Why Russia stares at first foreign default in a century?

As the Russian invasion of Ukraine entered its 58th day today, its effects on the world economy are clearly visible now.

And after Ukraine, it’s Russia which is bearing the maximum brunt -- not just its army but the economy is bleeding too.

So why is one of the world’s leading economies staring at an external debt default? And what will be its effect on its own economy?

Due to the series of sanctions, about half of Russia’s $640 billion of foreign currency reserves have been frozen. And it has drastically curtailed the country’s ability to make bond repayments in the currency the debt was taken-- which is dollar.

Meanwhile, Moody’s Investors Service has warned that Russia’s decision to make payments on debt, which was issued in dollars, in rubles would be considered a default. This is because it is in violation of the terms of the contract.  

How did things come to this?

The Russian government’s debt stands at a total value of 40 billion dollars. This debt is mainly in dollars and euros, and foreign investors own half of it.

The deadline to pay about 650 million dollars in interest and principle to the holders of two bonds that had been issued in dollars passed on April 4.

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Russia receives over 1 billion dollars every day just from its oil and gas deliveries. However, it now has limited access to dollars due to the sanctions imposed by the US.

Earlier, the US had allowed Russia to utilise some of the foreign reserves it had frozen to service debt payments. 

However, on 5th April, the US blocked Russia from using dollar reserves held at American banks to make debt payments.

So Russia has been left with little choice but to make the debt payments in rubles. Now, a 30-day grace period does allow Russia time until 4th May to avoid a default by converting the payments to dollars.

So, what are the consequences of such a default?

International investors will be unwilling or unable to lend more money to a country if it defaults on its foreign loan.

They might also demand much higher interest rates. Basically, the country will either face higher interest costs or it will be unable to borrow further.

Such a situation can force the country to reduce government spending, which, in turn, can lead to a fall in economic activity, an increase in unemployment and a slowdown in economic growth.