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Investors are bracing for the very real possibility of Russia defaulting on its debt, an event that threatens to further isolate the country from the global financial system, perhaps for years to come.
On Wednesday, Russia will have to pay a total of $ 117 million in interest payments on two dollar-denominated bonds. At the moment, it is unclear how or if the country will pay them.
Failure to pay interest rates would initiate a grace period of 30 days for Russia to clear the amount owed.
But currently, Russia is largely excluded from its dollar reserves due to sanctions imposed by the United States and its allies.
This makes it increasingly likely that Russia will default on its debt, the first time it fails to pay its foreign currency debt since the Russian Revolution over a century ago. (Russia defaulted on domestic debt in 1998).
During an interview with CBS News on Sunday, Kristalina Georgieva, head of the International Monetary Fund, expressed a pessimistic note. “I can say that we no longer think of the Russian default as an unlikely event,” she said.
This echoes what many investors and rating agencies have recently concluded,
In a note to clients, Morgan Stanley said a default is “the most likely scenario” and, according to Fitch Ratings, “a sovereign default is imminent”.
All three credit rating agencies have downgraded Russia to so-called “junk” status, which means its debt is at greater risk of default.
Here’s what to know as a Russian default frame perspective.
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What does Russia have to pay on Wednesday?
Like many countries around the world, Russia raises money from global investors by selling a variety of debt and paying interest rates on bonds.
On Wednesday, Russia is obliged to pay interest rates on two dollar-denominated bonds maturing in 2023 and 2043. Those payments amount to $ 117 million.
It is the first in a series of interest rate payments that Russia will have to pay in the weeks and months to come.
According to Morgan Stanley, Russia has 15 outstanding bonds denominated in dollars and euros and together they are worth $ 39.6 billion.
Will Russia pay?
Russia is unlikely to draw on its dollar funds to pay interest rates to investors as the country desperately needs to maintain its foreign exchange reserves amid global sanctions.
“I suspect that Russia will not pay,” says Mitu Gulati, a professor at the University of Virginia and an expert on sovereign debt. “They need to preserve their foreign capital.”
Russia said it was willing to pay the holders of the two bonds, but in rubles, not dollars. Russia claims it is unable to pay in dollars due to the sanctions.
However, most experts say that any payment in rubles would not live up to its obligations, as there is no clause in these two bonds that would allow Russia to make payments in any other currency.
In any case, the value of rubles has also plummeted and foreign investors would probably struggle to convert them into most other major currencies.
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What if Russia doesn’t make interest rate payments?
The country has some respite. There is a 30-day grace period inserted into each of these two bonds, which means that Russia really has until April 15th to make payments.
If Russia fails, investors can seek remedies in global courts, but experts say it will be difficult from a time perspective because its invasion of Ukraine is still ongoing and so much is in the air.
As the weeks pass, Russia will face other deadlines. An interest payment on another bond, which expires in 2030, is due on March 31st. But his grace period is only 15 days; therefore, Russia’s close deadline for that bond will also be April 15.
What would be the consequences of a debt default?
For Russia it would mean further isolation from the global financial system.
Russia is already facing a number of sanctions and has seen the exodus of global companies following the invasion of Ukraine.
Failure to pay debt obligations is seen as a gross violation of global financial rules and would likely make Russia more of a pariah among investors who would likely feel burned by the country’s insolvency.
Losing the ability to raise funds in global currencies is a big deal, although Russia has some sort of respite as European countries have not sanctioned Moscow’s energy exports.
Is there a risk of a wider contagion?
Opinions are still divided.
In 1998, when Russia defaulted on its ruble-denominated debt, it helped spark a cascade of events that rocked global markets that at the time were already teetering from the Asian financial crisis.
However, some analysts don’t see much room for concern. Despite its land and population size, Russia was never considered a major player in the global financial system and the country was shunned after the invasion of Ukraine.
That said, a default comes at a fragile time for global markets, which are already facing a surge in inflation in many parts of the world and deep economic uncertainty over the fallout from the Russian war in Ukraine.