Russia heading for sovereign default

The prospect of Russia defaulting on its sovereign debt is moving centre stage again with a deadline for a US licence allowing Moscow to make payments expiring on May 25 and $100m in interest payments due shortly afterwards.

Sweeping sanctions imposed on Russia by Western nations after its invasion of Ukraine as well as countermeasures by Moscow have all but severed the country from the global financial system. So far, Russia has been able to navigate the plethora of measures and make payments due on seven of its international bonds since the start of the war, averting a default. But with a key licence needed to transfer the funds about to expire, Moscow might be running out of time.

Here are some questions and answers on the issue:

Will the licence be extended?

The US Office of Foreign Assets Control (OFAC) issued a licence on March 2, allowing for transactions between US persons and Russia’s finance ministry, central bank or its National Wealth Fund in relation to debt payments. The licence is due to expire on Wednesday May 25.

An extension seems an increasingly remote scenario. Treasury secretary Janet Yellen said that while no final decision had been taken, it was “unlikely that it would continue”.

What are the arguments for and against extending?

Those in favour of extending argue that allowing Russia to service its debt would drain its war chest by forcing Moscow to use its foreign currency revenues to make payments to creditors after about half of its $640bn reserves were frozen.

Opponents of the extension point to Russia having to pay less than $2bn on its external debt until year-end. That pales in comparison with the country’s oil and gas revenue, which reached almost $28bn in April, thanks to high energy prices.

What payments are due?

On May 27, payments are due on two Eurobonds — $71m on a dollar-denominated bond due in 2026 and $29m of eurodenominated 2036 notes.

Both have provisions for payment to be made in alternative hard currencies such as dollars, euros, pound sterling or Swiss franc, while the rouble is also listed for the euro-denominated bond. Switching currency can only be done if for “reasons beyond its control, the Russian Federation is unable to make payments of principal or interest” in the original currency.

The premise has yet to be tested, but experts believe it could be difficult for Russia to make that argument, given sanctions are a response to its invasion of Ukraine.

Both bonds have a 30-day grace period. The next payment thereafter is $235m across two Eurobonds on June 23.

Can and does Russia want to pay?

Finance minister Anton Siluanov said Russia would service its external debt obligations in roubles if Washington blocks other options, adding Moscow would not call itself in default as it had money to pay its debts.

To avoid default, funds generally need to be paid within the prescribed time frame and in the right currency.

The case is complex, says Ian Clark, a partner at White & Case, who thinks Russia might still be able to make the payments to the registered noteholders at the national securities depository in Russia, outside US jurisdiction.

“It may be that those payments cannot then be trans ferred on to other holders, including US persons, but Russia may well have complied with its obligations under the terms of the bonds and escape default —

at least in the short term,” says Clark. Besides Russia potentially making the payment in roubles, it could also make the payment early and ahead of the May 25 deadline.

Why does Russia want to avoid default?

While Russia has enough money to make current debt payments, it will eventually look for overseas financing.

In a ceasefire scenario, the country will try to rebuild international economic ties that have been cut off during the war, says Chris Miller, Eurasia director at Greenmantle and author of Putinomics: Power and Money in Resurgent Russia.

A sovereign default would complicate access to capital markets even for nonsanctioned corporates and also push up their borrowing costs, he says.

Why is this default different?

Countries usually stop servicing their debt when they have little or no money left in international reserves and lack market access. But, a default by Russia was unthinkable until recently since the country was rated investment grade before the Ukraine invasion.

“Russia has the luxury of running a huge current account surplus,” says Wouter Sturkenboom, strategist at Northern Trust Asset Management.

“The real game changer is if Europe stops buying oil. That would certainly put a lot of pressure on them.”