Russia may be on the verge of its first foreign debt default since the Bolsheviks toppled Tsar Nicholas II a century ago.

On April 14, 2022, Moody’s Investors Service warned that the country’s decision to make payments on dollar-issued debt in rubles would constitute a default because it would violate the terms of the contract. A 30-day grace period allows Russia until May 4 to convert payments to dollars to avoid defaults.

A default is one of the clearest signals that sanctions imposed by the United States and other countries are having the intended effect on the Russian economy. But will this impact Russia’s ability to wage war in Ukraine?

We asked Michael Allen and Matthew DiGiuseppe, both political economy and conflict experts, to explain the consequences of defaulting and what it would mean for Russian President Vladimir Putin’s war.

Why did Russia default on its debt?

The Russian government has a total of $40 billion in dollar and euro debt, half of which is held by foreign investors. Russia had an April 4 deadline to pay about $650 million in interest and principal to holders of two bonds issued in dollars.

Russia has plenty of cash – it collects the equivalent of more than $1 billion a day from its oil and gas deliveries alone – but has limited access to dollars due to US sanctions . The Biden administration had allowed Russia to use some of the reserves it had previously frozen to pay off its debt. The United States changed course on April 5, when it prevented Russia from using dollar reserves held in US banks to make debt payments.

This gave Russia no choice but to try to make the payments in rubles, the value of which has been highly volatile since the invasion. If Russia does not change dollar payments by May 4, the government will default on its foreign obligations for the first time since 1918, when Bolshevik revolutionaries took control of Russia and refused to pay the the country’s international creditors. Russia also defaulted in 1998, but only on its domestic debt.

What are the consequences of a default?

When a country defaults on a foreign loan, international investors usually become unwilling or unable to lend it more money. Or they charge much higher interest rates.

Whether due to higher interest charges or an inability to borrow, it forces a country to cut spending. Less public spending reduces economic activity, increases unemployment and slows growth. While some of these effects, such as lower economic growth, are often short-lived, other consequences can haunt a country for years. Trade with other countries remains below normal for an average of 15 years after a default, while complete exclusion from capital markets typically lasts just over eight years.

For example, when Argentina defaulted in 2001, the peso plunged, the economy contracted and inflation soared. Food riots erupted across the country, leading to the president’s resignation. Although Argentina’s economy recovered in 2007, the country remained unable to borrow from foreign investors, leading to another default in 2014.

What does this mean for Russia? The country was already barred from international borrowing markets due to the sanctions. A government official recently said that Russia would also avoid borrowing domestically because a default would lead to “cosmic” interest rates.

But its sizable revenue from sometimes discounted oil and gas sales can help offset the need for short-term borrowing, especially if it can continue to find willing buyers like India and China. On April 14, 2022, Putin acknowledged that the sanctions were disrupting exports and increasing costs.

Does Russia care about a default?

The Russian government tried hard to avoid the default.

Until April 5, she was using her precious dollars to stay up to date on her bond payments. And before its invasion, it had built up a large reserve of foreign currency, largely to enable it to continue to repay borrowed debt in dollars and euros, even amid sanctions. Russia has even threatened to take legal action if sanctions force it to default.

Strange as it may sound, Russia is probably worried about its reputation, at least among bond investors.

A default by a sovereign borrower establishes a bad reputation that can take years to recover, as Argentina’s experience shows.

And the long-term impact could be worse for Russia. The reason Russia is at this stalemate is that it chose to invade Ukraine, despite repeated warnings that doing so would result in severe economic and financial sanctions.

Creditors may therefore wonder whether Russia will always prioritize its foreign policy interests over the interests of creditors and raise borrowing costs permanently. If so, it may be difficult for them to borrow for years.

Another risk is that a default could allow creditors to seize Russian assets abroad as repayment. International sanctions have already allowed countries to seize or freeze Russian assets, which could be used to pay off outstanding debts.

A tally suggests that 50% of creditors in recent sovereign debt cases have attempted to seize assets as an alternative to payment.

What does this mean for Russia’s war in Ukraine?

As long as there has been debt, governments have waged war with other people’s money. In fact, debt has become such a vital source of power that countries rarely fight without it.

About 88% of the wars from 1823 to 2003 were at least partly financed by funds borrowed from banks and other investors. This reality even bleeds into fantasy worlds, like “Game of Thrones,” in which funding from the Iron Bank of Braavos is vital to fund the wars of Westeros.

Our own research has shown that countries that have defaulted on their debts or have poor credit ratings find it difficult to build up their military capabilities and, therefore, are more reluctant to take up arms against other nations. Related work has shown that countries with lower borrowing costs tend to win wars – although this effect is stronger for democracies.

One reason is that borrowing allows countries to overcome the guns-for-butter trade-off: more money spent on the military means less for the welfare of its citizens, which can hurt the ability to a government to stay in power. Foreign loans can help overcome this problem, but losing access to credit forces a government to choose. In the short term, however, a default is unlikely to alter Russia’s war outcome – or force Putin into unpopular compromises – especially if Russia is able to achieve its new goals. more limited military forces in the eastern region of Donbass. rapidly.

This will change the longer the war lasts. The war was expected to last only a few days, but a stronger than expected Ukrainian defense pushed the conflict into its eighth week. Early estimates revealed that a protracted war could end up costing Russia more than $20 billion a day, including direct and indirect expenses, such as lost economic output.

If Ukraine becomes a protracted war of attrition, as some analysts expect, then Russia’s inability to borrow money will weaken its ability to maintain, supply and strengthen its position in Ukraine – by especially if oil prices fall or if the European Union boycotts or reduces its dependence on Ukraine. Russian fuel.

The Roman statesman Cicero wrote, “Nervos belli, infinitam pecuniam”, which loosely translates to “A successful war capability requires unlimited liquidity”.

And that means borrowed money. Wars usually end quickly without it.

This article is republished from The Conversation under a Creative Commons license. Read the original article here: – Ukraine-181139.


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