What happens if Russia can’t pay its debts after
western sanctions?
World Bank’s chief economist has warned Russia and
Belarus are ‘mightily close’ to default
Richard
Partington Economics correspondent
@RJPartington
Fri 11 Mar
2022 06.00 GMT
Russia is
close to being unable to pay its debts amid sanctions imposed by the west after
Vladimir Putin’s invasion of Ukraine.
The World
Bank’s chief economist, Carmen Reinhart, warned on Thursday that Russia and its
ally Belarus were “mightily close” to default.
A key test
will come on Wednesday next week, when the Russian state has to make a $117m
(£89m) payment on some of its debts denominated in US dollars. While Russia has
relatively low debts and its financial system is less integrated with the rest
of the world than other countries’, some analysts warn an imminent Russian debt
default could have unforeseen consequences.
The Bank of
Canada and Bank of England, which track global sovereign defaults, estimate the
total value of government debt in default around the world was $443.2bn in 2020
– about 0.5% of world public debt.
Recent
governments to default include Argentina, Belize, Ecuador and Suriname, with
nations typically failing to keep up on payments denominated in foreign
currencies. Some have strong track records, including the US and the UK.
However, both have defaulted in the past – including Britain in 1672 under the
reign of Charles II and the US in 1862 during the American civil war.
Russia must
make two coupon, or regular interest, payments on 16 March. However, it will
have a 30-day grace period, meaning a default would not formally happen until
at least April.
When was
the last time Russia defaulted?
Russia has
defaulted before, including during the 1917 revolution and in 1998, when the
country’s economy remained weak after the collapse of the Soviet union and the
costs of war in Chechnya meant it was unable to keep up with its debt payments.
However, even then, Russia kept up with dollar payments.
The
so-called rouble crisis caused severe damage for neighbouring economies and
sent shock waves through the global financial system, including huge losses for
the US hedge fund Long-Term Capital Management.
What’s at
stake
Russia has
strengthened its financial position in recent years in response to western
sanctions imposed after the 2014 annexation of Crimea, with the government
running budget surpluses and cutting its reliance on the US dollar.
According
to the Institute of International Finance (IIF), Russia’s external liabilities
– money owed to creditors by the government, companies and households – have
fallen from about $733bn in 2014 to about $480bn. Of this, $135bn is due to be
paid to creditors within one year.
However,
the amount owed by the government itself is relatively small. The state has
about $40bn in foreign currency bonds denominated in dollars and euros – tiny
compared with the size of its economy and with several comparable nations.
Overseas investors also hold $28bn of Russian debt denominated in roubles.
However,
the scale of the problem is bigger for Russian corporates, with just under
$100bn in international bonds outstanding.
Investors
in Russian debt include hedge funds, which prefer taking risky bets, and major
global asset managers. According to the Financial Times, the US fund manager
Pimco, one of the world’s biggest bond market investors, has amassed a $1.5bn
position in Russian sovereign debt.
Why could
Russia default?
Western
sanctions on Russia’s central bank and the country’s biggest lenders are
causing disruption for financial transactions. Moscow has also imposed capital
controls in response, including suspending the transfer of coupon payments on
sovereign debt to foreign investors.
Russia’s
finance ministry has said it will service and pay sovereign debts in full and
on time. However, Putin has said Russian entities can pay their foreign
currency debts in roubles priced at exchange rates set by the Russian central
bank to residents of “countries that engage in hostile activities”.
While
Russia would have had enough foreign currency to cover debt payments, having
amassed $630bn in reserves, the US, UK and EU freezing the assets of its
central bank have made much of this sum inaccessible.
The rating
agency Fitch downgraded Russia’s sovereign debt to its second-lowest level
earlier this week, saying a default was “imminent”.
What could
be the consequences for Russia?
Debt
defaults make it harder and more expensive to borrow in future, given the
reputational damage. However, Russia is already isolated on the global stage
after the invasion of Ukraine. Western governments have also blocked the
Russian state from raising new money on capital markets, including in London
and New York.
According
to the IIF, sanctions pushing up the cost of funding is likely to hit the
government’s financial position, potentially forcing Moscow to cut spending or
raise taxes.
What could
the consequences be elsewhere?
Targeting
Russia’s financial system is intended to inflict economic pain inside the
country, although there could be indirect effects on the wider global banking
system.
However,
many economists, including Andrew Bailey, the governor of the Bank of England,
have suggested Russia’s financial linkages to the rest of the world are small
and not of systemic importance.
Foreign
banks have about $121bn in exposure to Russia, mainly in Europe, according to
data from the Bank of International Settlements. The IIF estimates foreign
banks play a minor role in the country, holding only 6.3% of total assets.
The
country’s corporate sector mainly relies on loans for funding from state-owned
banks. Foreign participation in the Russian sovereign debt market currently
stands at 20% of total outstanding debt, with political uncertainty since 2014
discouraging overseas buyers.
The World
Bank’s Reinhart told Reuters that repercussions had been limited thus far, but
risks could still emerge.
“I worry
about what I do not see,” she said. “Financial institutions are
well-capitalised, but balance sheets are often opaque … There is the issue of
Russian private sector defaults. One cannot be complacent.”
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