSE CAN HAPPEN?

Russia could unilaterally declare a Moratorium, a temporary or permanent stop to payments.

A moratorium is an announcement or legislation that is separate from the default payment. According to the IMF, it can be either before or after the default payment.

A government could announce a moratorium to temporarily halt payments prior to initiating a restructuring of its debt. This is similar to what Mexico did in 1982.

A declaration of a moratorium can also trigger CDS contracts.

WHAT HAPPENS AFTER A DEFAULT

Funds that specialize in distressed situations often take over debt obligations in default or at risk. They either hope to make money from restructuring or to sue the debtor in court with the goal of obtaining compensation or seizing their assets.

Asset seizures and litigation can be costly and time-consuming. Many of the previous attempts failed, including when creditors attempted to seize Argentina’s famed navy vessel in 2012, over a decade-old debt default or Argentine dinosaur fossils exhibited in Europe.


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