What happens if a country defaults on its debts?

This article is brought to you thanks to the collaboration of The European Sting with the World Economic Forum.

Author: Victoria Masterson, Senior Writer, Formative Content

• 147 governments have defaulted on debts since 1960.
• If Russia defaults on its interest payments, creditors might lose money.
• But it’s unlikely that world financial markets would be destabilized, the IMF says.
• COVID-19 has raised debt distress, particularly in low-income countries and emerging market economies.

Russia could fail to pay $117 million in interest payments to foreign investors, experts are warning.

This would be the country’s first default on international debt since the Russian Revolution of 1917.

Sanctions in response to the invasion of Ukraine have restricted Russia’s access to the $630 billion in foreign currency reserves it uses to pay foreign debt. This typically has to be paid in dollars or euros. It’s thought Russia might pay in roubles, which would probably still count as a default because of legal terms on the debt.

Another $615m in interest payments will fall due by the end of March and a further $2 billion to fully repay a further debt by 4 April, according to Reuters.

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What does it mean to default and how does it happen?

The International Monetary Fund describes default in simple terms as a broken promise or breach of contract. When a government borrows money from foreign and domestic creditors, it is contractually obliged to pay the interest on those loans. If a payment is missed, this is described as a default.

Defaults happen when governments are not able to – or don’t want to – meet some or all of their debt payments to creditors.

Weakening economies and “reckless spending” are among the factors that can lead to defaults, according to Investopedia, the financial content website. Countries can also face problems if they borrow in a currency other than their own. This means that, if their budget falls short, their central bank can’t print more money to fill the gap.

What might happen after a default?

A 30-day grace period could give Russia until the end of April to pay the $117 million it owes. The country will officially be in default if no payment is made by then.

Foreign investors holding Russian bonds – government debt – might only get back 35% to 65% of their investment’s value, credit rating agency Moody’s has warned.

Credit rating agencies rate a debtor’s ability to repay debt. Since the invasion of Ukraine, Russia’s ratings have slumped from highly creditworthy to “junk” status.

When countries have a poor credit rating, it’s hard for them to raise debt. In Russia’s case, most government bonds are now worth a fraction of their previous value.

Would the world be affected?

The last Russian debt crisis, in 1998, involved domestic debt – bonds denominated in the Russian rouble. It followed a financial crisis in Asia and had a global impact on financial markets.

In the fallout, the US government bailed out a large hedge fund that was heavily invested in Russian government bonds, Long-Term Capital Management, over fears its collapse could trigger a wider financial meltdown.

This time, the IMF doubts a Russian default would be globally destabilizing. It says banks are owed about $120 billion by Russia. This sounds like a lot, but isn’t enough to cause failure in the financial system.

Historical context – has it happened before?

Since 1960, 147 governments have defaulted on their obligations, according to a sovereign debt database run by the Bank of Canada and Bank of England. This is more than half of the world’s 214 state governments.

COVID-19 has raised debt distress, particularly in low-income countries and emerging market economies, the IMF says. Argentina, Ecuador, Lebanon and Zambia are some of the countries that have recently looked to restructure their debts.

In Russia, the last default on debt in a foreign currency was in 1917. When Bolsheviks overthrew the imperial government of Tsar Nicholas II, they refused to recognize his administration’s debts. The move soured Russia’s relations with former allies, including France, for decades.