Russia Defaults. Nobody Cares

Three years ago, when Donald Trump sanctioned Ayatollah Khamenei, I described the decision as “about like sanctioning the Easter Bunny.” It sounded impressive, but it was purely symbolic. An escalation that wasn’t an escalation by virtue of being almost totally meaningless.

That’s the paradox of pariah regimes and attempts to isolate them, both politically and economically. The law of diminishing returns kicks in pretty quickly once economic actors and markets absorb the initial shock. Plainly, Russia isn’t Iran or Venezuela or North Korea (although it’s an ally of all three), but it’s not China either. The world can do without Russia and Russia can do without the world. It won’t be painless for either, and the break up will be remembered for an energy crisis in Europe and a deep recession in Russia, but eventually, assuming no reconciliation, Moscow will compartmentalize its trade via Asia and a handful of friendly nations, the West will figure out a way to backfill lost energy supply and Russia will become an economic backwater whose markets are totally isolated and even more inconsequential than they already were. If you’re inclined to quibble with that latter contention, I’d point you to recent policy statements from the Bank of Russia and remarks from Elvira Nabiullina regarding Russia’s adjustment period, a euphemism for economic regression.

It’s with that in mind that Russia’s first foreign currency default in 104 years was greeted with a collective shrug, both within Russia and without. A proposed G-7 ban on gold imports was likewise waved away as symbolic — the formalization of what was already happening as a result of sanctions.

The default story is well-worn territory. The grace period on coupon payments due late last month expired Sunday, and despite having the financial wherewithal to pay, Moscow lacked the technical capacity to do so thanks to Western efforts to force Vladimir Putin into default. This was a foregone conclusion. The market priced the odds at 99% months ago. Janet Yellen and, subsequently, the EU, effectively rendered payment impossible. Russia transferred rubles to its payment agent, but the relevant bonds don’t allow payment in rubles.

There are a couple of things worth noting. First, the very fact that Russia is in this situation in the first place speaks volumes about economic and financial asymmetry. Moscow has energy, and that’s obviously critical, but energy can be had from other places. By contrast, the US and Europe are the sole arbiters of dollars and euros. Moscow can’t force the US into a default. Technical, real or otherwise.

Second, Russian Finance Minister Anton Siluanov is unequivocally wrong to suggest this isn’t a default. “Anyone can declare whatever they like,” he said. “But anyone who understands what’s going on knows that this is in no way a default.” Like a lot of Kremlin propaganda, that sounds superficially plausible. Russia has the funds and is willing to pay, so how can this be a default? But, again like most Kremlin propaganda, it doesn’t hold up under any kind of scrutiny. If I commit a crime and lose access to my dollars or euros as a result, I still owe my electric bill. And my water bill. And my cable bill. And property taxes. And so on. Those obligations don’t just disappear. And I can’t print my own money on an inkjet and declare the obligations settled.

When it comes to Western sanctions, affected regimes typically respond in two ways. Initially, they claim not to care — that the measures are meaningless or that they’ll find ways around them. When such claims become untenable, they cry foul, and claim the sanctions are capricious.

Sometimes sanctions are capricious, but they’re never wholly unprovoked. Say what you will, but the US Treasury doesn’t just wake up in the morning and randomly sanction foreign actors for absolutely no reason. Every nation shown in the figure (above) is sanctioned for a reason. In Russia’s case, the reason is clear: Putin started a war. A sovereign entity took on foreign currency debt then invaded a country with friendly ties to the nations which control the relevant foreign currencies. So, too bad, so sad. It’s a default.

But, again, it doesn’t matter. It matters to the creditors, but they’ve had months to prepare for this, and because ratings agencies can’t do business in Russia, they presumably can’t declare Putin in default. Bondholders could make such a declaration on their own, but that seems risky. The chances of being repaid are slim enough as it is without aggravating Putin for no gain. It’s probably better to wait and hope. Hope the war ends and hope sanctions are eventually lifted to allow Moscow’s payment agent to transfer hard currency.

The bottom line was captured quite succinctly by Takahide Kiuchi, an economist at Nomura. “The Russian government has already lost the opportunity to issue dollar-denominated debt. As of now, Russia can’t borrow from most foreign countries.”

You could argue Russia doesn’t need to borrow from foreign countries, and that it can sustain itself in perpetuity as long as Europe needs gas and is willing to submit to Gazprom’s dual-account system and as long as China and India are buying, but the very fact that an otherwise monumental event was summarily waved off as meaningless by everyone involved says a lot about how quickly Russia has been relegated to total pariah status.

Siluanov threatened unspecified retaliation in the event creditors attempt to secure “diplomatic assets.” That would constitute “direct conflict,” he said, warning that Russia “would have to react differently — and not through legal channels.”

A text of a draft statement from the G-7 summit in Bavaria found leaders pledging indefinite support for Ukraine in the conflict. “We will continue to provide financial, humanitarian, military and diplomatic support and stand with Ukraine,” the statement said. “For as long as it takes.”