On Tuesday, the U.S. Treasury tightened the financial pressure on Vladimir Putin by prohibiting U.S. financial institutions from facilitating dollar-denominated debt payments to investors. Simply put, it made it much harder for Russia to pay its bondholders, raising the risk that Russia will default on its sovereign debt. Usually, governments that default on their debts face serious consequences. However, it is possible that Russia may be less worried about this action than other governments would be. Here’s what you need to know.
Russia might still be able to pay its debts — but it would be very hard
Russia, like other countries, borrows money by selling bonds. The bondholders provide it with money now in exchange for the promise to pay it back at a set date, paying interest along the way. The new U.S. government action doesn’t make it absolutely impossible for Russia to pay back its bondholders, but it makes it much harder. The idea is to force Russia to choose between using its scarce dollars for debt repayment (rather than other purposes), or facing the consequences of a sovereign default.
The U.S. decision means that if Russia wants to pay its bondholders, it will have to use dollars that are held outside U.S. institutions. Even that may be hard. Foreign banks may worry about the risk of U.S. financial sanctions and decide that the legal and reputational risks of helping Russia are too high for them to want any involvement.
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Governments can pay big costs for defaulting on their debts
Why should Russia care about avoiding default? Like most other governments, it borrows money to finance expenditures and smooth spending across economic booms and busts. While governments can borrow from commercial banks, from other governments (including China) or from multilateral financial institutions (like the World Bank), many governments borrow by issuing sovereign bonds. When, as was true for the last decade, there is a lot of money sloshing around in global capital markets looking for returns, bond-based borrowing becomes even more widespread.
Some investors prefer that governments borrow in a foreign currency — especially the dollar — to reduce their own risk. Lending in dollars means that investors don’t have to worry that their assets’ value will fluctuate along with the value of the borrower’s currency. Equally, this means that the borrowing government needs to generate foreign exchange to repay its debts. While foreign-denominated bond borrowing has become less common in recent years, it nonetheless offers some benefits to governments, like lower interest rates or longer bond terms.
Bondholders want to get their money back. Since there is no international bankruptcy court, investors seek additional reassurances against default. This means that a government’s reputation for paying back money is an important asset. Governments with a good reputation can borrow more easily and cheaply. That helps explain why governments often try to avoid default — they want to be able to borrow easily in the future. They also may not want to displease politically powerful banks and businesses within their own country who will suffer too from a default, since investors will be less willing to lend to them, driving up the cost of credit throughout the economy and imposing harm on debtors and borrowers.
Russia may be less likely to worry about this than other countries
However, Vladimir Putin is less likely to worry about this than the U.S. government might think. Defaulting on debt might be politically damaging, but losing a war would be politically catastrophic, endangering the survival of Putin’s regime. It would be unsurprising if Putin uses his scarce dollars to prosecute the war rather than to pay off bondholders. Furthermore, the key Russian banks and businesses that might protest are state-owned or owned by Putin’s close allies, meaning they are less likely to complain. A debt default would hurt Russian households and small businesses, but they don’t have much opportunity to make their voice heard.
Furthermore, Russia is probably less worried about its future ability to borrow than other countries might be. Countries that have high debt burdens need to think about refinancing their debt, which motivates some (but not all) governments to prioritize debt repayment.
But Russia’s debt burden is low. It was estimated at less than 20 percent of its GDP before the invasion. This very modest level of debt reveals that Russia’s government relies more heavily on other sources of finance — especially its oil revenue — to keep itself going. Global oil prices have gone up — in part thanks to the war — providing Putin’s government with a different source of revenue. This is likely to grow even though some traders are refusing to buy Russian oil, unless European countries introduce sanctions. More generally, Russia currently exports more than it imports, meaning that foreigners are paying Russia more than Russia is paying them. This leaves Russia with sufficient funds — even without the bond market.
Finally, Russia doesn’t face the risk of default on all of its debts. Interest and principal bond payments on two bond series were due on April 4; Russia has 30 days to make these payments before officially being in default. These bonds require repayment in dollars. But some of Russia’s other government bonds contain a contract provision allowing Russia to repay in “alternative currencies,” including (in some cases) rubles. These somewhat unusual provisions mean that the worry of default may be even less meaningful to Russia’s government.
This is not to say that additional financial sanctions, including further U.S. restrictions against Russian banks announced this week, will not further pressure Putin. But the bond market route is probably not an effective lever.
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Layna Mosley is professor of politics and international affairs in the School of Public and International Affairs and the department of politics at Princeton University. Follow her on Twitter.