US-led sanctions forcing Russia into default

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Russia may avoid defaulting on its debt on Friday, but worsening Western sanctions are dragging the country ever closer to default.

A $71 million payment due Friday may have already been completed before US officials eliminated an exemption this week that enabled Russia to pay its obligations in dollars using cash kept outside US financial institutions.

However, with additional payments looming, the world is likely to witness the first instance of a government involuntarily defaulting owing to international sanctions rather than a lack of funds.

According to RT on Wednesday, Russia's State Duma Speaker Vyacheslav Volodin announced, after the US blocked Russia from making sovereign debt payments to US bondholders, that Moscow will make its foreign debt payments in rubles.

What a debt default looks like 

When a government fails to fulfill its financial commitments, whether to another country, international financial organizations such as the IMF or World Bank, or investors who purchased its bonds, it is deemed to be in a payment default.

A partial default occurs when a country fails to repay only a portion of its debt.

A country can declare itself in default by declaring that it will not repay its debt, as Sri Lanka did last month and Russia did on its domestic debt in 1998.

A rating agency may also declare a default after the conclusion of an automatic 30-day grace period following the payment due date. In the case of Russia, however, the top three rating agencies discontinued covering the nation in order to comply with Western sanctions.

The default could also be formalized by a private borrower announcing publicly that a country had not paid, or via the International Swaps and Derivatives Association (ISDA), whose determination of a default unlocks the payment of credit default swaps (CDS), a form of debt payment insurance.

A $71 million interest payment is due on Friday, and the bond's provisions "don't foresee payment in rubles, only in dollars, euros, pounds sterling and Swiss francs," according to Slim Souissi, a professor at the IAE Caen business school.

Payment in rubles would be deemed a default, according to a Fitch rating agency analyst. However, the payment might have been paid before the US sanctions exemption expired.

The Russian situation

The Russian Finance Ministry claimed in a statement last week that the monies had already been transferred for distribution to bondholders.

"The payment obligation on Russian Federation bonds has been satisfied in full and in accordance with the issue documentation of the Eurobond by the Russian Finance Ministry," it said.

It also stated that the second payment of 26.5 million euros, which was due on Friday, had been made, but that payment could have been made in rubles under the conditions of the bond.

According to Bloomberg statistics, three other interest payments totaling slightly less than $400 million are due by the end of June. Certain bonds can only be paid in dollars.

The Russian government must make 14 bond payments by the end of the year.

Russia has the funds to pay and wishes to pay but is unable to do so owing to international sanctions.

This is a first, according to experts. Argentina had the money but refused to pay hedge firms that refused to accept a deal since it would have jeopardized the entire debt renegotiation.

According to Cyriaque Dailland, an asset manager at Sanso IS, the US is "pushing the Russians into default."

The Russian Finance Ministry has vowed to take the country to court if it is declared in default in order to demonstrate that it attempted to pay creditors.

A default often implies that a government loses its capacity to borrow in international financial markets for several years until it regains investor trust.

In this situation, Russia is unable to borrow due to international sanctions. Creditor confidence in Russia's ability to repay is not currently a concern, but it could be if the sanctions cause the country's economy to contract severely.