3 things to know as Russia heads to a historic debt default

Alexander Nemenov, AFP via Getty Images

A man walks past a currency exchange office in central Moscow on Feb. 28. The U.S. and its allies have imposed severe economic sanctions on Russia since its invasion of Ukraine.

Russia is on the verge of defaulting on its foreign debt for the first time since the Bolshevik Revolution more than a century ago.

Over the past week, the country faced two payment deadlines on bonds it previously sold to foreign investors. The combined interest was worth nearly $650 million, and Russia was supposed to have made the payments in dollars, according to the terms of the bond contracts.

But citing severe sanctions imposed by the U.S. and its allies, Russia made the payments in rubles.

That led credit-rating agency S&P Global to announce that Russia is now in a “selective default,” often a harbinger of a full default.

Russia does have a 30-day grace period, which gives it a little breathing room. But S&P Global isn’t optimistic that circumstances will change, and if Russia doesn’t make the payments in dollars by early May, the country will default.

Here’s what to know as the clock ticks down.

Is a default now inevitable?

It’s looking increasing likely.

Russia says it wants to pay foreign investors, but it argues it can’t do that in dollars because of the sanctions.

The U.S. and its allies have imposed a number of wide-ranging sanctions on Russian financial institutions and have prevented many global banks from working with Russia. They have also restricted Russia’s ability to tap its more than $600 billion in foreign exchange reserves.

So the U.S. has indeed made it exceedingly difficult for Russia to make those scheduled payments in dollars, as part of its efforts to isolate the country from the global financial system.

The Biden administration argues that Moscow can still find ways to pay, by using its earnings from energy exports, for example. Many EU members and other countries continue to buy Russian oil and natural gas.

There are also non-sanctioned financial institutions that Russia could turn to in order to facilitate debt payments.

“The Russian government has the ability, if they choose, to pay their debt obligations in the correct currencies stipulated in their contracts,” said Morgan Finkelstein, a Treasury Department spokeswoman, in a statement.

But Russia argues its hands are tied, and the country’s Finance Ministry has threatened to sue over its inability to access dollars to pay foreign investors.

What would be the impact of a default?

A default would make Russia more of a pariah in the global economy.

Selling bonds is a critical way that countries raise foreign currencies to fund projects and raise reserves of foreign currencies, among other purposes.

But the European Union is considering a ban on energy imports from Russia, which would further limit Russia’s ability to raise money in foreign currencies.

Countries that have defaulted on their bonds have eventually been welcomed back to global debt markets, but memories of a default linger and Russia may have to pay more to borrow from foreign investors in the future.

A default would also be historically significant and fraught with symbolism. It would mark the first time Russia has defaulted on foreign bond payments in more than a century (though it did default on local currency debt in 1998).

Russia’s predicament is yet another consequence of its invasion of Ukraine, according to Tim Samples, a professor at the University of Georgia who specializes in foreign investment.

“This is a reflection of just how far and how fast Russia has fallen from favor in Western capital markets,” he said.

So will foreign investors now lose their money?

Not necessarily, but most investors will need to go through a protracted legal battle to try to get the money they are owed.

Although Russia was not a big seller of foreign debt, major hedge funds and asset managers, including Invesco and PIMCO, bought bonds. Russia has 15 bonds outstanding that are denominated in dollars and euros, and altogether, they are worth around $40 billion, according to Morgan Stanley.

Much of Russia’s debt was registered in the United Kingdom, which is where it’s likely that most of the court fights will take place.

It can be a complicated process, and it will take a long time to resolve. After Argentina defaulted in 2001, several efforts were made to restructure the country’s debt. All told, negotiations lasted longer than a decade.

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Transcript :

AILSA CHANG, HOST:

Russia is on the verge of a default on its foreign debt, something that hasn’t happened in more than a century, since the Russian Revolution. Wide-ranging sanctions and trade restrictions have isolated Russia, but a default would make it even more of a pariah. And it could have lasting effects on the country’s economy. For more on this, we’re joined now by NPR’s David Gura. Hey, David.

DAVID GURA, BYLINE: Hey, Ailsa.

CHANG: So can you just explain for us, like, how did Russia get to this point where it’s on the edge of default?

GURA: Well, a lot has happened over the last week. Russia faced a deadline to make interest payments to foreign investors on two bonds to the tune of almost $650 million. Now, those payments had to be made in dollars, but Russia said that because of restrictions the U.S. and its allies have put in place, doing that, paying in U.S. currency, would be impossible. So Russia used rubles, and that is not allowed. These bonds are denominated in dollars. And the contracts require Russia to make these payments in dollars.

Shortly after this happened, the ratings agency S&P Global said Russia is in what’s called a selective default. This is often a preliminary step before a full default. Russia has a little breathing room here, a 30-day grace period, but the clock is already ticking on that. And if the country doesn’t make these payments in dollars by early May, Ailsa, Russia will effectively default.

CHANG: And what would be the effects of that if Russia defaults?

GURA: You know, a default would isolate Russia even more from the global economy at a time when it’s facing widening sanctions and dwindling reserves. Access to capital markets is crucial to countries that need to borrow to pay for all kinds of projects and programs. And while Russia’s debt load is fairly small relative to the size of its economy, a default would compound a situation that’s gotten worse and worse. So much of Russia’s foreign exchange reserves come from selling energy, and now the European Union is considering a ban on energy exports from Russia. A default is also something that would be historically significant and fraught with symbolism. Tim Samples is a professor at the University of Georgia who specializes in foreign investment.

TIM SAMPLES: This is a reflection of just how far and how fast Russia has fallen from favor in Western capital markets.

GURA: Now, countries have defaulted. And eventually, they’ve been welcomed back to the debt markets. But memories of a default tend to linger. And in the future, Russia may have to pay more to borrow.

CHANG: And, I mean, David, can Russia even make these payments that it owes?

GURA: This is a good question and a tricky question. I mean, the U.S. is making it as difficult as possible. The U.S. and its allies have frozen most of Russia’s foreign currency reserves. They’ve placed restrictions on financial institutions. Odette Lienau is a sovereign debt expert at Cornell Law School.

ODETTE LIENAU: There has been shift in policy. And so there is a lack of a technical capacity to actually make these payments.

GURA: But it’s not impossible. I mean, Russia does have dollars elsewhere. It could get more dollars selling energy. And although many banks are barred from doing business with Russia, there are nonsanctioned banks with which it could work.

CHANG: Well, what about foreign investors? Like, are they going to be losing money?

GURA: Yeah, when we say foreign investors, we’re talking about hedge funds and emerging markets funds run by asset managers like Invesco and PIMCO, along with some individual investors. Sovereign debt experts told me that if investors didn’t sell these bonds in the early days of the war, there’s not much more they can do than wait. But right now, all signs point to a default. And if that happens, what we can expect is a significant, protracted legal battle over these payments. The strange wrinkle here is that Russia’s finance minister says Russia is also prepared to sue over how this has played out. This is likely to take a while. Just keep in mind that after Argentina defaulted, negotiations went on for more than a decade.

CHANG: That is NPR’s David Gura. Thank you, David.

GURA: Thank you. Transcript provided by NPR, Copyright NPR.