U.S. Pushes Russia Closer to Default in Unprecedented Move

A sanctions expert has told Newsweek that the first Russian foreign debt default for more than a century has become more likely after the U.S. Treasury blocked Moscow from using frozen dollars in American banks.

Monday's move by the U.S. stopped Russia from paying holders of its sovereign debt using $600 million of dollar reserves it holds with American financial institutions.

"The architects of the U.S. sanctions policy are smart and they know how the capital markets work. It seems they have found fairly clear targets," said Andrew Jacobson, sanctions attorney at Seward & Kissel in New York City. "It certainly escalates the possibility of a default."

"It would have a pretty devastating effect on the Russian economy," he said. "Its ability to raise capital and its credit rating would be devastated."

Russian rouble and US dollar
A Russian ruble coin is pictured with US dollar bills and a one dollar coin in Moscow on March 15, 2022. The prospect of Russia defaulting on its foreign debt has become more likely following further U.S. sanctions. Getty Images

"The U.S. has more bullets in the gun, more meat to go after, I think this is probably the beginning of some seriously escalated sanctions."

The role of Russian bonds in the diplomatic crisis between the Kremlin and the West following Vladimir Putin's invasion of Ukraine adds to pressure on his country's economy, which is already facing a recession, inflation and shortages of essential goods.

Sanctions that followed Russia's invasion of Ukraine on February 24 froze Russian central bank foreign exchange currency reserves held at U.S. financial institutions.

But the Treasury Department had allowed Moscow to make coupon payments on dollar-denominated sovereign debt on a case-by-case basis.

However, with one of the largest of the payments coming due, including a $552.4 million principal payment on a maturing bond, the Treasury stopped JPMorgan Chase & Co from processing payments as a correspondent bank, CNN reported.

Now Moscow has a 30-day grace period to make the payment. While some external Russian government bonds allow payment of interest in rubles instead of U.S. dollars or euros, Moscow's threat to pay all externally owed interest in its own currency is risky.

"If they do so, this would constitute default on bonds not permitted to pay interest in rubles," said David Gulley, economics professor at Bentley University in Waltham, Massachusetts.

Kremlin spokesman Dmitry Peskov has said Russia would continue to pay its dues and that there are "no grounds for a real default."

If transfers are blocked, Peskov said "they will be serviced in rubles" and because Russia has the dollars to pay but just cannot access them, any default would be "artificial." Newsweek has contacted the Russian finance ministry for comment.

Russia has enormous foreign reserves, which in February stood at more than $631 billion.

The money is crucial to Vladimir Putin's war effort and withstanding sanctions but is becoming harder to access. Around half of that sum is cut off due to Western sanctions, although Russia still gets billions of dollars in crude oil and gas exports.

The latest measures force Russia to either drain its dollar reserves, use revenue coming in from energy exports, or default.

The last time Russia defaulted on its foreign currency debt was in 1918, when Bolshevik revolution leader Vladimir Lenin did not recognize the obligations of the deposed tsar's regime.

Russia defaulted on its domestic debt in 1998 when it was plunged into a financial crisis by a collapse in commodity prices which put huge stress on the Russian economy, sinking the ruble and spiking inflation.

Gulley told Newsweek that a Russian default on its external debt would not be as severe as in 1998 because it is about $40 billion, "which by international standards, isn't really that much."

"Losses would be concentrated in a handful of big investment funds," he told Newsweek. "A larger problem is the Russian equities and private Russian debt held by foreigners. Losses of these assets are already significant and may get worse."

"Clearly, being paid in depreciated rubles is a problem for bond holders—it's not an attractive currency to hold. What is worse is that due to sanctions, it would be difficult or impossible to convert the rubles into U.S. dollars or euros," he said.

Jacobson said the measures Russia faces can be compared with U.S. sanctions on Venezuela, in which it cut Caracas from dollar-denominated financing to force President Nicolas Maduro from power after rejecting his 2018 election win as fraudulent.

Whether the latest measures against Russia cause a global ripple effect depends on how the energy industry reacts, he said. Europe will need to find other gas sources particularly liquefied natural gas, while a OPEC members would have to make up the difference of lost Russian crude.

"There certainly will be an impact. The question is how much of a hit can the West take to advance its core policy, right now."