Russia may have just defaulted on its foreign debt for the first time since 1917

Russia is set to default on its foreign debt for the first time since the Bolshevik Revolution more than a century ago, further alienating the country from the global financial system following sanctions imposed over its war in Ukraine.

A 30-day grace period on interest payments originally due on May 27 expired on Sunday. But it may take time to confirm a fault.

“It appears the banks complied with international sanctions and withheld payment,” said Chris Weafer, a veteran Russian economics analyst at consultancy Macro-Advisory.

Last month, the US Treasury Department terminated Russia’s ability to repay its billions in debt to international investors through US banks. In response, the Russian Finance Ministry said it would pay dollar-denominated debts in rubles and offer “the possibility of later conversion into the original currency”.

Russia denies any discussion by default

Russia says it has the money to pay its debts but Western sanctions have created “artificial obstacles” by freezing its foreign currency reserves held abroad.

Kremlin spokesman Dmitry Peskov told reporters on a conference call on Monday that “there is no reason to call this situation a default,” saying Russia had paid but was not could not be processed due to sanctions.

The other side argues that “it happened because of the sanctions, but the sanctions were completely under your control,” Jay S. Auslander, one of Wilk Auslander’s top sovereign debt lawyers, told New York. York. “It was all under your control, because all you had to do was invade Ukraine.”

Here are the key things to know about a Russian default:

How much does Russia owe?

About US$40 billion in foreign bonds, about half to foreigners. Prior to the start of the war, Russia had approximately US$640 billion in foreign currency and gold reserves, much of which was held overseas and is now frozen.

Russia has not defaulted on its international debts since the Bolshevik Revolution, when the Russian Empire collapsed and the Soviet Union was created. Russia defaulted on its domestic debts in the late 1990s, but was able to recover from this default with the help of international aid.

Russia has effectively been in default for months in the eyes of bond investors, said Liam Peach, an emerging European markets economist at Capital Economics.

Insurance contracts that cover Russian debt have rated an 80% probability of default for weeks, and ratings agencies like Standard & Poor’s and Moody’s have put the country’s debt deep in junk territory.

How does a defect become official?

Rating agencies may deem a country functionally in default by lowering their debt rating on the country, or a court may declare the country in default. But the main rating agencies have stopped rating the country’s debt since the start of the conflict.

Bondholders who have credit default swaps – contracts that act as default insurance policies – can ask a committee of financial firm representatives to decide whether a the debt must trigger a payment, which is still not a formal declaration of default.

The Credit Derivatives Determination Committees — an industry group of banks and investment funds — would likely signal a “credit event,” Peach said.

The panel ruled on June 7 that Russia failed to pay the required additional interest after making a payment on a bond after the April 4 due date. But the committee postponed further action due to uncertainty over how the sanctions could affect any settlement.

What can foreign investors do to get their money?

The formal way to declare a default is if 25% or more of bondholders say they haven’t received their money. Once that happens, the provisions state that all of Russia’s other foreign bonds are also in default, and bondholders could then seek a court order to demand payment.

Under normal circumstances, investors and the failing government typically negotiate a settlement in which bondholders receive new bonds that are worth less but give them at least partial compensation.

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But the sanctions prevent relations with the Russian Ministry of Finance. And no one knows when the war will end or how many defaulted bonds might be worth.

In that case, declaring default and suing “may not be the wisest choice,” Auslander said. It is not possible to negotiate with Russia and there are so many unknowns that creditors may decide to “hold on for now”.

Investors who wanted to get out of Russian debt have probably already headed for the exits, leaving those who might have bought bonds at bargain prices in hopes of enjoying a long-term settlement. And they might want to keep a low profile for a while to avoid being associated with war.

Once a country defaults, it may be cut off from borrowing in the bond market until the default is resolved and investors regain confidence in the government’s ability and willingness to pay. But Russia has already been cut off from Western capital markets, so any return to borrowing is far from possible anyway.

The Kremlin can still borrow rubles at home, where it relies mainly on Russian banks to buy its bonds.

What would a formal default mean for Russia?

War-related Western sanctions have driven foreign companies to flee Russia and cut off the country’s trade and financial ties with the rest of the world. The defect would be one more symptom of this isolation and this disturbance.

Weafer says a default wouldn’t affect Russia’s economy right now because the country hasn’t borrowed internationally in years amid sanctions and is making a lot of money exporting commodities like petroleum and natural gas.

But in the longer term, when the war is resolved and Russia tries to rebuild its economy, “that’s where the legacy of the default will be a problem.” It’s a bit like if an individual or a business gets a bad credit rating, it takes years to get over that,” he said.

Investment analysts cautiously believe that a Russian default would not have the same impact on global financial markets and institutions as an earlier default in 1998. At the time, Russia’s default on domestic ruble bonds led the US government to step in and call on the banks. to bail out Long-Term Capital Management, a large US hedge fund whose collapse, it was feared, could have shaken the entire financial and banking system.

Bondholders – for example, funds that invest in emerging market bonds – could suffer heavy losses. Russia, however, played only a small role in emerging market bond indices, limiting losses for fund investors.

“The spillover to the rest of the world should be limited,” Peach said.

But a Russian default could have a ripple effect by adding pressure to global debt markets and making investors more risk averse and less willing to put money forward, which “could very well lead to new defaults in other emerging markets,” Weafer said.