What will happen if Russia cannot pay its debts after Western sanctions? | Russia

Russia is close to being unable to pay its debts amid the sanctions imposed by the West after Vladimir Putin’s invasion of Ukraine.

Chief Economist of the World Bank, Carmen Reinhart warned Russia and its ally Belarus said on Thursday they were “very close” to default.

A major test will come on Wednesday of next week, when the Russian state will have to repay $117m (£89m) on some of its US dollar debt. While Russia has relatively low debt and its financial system is less integrated with the rest of the world than other countries, some analysts warn that an imminent default on Russian debt could have unforeseen consequences.

What happens in default?

A default occurs when a borrower fails to make agreed payments on his debts.

The Bank of Canada and the Bank of England who Track global sovereign assumptionsthe total value of bad government debt worldwide was estimated at $443.2 billion in 2020 – about 0.5% of global public debt.

Recent governments that have defaulted include Argentina, Belize, Ecuador and Suriname, with countries usually failing to keep up with payments denominated in foreign currencies. Some of them have strong track records, including the United States and the United Kingdom. However, both have faltered in the past – including Britain in 1672 under Charles II and the United States in 1862 during the American Civil War.

Russia is due to make two regular coupons or interest payments on March 16. However, it will have a grace period of 30 days, which means that the default will not officially occur until at least April.

When was the last time Russia faltered?

Russia has stumbled 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 the war in Chechnya meant it was unable to keep up with its debt payments. However, even then, Russia continued payments in dollars.

The so-called ruble crisis caused massive damage to neighboring economies and sent shock waves through the global financial system, including huge losses for US hedge fund Long-Term Capital Management.

What is at stake

Russia has strengthened its financial position in recent years in response to Western sanctions imposed after the 2014 annexation of Crimea, as the government runs budget surpluses and reduces its dependence on the US dollar.

According to the Institute of International Finance (IIF), Russia’s external liabilities – money owed to creditors by the government, businesses and households – have fallen from about $733 billion in 2014 to about $480 billion. Of this amount, $135 billion is due to be paid to creditors within one year.

However, the amount owed by the government itself is relatively small. The country owns about $40 billion in foreign-currency bonds denominated in dollars and euros – a tiny fraction compared to the size of its economy and many similar countries. Foreign investors also own $28 billion of Russia’s ruble-denominated debt.

However, the scale of the problem is even greater for Russian companies, with just under $100 billion in international bonds outstanding.

Investors in Russian debt include hedge funds, which prefer risky bets, and major global asset managers. According to the Financial Times, the US fund manager Pimco, one of the largest investors in the bond market in the world, has collected $1.5 billion in Russian sovereign debt.

Why Can Russia default?

Western sanctions against the Russian Central Bank and the country’s largest lender have disrupted financial transactions. Moscow has also imposed capital controls in response, including suspending the transfer of coupon payments on sovereign debt to foreign investors.

The Russian Finance Ministry said it will serve and repay the sovereign debt in full and on time. However, Putin said that Russian entities can repay their foreign currency debts in rubles priced at exchange rates set by the Russian Central Bank for residents of “countries that engage in hostile activities.”

While Russia had enough foreign currency to cover debt payments, having amassed $630 billion in reserves, the US, UK and EU freezing of its central bank assets made much of that amount inaccessible.

Rating Agency Fitch Russia’s sovereign debt has fallen to its second lowest level Earlier this week, he said default was “imminent”.

What could be the consequences for Russia?

Debt default makes borrowing more difficult and expensive in the future, given the reputational damage. However, Russia is already isolated on the world stage after the invasion of Ukraine. Western governments also prevented the Russian state from raising new money in the capital markets, including in London and New York.

According to the Institute of International Finance, sanctions that increase the cost of financing are likely to hurt the government’s financial position, potentially forcing Moscow to cut spending or raise taxes.

what can Will the consequences be elsewhere?

The targeting of the Russian financial system is intended to inflict economic damage within the country, although there may be spillover effects on the broader global banking system.

However, several economists, including Andrew Bailey, governor of the Bank of England, have suggested that Russia’s financial ties with the rest of the world are small and not of systemic importance.

Foreign banks have about $121 billion of exposure to Russia, mainly in EuropeAccording to the data of the Bank for International Settlements. The Institute of International Finance estimates that foreign banks play a minor role in the country, owning only 6.3% of total assets.

The country’s corporate sector mainly relies on loans for financing from state-owned banks. Foreign participation in the Russian sovereign debt market is currently 20% of the total outstanding debt, with political uncertainty since 2014 discouraging overseas buyers.

Reinhart of the World Bank told Reuters that the repercussions have been limited so far, but the risks remain.

“I’m worried about what I don’t see,” she said. “Financial institutions are well-capitalized, but balance sheets are often opaque … There is an issue of default in the Russian private sector. One cannot be complacent.”