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Russia slides into historic debt default as payment period expires

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Russian Finance Minister Anton Siluanov (seen here with Russian President Vladimir Putin in 2019) reportedly told Russian newspaper Vedomosti that Moscow will proceed to service external debts in rubles, but foreign Eurobond holders might want to open ruble and hard currency accounts with Russian banks as a way to receive payments.

Mikhail Svetlov | Getty Images News | Getty Images

Russia has entered its first major foreign debt default for over a century, after a grace period on two international bond payments lapsed on Sunday night.

Interest payments totaling $100 million were due on May 27 and subject to a grace period which expired on Sunday night. Several media outlets have reported that bondholders haven’t received the payments, after Russia’s attempts to pay in its ruble currency were blocked by international sanctions.

The Kremlin has rejected the claim that Russia is in default, with spokesperson Dmitry Peskov reportedly telling a press call this morning that Russia made the bond payments due in May but they’ve been blocked by Euroclear resulting from Western sanctions, rendering the non-delivery of payments “not [Russia’s] problem.”

Sweeping sanctions imposed by Western powers in response to Russia’s unprovoked invasion of Ukraine, together with countermeasures from Moscow, have effectively ostracized the country from the worldwide economic system, but to date the Kremlin has managed to seek out ways to get payments to bondholders on multiple occasions.

Attempts to avoid sanctions took an extra blow in late May, nonetheless, when the U.S. Treasury Department allowed a key exemption to run out. The waiver had previously allowed Russia’s central bank to process payments to bondholders in dollars through U.S. and international banks, on a case-by-case basis.

Russian Finance Minister Anton Siluanov suggested earlier this month that Russia can have found one other technique of payment. Moscow wired the $100 million in rubles to its domestic settlement house, however the two bonds in query are usually not subject to a ruble clause that may allow payment within the domestic currency to be converted overseas.

Reuters reported early on Monday, citing two sources, that some Taiwanese holders of Russian eurobonds haven’t received the interest payments due on May 27, indicating that Russia could also be entering its first foreign debt default since 1918, despite having ample money and willingness to pay.

Siluanov reportedly told Russian state-owned news agency RIA Novosti that the blockage of payments doesn’t constitute a real default, which often come as the results of unwillingness or inability to pay, and called the situation a “farce.”

An extra $2 billion in payments is due before the tip of the yr, though a number of the bonds issued after 2014 are permitted to be paid in rubles or other alternative currencies, in accordance with the contracts.

Although the signals are that payments have indeed been held up by international sanctions, it could take a while to verify the default.

A long time of default?

Timothy Ash, senior emerging market sovereign strategist at Bluebay Asset Management, said while the default won’t have much immediate market impact, Russian sovereign longer maturity eurobonds that were trading at 130 cents before the invasion have already crashed to between 20 and 30 cents, and are actually trading at default levels.

“Indeed, Russia likely already defaulted on some ruble denominated instruments owed to foreigners within the weeks just after the invasion, albeit having pulled their rankings, the rankings agencies weren’t capable of call this a default,” Ash said in a note Monday.

“But this default is essential as it’s going to impact on Russia’s rankings, market access and financing costs for years to return. And essential herein, given the U.S. Treasury forced Russia into default, Russia will only have the ability to return out of default when the U.S. Treasury gives bond holders the green light to barter terms with Russia’s foreign creditors.”

Ash suggested this process could take years or a long time, even within the event of a cease-fire that falls in need of a full peace agreement, meaning Russia’s access to foreign financing will remain limited and it’s going to face higher borrowing costs for a very long time to return.

He argued that Russia’s alternative sources of foreign financing beyond the West, corresponding to Chinese banks, would even be reluctant to look beyond the default headlines.

“In the event that they are prepared to run the secondary sanctions risks — which to date they’ve not — and still lend to Russia, they may add an enormous risk premium to lending rates for the prospect of in some way being dragged into future debt restructuring talks,” Ash said.

“It just makes lending to Russia that far more difficult, so people will avoid it. And which means lower investment, lower growth, lower living standards, capital and human flight (brain drain), and a vicious circle of decline for the Russian economy.”

Russia has so far managed to implement successful capital controls which have supported the ruble currency, and continued to herald substantial revenues from energy exports in consequence of soaring oil and gas prices.

Nonetheless, Ash suggested that the carbon transition and accelerated Western diversification away from Russian energy and commodities implies that this “golden goose is cooked two to 3 years down the road.”

“So on a two to 3 years outlook Russia faces a collapse in export receipts, with almost no access to international financing due to sanctions and default,” he said.

“Meanwhile, with much of Putin’s military having been destroyed in Ukraine, he’ll struggle to finance military rebuild which he can be desperate to realize given his desire to retain some type of parity with NATO.”

The resulting diversion of resources away from consumption and into military investment, Ash argued, could lead on to an outlook of “decay and decline” for Putin’s Russia.

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