Picture Credit: Central Banking website
For the first time since the Bolshevik revolution more than a century ago, Russia has defaulted on its foreign debt. Russia's situation is complicated by its growing isolation as a result of unprecedented sanctions imposed on it by Western powers.
What is a default?
Governments take out loans to finance large projects, and those loans must be repaid on a regular basis according to a schedule. A default occurs when a borrower fails to pay the interest or principal on a loan when it is due. Bonds are issued by governments to borrow money. Investors both at home and abroad purchase those bonds, effectively lending money to the government with the agreement of repayment with interest. Failing to pay results in a default, which is now the situation in Russia. Russia hasn’t defaulted on foreign debt obligations since 1917 until now.
Moscow failed to pay approximately $100 million in interest on two bonds during a 30-day grace period that expired Sunday, demonstrating the power of Western sanctions imposed on Russia since its invasion of Ukraine. Russia denied the default state, mentioning that the payments had been made on May 27th using dollars and Euros, and that the money was stuck with a settlement house based in Belgium, Euroclear. The Kremlin had been determined to avoid the default, which is a major scar to the nation’s prestige. The finance minister of Russia has branded the situation as "a farce."
The last time Russia defaulted on foreign debt was when the new communist leader, Vladimir Lenin, refused to pay the debts of the Russian Empire in 1918, during the Bolshevik Revolution. In 1998, when the country was in the midst of a roble crisis at the end of Boris Yeltsin’s regime, Moscow failed to keep up on payments for domestic bonds. Yet the country managed to default on its overseas debt.
Although the United States and other Western governments managed to have half of Russia’s foreign reserves frozen, the country has managed to avoid default up to now. The sanctions failed to cripple Russia’s economy largely as many had expected, as a surge in energy prices was observed in world economy. Though Russia has the money to pay its debts, and it has been unable to access its foreign reserves, the country has continued to pay its creditors without accessing the country’s frozen foreign assets.
This historic default had been anticipated by the world, as most of Russia’s foreign reserves were frozen and the US Treasury decided not to renew the special exemption in sanctions rules allowing investors to receive interest payments from Russia, which expired on May 25th. The European Union too has made it harder for Moscow to meet its debt obligations with the sanctioning of Russia’s National Settlement Depository, which is the country’s agent for its foreign currency bonds, earlier this month.
The Kremlin appears to have accepted this too, stating that all future debt payments would be made in rubles via a Russian bank, The National Settlement Depository, though the contracts mention that they should be made in dollars or other international currencies.
It's not clear what effect the default will have on Russia's economy in the near future, as its existing bonds have collapsed in value and defaulting nations usually find it impossible to borrow any more money. In the long term, Russians will certainly suffer as the country is left with few friends in the international community due to its assault on Ukraine, and the default will cut off access to foreign financing for a long period.
Picture Credit : The West Australian website