What are the risks of a Russian default?
In recent weeks, there has been speculation that Russia could be forced into default due to its inability to meet its debt payments in dollars. Cases such as Argentina’s give clues as to what the consequences of such a move might be.
Rumours in financial circles had Russia on the brink of default in mid-March. The reason for this was difficulties in meeting its US dollar debt repayment commitments on schedule.
The fact is that so far the country has managed to meet its scheduled payments. However, doubts remain, as the amount that Russia must repay in April, more than 2 billion dollars, is much higher than in March. The blocking of Russian assets by the EU and the US is a serious obstacle to making payments in dollars.
International debt rating agencies have downgraded Russia’s debt to pre-default levels. And Kristalina Georgieva, managing director of the International Monetary Fund (IMF), acknowledged a few weeks ago that a Russian default “is no longer an unlikely event“.
Russia would not be the first country to declare a default. Indeed, the Spanish state did so seven times in the 19th century. And the case of Argentina in this century offers many lessons on the consequences of such a move.
One month grace period
When such a situation arises, countries have a period of 30 days to renegotiate the debt with creditors, which are mostly banks. The aim may be to refinance the debt, have a part of it written off, or agree on a temporary moratorium on payments.
Another option is to seek alternative financing, either by raising interest rates on the debt to attract new investors, as Iceland did in 2008, or by resorting to international organisations such as the IMF, the solution applied by Greece in the past decade. In any case, Russia would find the latter route complicated by the majority of nations’ rejection of the invasion of Ukraine.
If after 30 days, the country does not achieve any of the above, the only option is to declare insolvency or default. This is what Argentina did between late 2001 and early 2002, in what was the largest state default in history. The state owed almost $200 billion and had only $10 billion in foreign exchange reserves.
Obviously, the suspension of a country’s payments implies the loss of investor confidence in that economy. This translates into the impossibility for the state to continue borrowing to finance itself and a massive exodus of capital, especially foreign investment.
The drastic contraction of private investment leads to a recession in the economy, which leads to a vicious circle of more unemployment and shrinking state revenues. It should be borne in mind that in the case of Argentina, unemployment doubled in five years and the need to cut public spending hit pensioners and civil servants particularly hard, as their incomes were considerably reduced.
Moreover, following a default, a devaluation of the local currency is common in the face of a loss of external confidence, which leads to higher prices.
The population’s fear of devaluation and hyperinflation often leads to a massive withdrawal of funds from banks in order to move them abroad. This phenomenon forced the Argentine government to freeze bank accounts and limit the amount of money that could be withdrawn daily, which became known as the “corralito”.
The perfect storm
This inflationary environment, coupled with a sharp decline in incomes and limited access to savings, is the ideal breeding ground for social unrest, rising crime, and the flight of human capital.
Six months after the default, almost a quarter of Argentines were considered destitute and another quarter below the poverty line. These are hard figures to swallow considering that this is a country rich in natural resources and with one of the largest livestock herds in the world.
The loss of confidence in paper money even led to the proliferation of up to 8,000 barter clubs in Argentina, some of which went so far as to issue their own “coins”.
Risk of international contagion
A country’s suspension of payments can also have negative consequences beyond its borders. It should be borne in mind that the first effect of this measure is that creditors cease to be paid. This can put a strain on international creditors who are heavily exposed to that debt or on insurers who have decided to hedge those investments. In certain cases, the banking and insurance system may be affected by the domino effect.
It now remains to be seen what Russia’s ability to meet its commitments will be in the coming weeks, and whether the IMF managing director’s warning takes shape as the cost of the war in Ukraine and international sanctions put the Russian economy on the ropes.
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