Russia gets caught in a messy financial web woven by the West

Russia’s “default” on its foreign currency sovereign debt last weekend is one of the stranger outworkings of the web of sanctions the West has woven around Russia’s finances.

While the failure of about $US100 million ($144 million) of interest payments to reach foreign bond holders is being described as a default, and technically is one, the ratings agencies that would normally declare the default have yet to do so.

The West made a Russian default inevitable.Credit:AP

They can’t, because the sanctions prevent them from rating Russian bonds.

The bond holders who haven’t received their money could themselves declare a default but, in a practical sense, it would have no near-term impact. Russia didn’t waive its sovereign immunity in the bonds’ documentation and it is unclear who, if anyone, would have the jurisdiction to hear any claim they might have or whether Russia would observe any judgement if one were made.

Russia had gone to great lengths, until the weekend, to avoid triggering any defaults but a pathway through the sanctions net that had been deliberately left open and that allowed US bond holders to receive payments from the Russian government was closed by the US Treasury late last month.

Then the European Union sanctioned Russia’s National Settlement Depositary, completing the wall around Russia’s ability to transfer funds out of the country.

The bizarre aspect of the situation is that Russia has the funds to meet the payments and avoid default – it is still raking in billions of dollars a month from its oil sales – and is willing to pay them out. Indeed, the government transferred the funds to an agent within Russia. The problem is that the agent is unable to deposit those funds in the bondholders’ accounts because of the sanctions.

Perversely, it’s not Russia being punished by the default but the foreign bondholders who haven’t received their interest payments.

The default is being widely described as “symbolic,” which was perhaps the point of the decisions by the US and EU to act to ensure Russia couldn’t complete the payments and therefore to force it into its first default on foreign debt in more than a century. (The Bolsheviks repudiated Russia’s foreign debt obligations in 1918 while Boris Yeltsin’s government defaulted on $US40 billion of purely domestic debt).

Russia’s finance minister, Anton Siluanov, said of the failure to get the funds into bondholders’ accounts that anyone could declare whatever they wanted to but “anyone who understands what’s going on knows that this is in no way a default.” At the fundamental rather than technical level, it’s hard to argue against that.

The bid by the US and EU to choke Russia’s energy revenues is much more devastating for Moscow than falling into a default. Credit:AP

The US and Europe presumably wanted to attach the odious label of defaulters to the Russians, as well as signalling that the net of financial sanctions had been completed and that Russia is now largely, albeit not entirely given its relationships with China and India and a handful of others, cut off from the core of the global financial system.

It was a manufactured default that will inevitably be followed by others as interest and principal payments on other issues of the $US20 billion of debt owed to foreigners fall due.

It is a messy situation, although Russian bonds have traded at fractions of their face value ever since the first round of sanctions were announced and therefore the bondholders were well aware of the prospect of default.

Theoretically, the bondholders could try to sue for payment although, as noted, that’s not straightforward. They could also try to convince a court to allow them to seize assets, including the central bank reserves that have been frozen in offshore jurisdictions, or Russian government properties offshore. Sovereign and diplomatic immunities would complicate those efforts.
Alternatively, they could simply wait for the eventual resolution of the war in Ukraine and hope that the sanctions will eventually be lifted and Russia allowed to re-engage with the global financial system and bond markets and be able to repay their debt.

As Argentina has demonstrated – even after defaulting eight times on its sovereign debt – for investors, time and attractive yields heal most wounds.

Apart from Russia’s demonstrated willingness to pay, there’s no doubt about its capacity to pay.

After sanctions were imposed after its invasion of Crimea in 2014 Russia went to great lengths to build up its foreign exchange reserves (half of which are now frozen by the Ukraine-related sanctions) and reduce its overall debt and its foreign liabilities.

It has a debt-to-GDP ratio of only about 17 per cent and, with higher oil prices offsetting the limited markets into which it can now sell its oil and the big discounts it has to offer to attract those buyers (primarily China and India), it is estimated to have generated roughly $US100 billion in oil revenues since the start of the invasion.

The US and Europe presumably wanted to attach the odious label of defaulters to the Russians.

The US and EU are now trying to choke those revenues by imposing price caps on Russian oil, using the dominance of UK, EU and US insurers and reinsurers and the threat of uninsured ships and cargoes to enforce them.

That is of more consequence for Russia and its economy than any default.

It already has economic issues, given it is experiencing an inflation rate of more than 17 per cent and is economy is tracking towards a double-digit contraction. The World Bank has said it expects Russia’s GDP (which includes a first quarter largely unaffected by the sanctions) to shrink 8.9 per cent this year. The oil revenues are its economic lifeline.

The default that has captured so much attention this week is unusual, indeed unprecedented, but in contrast to the more serious threats to Russia’s finances will eventually be an historical curiosity as the first sovereign debt default triggered, not by the inability or unwillingness to pay by the debtor nation, but by the active efforts of its creditor nations to prevent it from paying.

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