Russia could default on sovereign debt, as sanctions cripple its ability to repay investors

The Russian government may be headed for its first foreign debt default since the Bolshevik Party shocked Western investors in 1918 by refusing to repay the borrowings of Czar Nicholas II.

At issue is a $117 million interest payment, which Russia was due to make Wednesday on two U.S. dollar-denominated bonds issued several years ago.

As of Wednesday evening in the United States, it was not clear what had happened. Earlier in the day, Russian Finance Minister Anton Siluanov told the RIA Novosti news agency that the payments in the U.S. dollars might not reach foreign bondholders because the government's foreign currency accounts were frozen by U.S. sanctions.

Russia would then attempt to pay in rubles, rather than dollars as required by the terms of the two government bonds, Siluanov told Tass, another state-owned Russian news outlet, earlier this week. But if the government of President Vladimir Putin fails to deliver the required dollars within a 30-day grace period, the country would officially be in default, according to Fitch, the credit-rating agency.

The looming default underscores Moscow's pariah status in the wake of its Feb. 24 invasion of Ukraine. Russian financial markets have been shuttered for nearly three weeks. Foreign corporations have exited the country. And now some of Russia's government bonds - just last month widely traded global assets - are selling for just 12 cents on the dollar.

"The sanctions, broadly speaking, have been an attempt to isolate Russia from the global economy and financial system in an unprecedented way - and they have succeeded," said Blaise Antin, managing director of the emerging markets group at TCW, a Los Angeles-based investment firm.

Further clouding the outlook is Putin's March 5 decree allowing Russia to repay creditors who are "associated with the countries involved in hostile actions" against it using rubles rather than scarce foreign currency.

The financial combat between Russia and the U.S.-led coalition is a throwback to past government debt wrangles, according to Mitu Gulati, a sovereign debt specialist at the University of Virginia law school. In the 1800s, major governments often sold bonds to finance wars - and then balked at paying investors from enemy lands.

"This is a familiar situation, even if in the modern world it's unusual," Gulati said. "This is what used to happen all the time."

The interest payments due Wednesday are the first test of Putin's approach.

Citibank is the intermediary or "paying agent" designated to receive interest payments on the bonds and distribute them to investors. A spokeswoman did not respond to a request for comment.

By itself, a Russian government default is unlikely to have major repercussions. U.S. sanctions already block Putin from tapping global capital markets, and, flush with revenue from oil and gas exports, the government has no immediate need to borrow.

Foreign creditors are owed about $62.5 billion, including $21.5 billion that requires repayment in dollars and euros, according to the Institute of International Finance (IIF), an industry association.

But a sovereign default could trigger a similar approach by Russian corporations to their borrowings, which are roughly four times what the Russian government owes, according to William Jackson, an economist with Capital Economics in London.

Russian companies so far have continued making debt payments. But with the economy expected to shrink by 30%, according to IIF, and most exports blocked by sanctions, Russian businesses will struggle to keep paying, Jackson said.

Financial institutions - including bond specialist Pimco - also will be forced to absorb losses. The credit-rating agency Moody's said earlier this month that it expects investors to lose up to 65% of what they put into Russian government bonds, even after any eventual settlement of credit claims.

Already, BlackRock, the world's largest asset manager, has acknowledged absorbing a $17 billion loss on its Russian stock and bond investments. The firm's largest Russia-oriented exchange-traded fund posted a 79% decline over the past month.

Banks that sold insurance against a potential Russian sovereign default also stand to lose. But their identities will become available only after the payouts are made on those instruments, known as credit-default swaps.

With the United States and its allies waging a financial war on Russia, Moscow already has failed to make some required payments to foreign investors. Earlier this month, the government deposited interest payments on ruble bonds into its National Settlement Depository. The Central Bank of Russia has blocked the money from being transferred to investors' accounts.

Fitch says that move will constitute a default once the 30-day grace period expires.

U.S. sanctions should be no bar to the dollar payments Russia owes. The Treasury Department issued guidance earlier this month, allowing U.S. investors to receive interest payments on Russian debt through May 25.

Russia deliberately reduced its dependence on global capital flows after the U.S. and its allies imposed sanctions following Putin's 2014 takeover of the Crimean Peninsula. Since that time, Russia has sharply cut its foreign debt and whittled down by almost half its bank borrowings, according to the Bank for International Settlements (BIS) in Basel, Switzerland.

Global banks have $121.4 billion at stake in Russia, according to BIS. Banks in France, Italy and Austria would be hit hardest if Russian banks and corporations fail to make their loan payments.

Today's debt struggles pose an apparent contrast with Russia's 1998 financial crisis. Less than a decade after the collapse of the Soviet Union, Moscow was eager to secure a place in the global financial system. Even as the value of the ruble collapsed, then-President Boris Yeltsin prioritized payments to foreign creditors while the government defaulted on its ruble obligations.

That stance caught a major hedge fund called Long-Term Capital Management by surprise, sparking major losses and raising fears of a wider financial crisis that required intervention by the Federal Reserve.

Today, most officials anticipate no wider cataclysm.

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