There is now a real risk that Russia could default on its national debt as the U.S. tightens economic sanctions on President Vladimir Putin's government amid the ongoing war in Ukraine.
On Monday, the U.S. Treasury Department stopped Russia from paying its bondholders more than $600 million from reserves the country holds in U.S.-based banks in a move that could force Russia to dip into dollar assets held at home or try to service its debt in rubles.
The Treasury had frozen the Central Bank of Russia's access to around $300 billion of the country's total reserves of about $640 billion but had been allowing the Russian government to use U.S.-held reserves to make coupon payments on dollar-denominated debt on a case-by-case basis.
However, the Treasury prevented Russia from doing just that on Monday as a $552.4 million principal payment on a maturing bond became due along with a separate $84 million coupon payment on a 2042 sovereign dollar bond.
Russia has a 30-day grace period to make Monday's payment but a default would occur if the country fails to make the payments within that timeframe or if Russia pays in rubles where other currencies, such as the dollar and euro, were specified.
Russia has 15 outstanding international bonds with a combined face value of about $40 billion.
Kremlin spokesperson Dmitry Peskov said on Wednesday that Russia could service its debts but may have to pay in rubles.
"Significant amounts of our reserves are blocked in foreign countries, so if this blocking continues and these transfers are blocked from the blocked amounts, then they will be serviced in rubles," Peskov told a press conference.
"If this is not possible, then, in theory, of course, a default situation can be organized," he said.
Experts who spoke to Newsweek suggested there was a genuine risk of default but Russia was likely to choose to service its debts.
Tatiana Orlova is lead Emerging Markets (EM) economist at Oxford Economics. She told Newsweek that Russia was likely to pay its debts using the foreign currency (FX) funds available to it.
"Russia will have a choice between defaulting and using FX funds it still has available—for example, export proceeds—to repay bondholders," Orlova said.
"So far, Russia has shown willingness to honor its sovereign debt obligations. I see a high probability that the government will make a decision to continue doing so despite the new U.S. ban," she said.
"As Russia's oil and gas exports have not been embargoed, it is continuing to receive a steady stream of FX export proceeds, and apart from exports of gas and oil, there are also wheat, metals, fertilizer exports and so on," Orlova said.
President Joe Biden has imposed a ban on U.S. imports of Russian energy but most European countries have not yet done so. Russia provides about 40 percent of the European Union's gas needs and 27 percent of its oil.
Orlova said it was "hard to find a way to ensure that the U.S. dollar-denominated funds reach bondholders."
"The amount of total sovereign external debt is around $40 billion," Orlova said. "It is not front-loaded, which means that this year's repayments are not a big burden even when Russia no longer has access to the bulk of its FX reserves."
"In my opinion, Russia still has enough funds to keep up with its sovereign debt repayments—the only problem is that it may be prevented from doing so by the technical barriers erected by the U.S. sanctions," she said.
Sanctions and Sovereign Debt
Orlova warned that there is still the risk that Russia could default and that would potentially have a broader effect on sovereign borrowing in the U.S. dollar.
"The default risk is very high as the U.S is doing its utmost to block Russia's sovereign debt repayments," Orlova said.
"If Russia defaults, it will be a unique case of a sovereign borrower who is able and willing to pay being unable to do so because of the sanctions imposed by the country whose currency the debt has been issued in," she said.
Orlova said that a Russian default could "potentially reduce the popularity of sovereign debt issuance in the U.S. dollar with other emerging markets, especially those which have their own ideas about the direction of their foreign policy—China, Saudi Arabia, Turkey."
"The share of U.S dollar-denominated sovereign debt in circulation will gradually decline," she said.
Bondholders Sit Tight
Anna Gelpern is nonresident senior fellow at the Peter G. Peterson Institute for International Economics and a professor of law at Georgetown University Law Center. She also co-directs the Sovereign Debt Forum, which focuses on research about sovereign debt management.
Gelpern told Newsweek that if Russia defaults, the results may not be felt in the short term.
"In the near term, if they fail to pay past the grace period, it is entirely plausible—though not certain—that nothing would happen right away," Gelpern said.
"If you are a bondholder, enforcement would be very messy once you accelerate, with all the uncertainty about the legal, regulatory, institutional, political, and reputational factors," she said.
"Unless you have found some assets against which you could enforce without having to share with too many fellow travelers, you might just sit tight," Gelpern said.
"When some of the dust settles but before sanctions are lifted—however long that takes—I suspect that creditors might try to find and set off their claims against funds flowing to or for the benefit of Russian government entities," she added.
Gelpern said she would expect to see "some interesting battles, not between Russia and its creditors, but among the creditors outside Russia and among the creditors and people who might owe money to Russia."
In the short and medium term, Gelpern said she "would stay laser-focused on payment systems."
"Catching payment flows, not finding treasure chests, is the name of the game for creditors and other claimants," she said. "This would have the effect of amplifying the effect of financial sanctions, since Russia would need to find its way around sanctions and private creditor claims."
Gelpern said that it was possible the Russian government "managed to buy up a lot of the debt directly or by proxy when the price plummeted" and that "whoever ends up holding the debt for the government would keep it" until an opportune time for the country.
"If so, I do not think they would simply cancel the debt," she said, saying that whoever holds the debt will likely keep it
"For now, they do not really need debt relief—they do not have much debt relative to where they were in past crises or relative to other countries in crisis. The concern is payment disruptions," Gelpern said.
The Long Term
Gelpern and Orlova suggested to Newsweek that Russia may not experience severe problems in the short term resulting from a default but that the country would find it difficult to borrow on international markets in the longer term.
"For Russia, it will probably not mean much in the short term—it is currently unable to raise funds in international capital markets anyway," Orlova said.
"Also, there is no acute need for the government to raise external financing while commodity prices are high," she went on.
"When eventually Russia comes to international borrowing markets, which isn't going to happen very soon, its borrowing costs will be like those of Argentina or other emerging markets that have recently defaulted. Russia will probably wait for many years before it tries to place a sovereign bond again," Orlova said.
Gelpern suggested that the issue of claims on Russia's debt could be subject to an international process once the conflict is over.
"A long time from now, I would not be surprised to see a process—a special international tribunal or similar—to sort and satisfy the various the competing claims," she said.
"But not before a political settlement, which could take ages," Gelpern said.