What does the Russian default mean for the world economy?

The Russian default on foreign debt was waiting to happen and on Sunday, the default actually happened. Russia missed payments on two foreign-currency bonds even after the completion of the 30-day grace period. The amount of $100 million had become due on 27th May, but since such payments have a regular grace period of 30 days, the actual default is said to have occurred when the payment was not made by 27th June. This is the first time that Russia had defaulted on a foreign loan after 1918.

Interestingly, the default is not because Russia does not have the funds or does not intend to pay. It is just that most of their dollars held abroad have been frozen to limit the funds for their war operation in the light of Russia’s recent onslaught on Ukraine. This had virtually cut off Russia from the global payment and financial system. Russian banks had been banned from the international SWIFT participation while even the clearing banks for the Russian government were part of the overall sanctions on Russia.

It is not like there have not been defaults in the past. Just a few weeks back, Russia had defaulted on about $1.8 million of interest payment, but that was a very small default to be material. In 1998, during the Rouble collapse, Russia had defaulted on $40 billion of domestic debt. But the last big default on international debt was in 1918, when in the aftermath of the Bolshevik Revolution, Vladimir Lenin abdicated all the debts owed by the Tsarist regime of the day. This is the first big overseas default since then.

Of course, the actual issue could pull on interminably. Russia has consistently argued that it was a default manufactured by the United States of America but artificially freezing its dollar reserves abroad. At the same time, Russia has also underlined that they would transfer equivalent amounts at each due date in roubles and the same would be treated as discharge of obligations. The final opinion of default will depend on what the rating agencies would say, but then most rating agencies have already withdrawn their ratings on Russia. 

Actually, Russia is not technically incorrect. They earn billions of dollars from the sale of oil and gas and the total foreign debt of Russia at $40 billion was just a small portion. So, default should never be a major issue for Russia. Vladimir Putin has himself alleged that the US has been trying to force a default on Russia by Kremlin’s ability to tap foreign bank accounts or use cross-border payment networks to move money. There was a sanctions exemption to pay in Roubles, which the US Treasury has allowed to expire.

So, what happens next?

The big question is what happens next? Here are some possibilities
 
   1) Since Russia has the resources and the intent to pay the debt, it poses unique legal challenges. Bond investors will declare a default but Russia would declare its obligation as being fulfilled. It may finally boil down to a battle over jurisdiction.

    2) To begin with, if default has to be enforced, then 25% of the bonds have to agree through their holders to invoke the acceleration clause, by which then can demand immediate repayment. That gives bond holders 3 years to being claims.

    3) There are also some legal grey areas. There are cases where Euroclear received funds for May interest payment before the exemption expiration. It is not clear if the dollar payment rule would then apply in this case or Russia would get an exemption.

    4) No ripple effect is seen in the Russian market as the markets are already in the doldrums with a sharp fall in bond values, a steep decline in growth and sky high inflation. Any additional impact of the default looks unlikely on Russia.

    5) Theoretically, once the claims are established, creditors can chase Russian sovereign assets abroad in various countries. But that is a situation which most of the bond holders themselves are wary of, knowing how tough it is dealing with the Russian government. 

For now, bond holders are hoping that the war would end, sanctions lifted and things would be back to normal. The alternate methods of recovering funds are much worse. It would be interesting to see how the bond holders actually react. Global impact is likely to be limited.