War in Ukraine: should we be afraid of a payment default from Russia?
Russia may not be able to repay, on Wednesday, $ 117 million it owes to international creditors. It would then default on its external debt for the first time since the 1917 revolution. A strong symbol, due to the sanctions imposed after the start of the Russian invasion in Ukraine, but the consequences of which would be limited.
Two Vladimirs, one flaw. Vladimir Putin's Russia runs a strong risk, on Wednesday March 16, of not reimbursing its international creditors. The last time the country thus defaulted on its external debt dates back to the beginnings of the Bolshevik Revolution in 1918, when Vladimir Ilyich Ulyanov, known as Lenin, was in charge.
A default by Moscow “is no longer unlikely”, warned Kristalina Georgieva, the director of the International Monetary Fund (IMF), Sunday March 13. The major rating agencies - Fitch, Standard & Poor's and Moody's - have all downgraded Russian debt to toxic investment status, signaling their lack of faith in the Russian state's ability to repay.
The threat of paying in rubles
This widespread pessimism concerns a $117 million payment Russia is due to make on Wednesday. It's nothing and, even a month ago, the idea that Moscow was unable to repay this debt would have made any investor smile. “Russia was in a most comfortable fiscal situation, thanks to the significant gas and oil revenues and the more than 630 billion dollars of foreign currencies held by the Russian Central Bank”, recalls the Wall Street Journal.
But since then, Vladimir Putin has launched the invasion in Ukraine, inciting the Western powers to multiply economic sanctions in order to deprive the Kremlin of the famous “nerve of war”: access to money.
"What took Russian power by surprise was the American decision to freeze the Russian Central Bank's dollar assets," said Sergueï Popov, economist at Cardiff University, contacted by France 24. The story therefore does not stutter completely since in 1917, Lenin had decided not to reimburse the debts contracted by the tsarist regime. Today, even if Russia wanted to pay, it simply would not have access to the funds (in dollars) necessary to mop up its slate, however small.
Anton Silouanov, Russian Minister of Finance, has also warned that the debts owed to investors from “countries which have shown themselves hostile to Russia will be paid in rubles”. What give cold sweats to these international creditors, since the Russian currency is currently in free fall. They may be able to be paid in rubles the equivalent of what they were owed in dollars one day, but the next day that sum paid will probably be worth much less.
But this trick will not allow Moscow to escape default. Receivables whose interest must be paid on Wednesday are to be settled in dollars, so “technically, paying in rubles is a breach of contract which is equivalent to a default in payment”, summarizes Sergei Popov.
Very different from the default of 1998
Default of payment that will not occur immediately, because there is always a grace period of thirty days to give a chance to negotiations on the debt. Except that in this case, the mood is not too much for amicable settlement. “The grace period can be shortened by rating agencies [who have the authority to declare that a debtor cannot pay] if they believe that Russia is not willing to find a compromise”, underlines the American channel CNN.
This likely default raises the specter of 1998, when Russia last failed to pay some of its debts. At the time, the near bankruptcy of the state had led to a deep economic crisis in the country. Unemployment had skyrocketed from about 8% to nearly 12% in one year, while prices had soared more than 80% in 1999.
If history were to repeat itself, perhaps the Russian population would revolt against the master of the Kremlin for his decision to drag the country into a costly war? It is far from certain. Without even mentioning the uncertainties linked to a popular uprising in Russia, the default of 2022 has nothing to do with that of 1998.
“At the time, it was a default on internal debt, held by Russian banks and companies. In other words, they could no longer function properly, because they relied on the reimbursement by the State of the debts they held. This time it is only foreign investors who are concerned, which has no direct impact on the lives of Russians”, summarizes Sergei Popov.
The only concrete consequence, if Moscow cannot repay, is that the country will no longer have access to international capital markets to raise funds. "It does not bother Vladimir Putin unduly at the moment," said Sergei Popov. Especially since the Russian state finances itself more on the domestic market than on borrowing from international creditors.
What may have a stronger impact on the Russian President's warlike determination, it is all foreign companies that are withdrawing from the Russian market. This big departure means “everything that was manufactured abroad and that the Russian economy needs will soon no longer be available”, explains Sergei Popov. Some parts of the planes are built by foreign groups, as are spare parts for tractors used in cereal fields or machine tools used in oil-to-diesel processing plants.
The whole question is when Russian stocks will run out. It may not be fast enough to have an impact on the offensive in Ukraine, but “the idea is to avoid Vladimir Putin pushing his ambitions even further, whether in Poland or Estonia, for example,” says Sergei Popov. Without spare parts to repair planes or the ability to quickly produce fuel for tanks, fighting a war becomes much more difficult.
But before we get there, the default that is looming on the horizon could hit Western banks or businesses hard. In 1998, one of the largest American investment funds almost went out of business, while the Russian (payment) default was above all an internal affair, recalls the Financial Times. This time, Moscow is directly threatening not to repay its international creditors. Some large groups risk big, such as the American investment fund Pimco which could lose more than 1 billion dollars, underlines Bloomberg.
However, Moscow has been careful since 2014 not to borrow too much money from international creditors. In all, the Russian state only owes about $70 billion to banks or foreign investment funds. Not enough to destabilize the international financial system if Russia were to reimburse nothing. “The GameStop affair [of small investors having bet on groups in decline on the stock market, causing the loss of billions to large funds which were betting on the fall of these values] had a greater impact than what could have the Russian default,” said Sergei Popov. And when Argentina went bankrupt in 2001, it owed some more money to international creditors and despite that there was no global financial shock.
But the game of historical comparisons has its limits, warns Capital Economics, a North American financial think tank which published, in early March, an analysis note on the consequences of a Russian default. The main danger would come from a bank or an investment fund that has invested too much in Russia and finds itself on the verge of bankruptcy because Moscow can no longer repay. And the existence of such a black sheep will only be known if Russia is really lacking.
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