EXPLAINER: Has Russia avoided default and can it keep doing so?

LONDON, United Kingdom – Russia has made dollar-denominated bond payments this week despite fears it might not be able or willing to do so after Western countries imposed unprecedented sanctions over Moscow’s actions in Ukraine.

That means it has avoided its first default since a 1998 financial crisis and its first on international bonds since the 1917 revolution, when the Bolsheviks repudiated obligations of the Tsarist government.

But with Russia due to repay another $4.7 billion between now and year-end, there are further tests to come.

What has happened?

Russia has 15 international bonds currently outstanding with a face value of around $40 billion. Prior to the Ukraine crisis, roughly $20 billion was held by investment funds and money managers outside Russia.

This week’s drama centered on two bonds the government issued in 2013, for which coupon, or interest, payments with a combined value of just over $117 million were due on Wednesday, March 16.

Like many international bonds, there was a 30-day grace period, meaning Moscow effectively had until April 15 to pay.

Initially, Russia seemed to balk at the prospect of sending scarce hard currency overseas, but on Monday, March 14, the finance ministry said it had approved a temporary procedure to make the payments.

Under a temporary license issued by the US Office of Foreign Assets Control (OFAC), Russia’s correspondent bank JPMorgan was able to process the cash before crediting it to another US bank, Citigroup, the paying agent.

Citi checked the details and distributed it to bondholders, who market sources said on Thursday, March 17, and Friday, March 18, had received the money.

The next test

Further tests come thick and fast. On Monday, March 21, Russia is due to make a $66-million payment although technically it could pay that, and another a week later worth $102 million, in roubles.

On March 31, there is a $447-million payment that must be made in dollars, while its biggest payment of the year – and its first full repayment of “principal,” of $2 billion – is due on April 4.

Foreign investors also owned about $38 billion worth of rouble-denominated sovereign bonds known as OFZs before this crisis, JPMorgan estimates – nearly 20% of that market. Some of payments that were due on those have not yet been made.

Can Russia keep paying?

Even if Russia remains willing to pay, there may be complications, especially for bonds that must be serviced in dollars.

Western sanctions ban transactions with Russia’s finance ministry, central bank, or national wealth fund, although the temporary general license 9A issued by OFAC on March 2 makes an exception for the purposes of “the receipt of interest, dividend, or maturity payments in connection with debt or equity.”

That license currently expires on May 25, however, after which Russia will still have almost $2 billion worth of external sovereign bond payments to make before the end of the year.

Some analysts suggest money frozen abroad under the sanctions may have been used for this week’s payments, although Russia has generally paid debt out of budget funds in the past.

What will happen if it doesn’t pay?

If Russia fails to make any of its bond payments within their defined grace periods, or pays in roubles where dollars or euros are specified, it will be a historic default.

Such an event would have been unthinkable before the February 24 invasion of Ukraine, which Moscow describes as a “special military operation,” and the subsequent Western sanctions.

Russia has nearly $650 billion of central bank reserves, one of the lowest debt-to-gross domestic product levels in the world, and has been raking in money from soaring oil and gas prices.

A default would lock it out of the international borrowing markets until the sanctions were lifted and it repaid creditors for any losses they had suffered.

It would also depress its credit ratings for some time, pushing up the interest rates the government and big Russian companies can borrow at. – Rappler.com