Russia may be on the brink of its first foreign debt default since the Bolsheviks overthrew Tsar Nicholas II a century ago.
On April 14, 2022, Moody’s Investors Service warned that the country’s decision to make payments on debt issued in dollars in rubles would constitute a default because it violates the terms of the contract. A 30-day grace period allows Russia until May 4 to convert payments into dollars to avoid default.
A breach is one of the clearest signs that the sanctions imposed by the US and other countries are having the desired effect on the Russian economy. But will it have any impact on Russia’s ability to wage war in Ukraine?RELATED
We asked Michael Allen and Matthew DiGiuseppe, both political economy and conflict experts, to explain the consequences of the default 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 debt of $40 billion in dollars and euros, half of which is owned by foreign investors. Russia had an April 4 deadline to pay some $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 sanctions imposed by the US. meet debt payments. The United States changed course on April 5, when it stopped Russia from using dollar reserves in US banks to make debt payments.
That gave Russia little 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 payments into dollars by May 4, the government will default on its foreign obligations for the first time since 1918, when Bolshevik revolutionaries took over Russia and refused to pay the country’s international creditors. Russia also defaulted in 1998, but only on its domestic debt.
What are the consequences of non-compliance?
When a country defaults on a foreign loan, international investors are often unwilling or unable to lend it more money. Or they demand much higher interest rates.
Whether it’s higher interest costs or an inability to borrow, this forces a country to cut spending. Less government spending reduces economic activity, increases unemployment and slows growth. While some of these effects, such as weaker 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 total exclusion from capital markets typically lasts just over eight years.
For example, when Argentina defaulted in 2001, the peso sank, the economy contracted, and inflation soared. Food riots broke out across the country, leading to the resignation of the president. Although Argentina’s economy recovered in 2007, the country was still unable to obtain loans from foreign investors, leading to a default again in 2014.
What does this mean for Russia? The country was already barred from international loan markets due to sanctions. A government official recently said that Russia would also avoid borrowing domestically, because a default would lead to “cosmic” interest rates.
But its significant income 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 driving up costs.
Does Russia care if it defaults?
The Russian government has worked hard to avoid default.
Until April 5, he was using his precious dollars to keep up with his bond payments. And before his invasion he had built up a significant foreign exchange reserve, in large part to allow him to continue to pay off the debt he borrowed in dollars and euros even amid sanctions. Russia has even threatened to take legal action if sanctions force it to default.
Oddly enough, Russia is probably worried about its reputation, at least among bond investors.
A sovereign borrower’s default 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 in this bind is because it chose to invade Ukraine, despite repeated warnings that doing so would result in severe economic and financial sanctions.
So creditors might wonder if Russia will always prioritize its foreign policy interests over the interests of creditors and raise borrowing costs permanently. If so, they may find it difficult to borrow for years to come.
Another risk is that a default could allow creditors to seize Russia’s assets abroad as a form of payment. International sanctions have already allowed countries to seize or freeze Russian assets, which could be used to pay off outstanding debts.
One count 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 fought wars with other people’s money. Indeed, debt has become so vital as a source of power that countries rarely struggle without it.
About 88% of the wars from 1823 to 2003 have been financed, at least in part, with funds borrowed from banks and other investors. This reality even seeps into fantasy worlds, such as “Game of Thrones,” in which funding from the Iron Bank of Braavos is vital to financing the wars of Westeros.
Our own research has shown that countries that have defaulted on their debts or have poor credit ratings have difficulty building military capacity and are therefore more reluctant to take up arms against other nations. Related work has found that countries with lower borrowing costs tend to win wars, although this effect is stronger for democracies.
One reason is that loans allow countries to overcome the gun-versus-butter tradeoff: More money spent on the military means less for the well-being of its citizens, which can damage a government’s ability to stay in power. Foreign loans can help overcome this problem, but losing access to credit forces the government to choose.
In the short term, however, a default is unlikely to alter the outcome of Russia’s war, or force Putin to make unpopular concessions, especially if Russia is able to achieve its new and more limited military objectives in the eastern region. from Donbas. quickly.
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 has pushed the conflict into its eighth week. Early estimates found 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.
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If Ukraine turns into a long war of attrition, as some analysts expect, Russia’s inability to borrow money will weaken its ability to sustain, supply and strengthen its position in Ukraine, especially if oil prices fall or the European Union boycotts. or reduce its dependence on Ukraine. Russian fuel.
The Roman statesman Cicero wrote: “Nervos belli, infinim pecuniam,” which roughly translates to “The successful ability to wage war requires unlimited cash.”
And that means borrowed money. Wars usually end quickly without him.
This article is republished from The Conversation under a Creative Commons license. Read the original article here: ukraine-181139.