On Saturday, rating agency S&P cut its rating on Russia to “Selective Default” on Saturday after the Russian government said last week that it had repaid about $650 million in dollar-denominated debt in rubles (the payment was contractually due in dollars but Russia claims that sanctions make payment impossible).
The downgrade to what is effectively a determination of default was S&P’s final assessment before it pulled coverage (ratings firms are abandoning Russia because of a European Union ban; Moody’s Investors Service and Fitch Ratings have also withdrawn ahead of an April 15 deadline).
On April 4, Russia had been due to make a payment of $649 million to holders of two of its sovereign bonds, but the U.S. Treasury blocked the transfer, preventing Russia from using any of its frozen foreign currency reserves to service its debt. The ratings agency said late Friday that it didn’t expect investors to be able to convert the ruble payments into U.S. dollars that were equivalent to the original amount due, pushing Russia toward its first default on foreign currency sovereign debt in more than a century.
While the bonds do have a 30-day grace period, giving the Russian government time to repay in dollars or find some other way to avoid a default, but S&P said it didn’t expect the government to convert the payments within the grace period.
“Sanctions on Russia are likely to be further increased in the coming weeks, hampering Russia’s willingness and technical abilities to honor the terms and conditions of its obligations to foreign debt holders,” the ratings agency said.
Instead of pushing for a default in response to the barrage of western sanctions, Russia’s view is the opposite and even though Moscow has said it won’t be accessing the international bond market this year due to exorbitant debt prices, the country has not been seeking to default. On the contrary, Finance Minister Anton Siluanov told the pro-Kremlin Izvestia newspaper on Monday that Russia will take legal action if the West tries to force it to default on its sovereign debt, sharpening Moscow’s tone in its financial wrestle with the West.
“Of course we will sue, because we have taken all the necessary steps to ensure that investors receive their payments,” Siluanov told the newspaper in an interview.
“We will present in court our bills confirming our efforts to pay both in foreign currency and in roubles. It will not be an easy process. We will have to very actively prove our case, despite all the difficulties.”
Siluanov did not elaborate on Russia’s legal options and did not say where any court hearing could happen, according to Reuters.
The bonds in question were issued under English law, which allows a borrower to defend itself by saying that an external force made it impossible to honor obligations, so the court may postpone the payment, said Mitu Gulati, professor of law at the University of Virginia.
“So I think Russia is going to argue this but … this is a war … caused by Russia,” said Gulati, also an expert on debt restructuring, adding:
“This is not a completely implausible legal argument.”
Meanwhile, Siluanov has said Russia will do everything possible to make sure its creditors are paid.
“Russia tried in good faith to pay off external creditors,” Siluanov was quoted saying. “Nevertheless, the deliberate policy of Western countries is to artificially create a man-made default by all means.”
Siluanov said Russia’s external liabilities amount to about 20% of the total public debt, which stood at about 21 trillion roubles ($262 billion). Of that, about 4.5-4.7 trillion roubles were external liabilities.
As noted above, Siluanov also said Russia was halting bond auctions because of prohibitive borrowing costs. “We do not plan to go to the local market or foreign markets this year,” he said. “It makes no sense because the borrowing cost would be cosmic.”
Todd Schubert, head of fixed income at Bank of Singapore, said Russia’s fiscal position at the onset of the Ukrainian conflict was favorable thanks to low leverage and sizable foreign exchange reserves. It also has massive inflows of funds thanks to its oil and gas exports, with the European Union alone paying about 1 billion euros a day for energy.
“This gives the government flexibility to abstain from the public debt markets for the foreseeable future,” Schubert said.
Russia has not defaulted on its external debt since the aftermath of its 1917 revolution, but its bonds have now emerged as a flashpoint in its economic tussle with Western countries. The last time Russian debt served as a focal point of a global financial crisis was in 1998 – it led to the eventual collapse and bail out of Long-Term Capital Management, ushering in the era of Too Big To Fail.
According to Artur Starikov, a partner with Capital Law Office, a key question is whether Russian assets previously frozen by Western countries, such as nearly a half of Russia’s $640 billion in gold and foreign exchange reserves, could be claimed by creditors following the default. A default was unimaginable until recently, with Russia rated as investment grade in the run-up to its Feb. 24 invasion of Ukraine.
“If an economic and financial war is waged against our country, we are forced to react, while still fulfilling all our obligations,” Siluanov said. “If we are not allowed to do it in foreign currency, we do it in roubles.”