Russia is facing a technical default. What does it mean and what are the possible consequences?
Let's get into terminology.
A default is the failure of a borrower to honour their debts in time and in full in the currency specified in the documents of issue. To simplify, default can be of two types: debt services default and technical default.
Debt services default occurs when a government cannot honour its debt obligations because there is no income or savings to cover these debts.
A technical default occurs when a government has money but is unable to pay its debts in full and within the envisaged time frame.
What happened?
Since the beginning of the war, most of the Bank of Russia's reserves abroad have been blocked. According to the head of the Ministry of Finance, Siluanov, we are talking about at least ~$300bn, which, according to the average estimates of analysts, is about half of Russia's international reserves. According to some reports, about $368 billion in total has been frozen since Japan imposed the sanctions.
Russia has the funds to repay its external debt payments, but there is no way to use them. Foreign agent banks cannot execute orders, so as the borrower Russia is considered to be in breach of the terms of the debt obligations. This is exactly when a technical default is declared.
In an attempt to twist things around, the government wants to convert the currency payments and transfer them to bondholders in rubles, which in fact is also a breach of debt obligations.
The Ministry of Finance denies default itself, if we refer to the comments of their press service: "Default means that a debtor has no funds to fulfil its debt obligations or is unwilling to fulfil those obligations though the funds are available. Neither of these is Russia’s case. The Russian Federation has enough resources to service and repay all of its debt obligations on time.
The misconduct of US banks and the US government in stopping payments to Russia in foreign currency has blocked some foreign investors from receiving their due payments.”*
* Сommentary from the Ministry of Finance’s press centre on the CNN article on Russia's default from April 12th, 2022
What is going to happen?
As the consequence of a technical default, the country faces a cross-default. A cross-default is the advance demand for payment of all debts at once to an issuer that has not paid their current debts in time. In this case, it is hard to imagine that the country would find enough reserves to repay such a heavy amount in a lump sum.
Earlier, various international rating agencies downgraded Russia to pre-default, with Fitch saying the default is "imminent". In fairness, it should be noted that Fitch has always been the most positive towards Russia. So this sudden downgrade was a wake-up call for most investors.
Is default imminent?
Not necessarily. We need to understand that default can also be a threat to various separate organisations, structures, etc. For example, Bloomberg already reported on April 11th the default of Russian Railways, which failed to make a payment on one issue of Eurobonds in Swiss francs with a payment date of March 14th. They were unable to do this due to the sanctions imposed. The mechanisms to circumvent some bans still exist, such as independent international organisations involved in securities trading, which means that so long as they exist, they will be used.
How is the situation different from the infamous 1998?
Firstly, in 1998 the country was able to pay its external debts, but could not cope with its domestic obligations. Secondly, after the default in 1998, there was no absolute isolation: other countries were quite willing to lend to Russia, foreign companies were entering the Russian market, and the country's economy was integrating into the world economy.
Right now the situation is the opposite. Many companies which are interested in cooperating despite Russia's actions cannot afford to return for at least two reasons: a reputational loss (which someone still is able to bear) and a capacity to pay. The second reason involves a whole set of facts: the disconnection from SWIFT, potential freezing of investors' accounts by foreign banks, prohibition of foreign currency transactions by presidential decree, etc.
What are the long-term risks?
First and foremost, Russia would stigmatise itself as an "unreliable borrower". This means that the country will either not be loaned to at all, or it will, but on "special" terms with sky-high interest rates. In terms of external investment, there will also be no prospects left. On top of this is the rhetoric of officials about the nationalisation of foreign investors' property in the Russian Federation. By all means, Russia is the least profitable project for investors.
The Central Bank has so far kept Russian banks from going bankrupt, but this is most likely to lead to even higher inflation and budget shortfall.
Ordinary citizens will be quite predictably affected by the games of the men in suits. They will face rising prices and rising costs, a decrease in real incomes, rising unemployment, a hit to small and large businesses, a huge increase in the number of Russians living below the poverty line, and a setback in all domestic production.
Let's consider Lebanon as an example. Lebanon defaulted in March 2020 on $1.2bn worth of Eurobonds. The Lebanese government declared that there was no money in the budget to pay off the country's external debt and obligations to its citizens. The country declared de facto bankruptcy but de jure delayed default indefinitely. Due to the sanctions and the financial situation in the country, energy and fuel problems had started. Also due to rising world grain prices and the situation in Ukraine, which used to be the main importer of food to Lebanon, the country has found itself on the verge of starvation. The only solution for the country now is to get large loans from EU countries and the International Monetary Fund, increasing its external debt in order to survive.
This scenario does not seem very rosy, and Russia is not a country that everyone would rush to help.