The U.S. has announced that it will not extend an exemption permitting Moscow to pay foreign debt to American investors in U.S. dollars, potentially forcing Russia into default.
Up until Wednesday, the U.S. Treasury Department had granted a key exemption to sanctions on Russia’s central bank that allowed it to process payments to bondholders in dollars through U.S. and international banks, on a case-by-case basis.
This had enabled Russia to meet its previous debt payment deadlines, though forced it to tap into its accumulated war chest of foreign currency reserves in order to make payments.
However, the Treasury Department’s Office of Foreign Assets Control has allowed the exemption to expire as of 12:01 a.m. ET on Wednesday, it was announced in a bulletin Tuesday.
Russia has built up substantial foreign currency reserves in recent years and has the funds to pay, so will likely contest any declaration of default on the grounds that it attempted payment but was blocked by the tightened sanctions regime.
Moscow has a deluge of debt service deadlines coming up this year, the first being on Friday, when 100 million euros in interest is due on two bonds, one of which requires dollar, euro, pound or Swiss franc payment while the other can be serviced in rubles.
Reuters and the Wall Street Journal reported Friday that the Russian Finance Ministry had already transferred funds in order to make these payments, but a further $400 million in interest is due late in June.
In the event of a missed payment, Russia will face a 30-day grace period before likely being declared in default.
Russia has not defaulted on its foreign currency debt since the Bolshevik revolution in 1917.
‘Unknown territory’
Central to the fallout from the OFAC’s decision not to extend the waiver is the question of whether Russia will consider itself to be in default.
Adam Solowsky, partner in the Financial Industry Group at global law firm Reed Smith, told CNBC on Friday that Moscow will likely argue that it is not in default since payment was made impossible, despite it having the funds available.
“We’ve seen this argument before where OFAC sanctions have prevented payments from going through, the sovereign issuer has claimed that they are not in default because they tried to make the payment and were blocked,” said Solowsky, who specializes in representing trustees on sovereign bond defaults and restructuring.
“They are potentially looking at a scenario of prolonged litigation after the situation has resolved as they try to determine if there was in fact a default.”
Solowsky highlighted that Russia’s situation is unlike the usual process for sovereign default, in which as a country nears default, it restructures its bonds with international investors.
“That’s not going to be feasible for Russia at this time because basically under the sanctions, nobody can do any business with them, so the normal scenario that we would see play out is not what we would expect in this case,” Solowsky said.
He added that this will affect Russia’s access to global markets and potentially drive up asset seizures both domestically and overseas.
“We’re getting into some unknown territory. This is a major world economy. I think we’ll be seeing the fallout effect from the next few days for many years,” Solowsky said.
Default ‘for years to come’
Timothy Ash, senior emerging markets sovereign strategist at BlueBay Asset Management, said in an email on Tuesday that it is only a matter of time now before Moscow defaults.
“The right move by OFAC as this move will keep Russia in default for years to come, as long as Putin remains president and/or leaves Ukraine. Russia will only be able to come out of default when OFAC allows it to. OFAC hence retains leverage,” Ash said.
“This will be humiliating for Putin who made a big thing with [Former Chancellor of Germany] Schroeder at the time Russia was last on the brink of a Paris Club default that great powers like Russia pay its debts. Russia can no longer pay its debts because of its invasion of Ukraine.”
Ash predicted that Russia will lose most of its market access, even to China, in light of the default, since Moscow’s only financing will come at “exorbitant” rates of interest.
“It means no capital, no investment and no growth. Lower living standards, capital and brain drain. Russians will be poorer for a long time to come because of Putin.”
Ash suggested that this would further Russia’s isolation from the global economy and reduce its superpower status to a similar level to “North Korea.”
‘Burning bridges’
Agathe Demarais, global forecasting director at The Economist Intelligence Unit, told CNBC on Friday that since Russia’s sovereign debt is low and was falling prior to the invasion, entering what the EIU sees as an inevitable default may not pose a huge problem for Russia.
“To me, it’s really a signal as to whether Russia thinks that all bridges have been burned with the West and financial investors. Normally if you’re a sovereign country, you do your utmost to avoid a default,” Demarais said.
“All the moves that we are seeing at the moment – at least to me – suggest that Russia isn’t really concerned about a default, and I think that is because Russia really expects that there isn’t going to be any improvement on the front of relationships with western countries any time soon.”
She added that the punitive sanctions against Russia from the U.S. and Western allies will likely remain in place “indefinitely,” since the Kremlin’s false characterization of the invasion as being a “denazifying” effort means it cannot easily U-turn.
The EIU anticipates a hot war throughout the year and protracted conflict thereafter, as Russia and the West attempt to reconfigure supply chains to adapt to the new sanctions regime rather than seeking ways to end it.
Russia is still attracting substantial amounts of cash from energy exports, and is attempting to force European importers to pay for oil and gas in rubles in order to swerve sanctions.
“What this really shows is this burning bridges strategy of Putin feels he has nothing to lose anymore,” Demarais added.
