FAQ
Russia appears to be facing its first default on foreign debt in more than a century. This is primarily due to the financial sanctions imposed as a result of the Ukraine war. The long-term consequences could be problematic for the Kremlin.
If a state has debts, interest is due on them – and if a state cannot pay them, it is considered insolvent, with often dramatic consequences. Such a case is now also threatening Russia, at least on paper: A 30-day period expired at the weekend during which Russia can still make late interest payments without triggering a default.
“We do not agree with that,” said Kremlin spokesman Dmitry Peskov, according to the Interfax agency, and rejected the reports. Russia stressed that it was economically able and willing to service the debt. However, Western sanctions are preventing the payment, since Moscow can neither access its foreign assets frozen in the West nor transfer domestic reserves to foreign financial institutions.
The most important questions and answers at a glance:
When is a state insolvent?
Basically, a state is considered insolvent if it can no longer service its debts, i.e. has problems with interest payments or debt repayments. Typically, such problems arise when governments have spent beyond their means and are over-indebted or have otherwise lost creditworthiness and have a liquidity problem. Typical examples are Argentina’s earlier national bankruptcies or Greece’s financial problems during the euro crisis from 2010. However, the situation in Russia is very different.
What is so special about the Russian case?
Due to its financial situation, Russia is actually not a case for state bankruptcy. The country has significant financial resources at home and abroad. The main source of income is the large amounts of raw materials that Russia has sold abroad over the years. In return, the country received foreign exchange, i.e. foreign currency. In addition, Russia is not highly indebted by international standards: at around 20 percent of economic output, the debt ratio is significantly lower than in many western industrialized countries.
Why is Russia having trouble servicing its national debt?
The most important reason is the severe financial sanctions that predominantly Western countries have imposed on Ukraine because of the Russian war. The sanctions effectively exclude Russia and its banks from the financial system, which is dominated by Western states. A significant part of Russia’s financial reserves stored abroad is also blocked by sanctions. And US banks are now banned from forwarding payments from the Russian state to their customers. These restrictions make it almost impossible for Russia to pay its creditors abroad – even though the financial means are actually there.
What is the Kremlin doing about it?
Russia continues to pay interest due on government bonds – not in dollars or euros, but in rubles. The country has set up a new procedure for this via its NSD payment office. The problem, however, is that the payments from there can hardly be forwarded to western payment offices and thus to western creditors because of the sanctions. The payment in rubles is also controversial: actually, interest payments on foreign debts are usually provided in US dollars or euros. Therefore, experts consider payment in the Russian national currency to be inadmissible.
Who determines if Russia is insolvent?
Normally this is a case for the rating agencies. The three major credit watchdogs, Standard & Poor’s, Moody’s and Fitch, are paid by governments and lenders to assess borrowers’ creditworthiness. In the case of Russia, however, they are left out because European Union sanctions prevent them from assessing the financial situation. There is also the international investor committee CDDC, which consists of large banks. In the event of payment problems, it decides whether credit default insurance (CDS) is due and whether the buyers of such insurance receive compensation. Such a case comes at least close to a default and thus a state bankruptcy.
What sums are involved?
The sums are comparatively small. For example, a few weeks ago Russia failed to pay $1.9 million in late-arrears interest as part of a arrears interest payment. Strictly speaking, this was already a default by the Russian state. The current interest payments involve significantly higher sums, often in the hundreds of millions. Measured against Russia’s financial strength, however, this is still little. The Russian central bank currently puts the total – partly blocked – foreign exchange reserves at almost 600 billion dollars.
Is the situation comparable to past Russian state bankruptcies?
No, the situation is completely different from that of Russia’s previous national bankruptcy in 1998. At that time, oil prices were at a low point and Russia’s foreign exchange earnings from raw material exports were not sufficient to pay off the debt. This time, Moscow has enough money and is also willing to pay off its debts.
What would be the immediate consequences of a default for Moscow?
Since the payment default has nothing to do with an acute lack of money on the part of the Russian government, the direct consequences are initially minor. A drastic devaluation of the ruble or the collapse of the banking system is not to be expected. If the default is determined, however, creditors could demand that Russia repay all debts – even those that are not actually due yet.
What would be the long-term consequences of an insolvency?
They could well be problematic for Russia. Russia cannot issue new bonds. Moscow’s isolation from the global financial market, initiated by the sanctions, is being reinforced. The property of Russian state-owned companies abroad, such as Gazprom, may also be threatened. Plaintiffs could sue in court for that possession in exchange for lost interest payments.
Source: Stern
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