What happens if a country defaults on its debts? – The European Sting – Critical news and insights on European politics, economics, foreign affairs, business and technology

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This article is brought to you through The European Sting’s collaboration with the World Economic Forum.

Author: Victoria Masterson, Senior Writer, Training Content

  • 147 governments have defaulted on their debts since 1960.
  • If Russia does not pay its interest, creditors could lose money.
  • But global financial markets are unlikely to be destabilized, according to the IMF.
  • COVID-19 has worsened debt overhang, particularly in low-income countries and emerging market economies.

Russia may not pay $117 million in interest to foreign investors, experts warn.

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

Sanctions in response to Ukraine’s invasion have restricted Russia’s access to the $630 billion in foreign exchange reserves it uses to pay its foreign debt. This usually has to be paid in dollars or euros. It is believed that Russia could pay in rubles, which would still likely be considered a default due to the legal terms of the debt.

Another $615 million in interest payments will fall due by the end of March and another $2 billion to pay off new debt in full by April 4, according to Reuters.

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What does this mean by 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 obligated to pay the interest on those loans. If a payment is missed, this is described as a default.

Defaults occur when governments are unable – or unwilling – to meet some or all of their debt payments to their creditors.

According to the financial content website Investopedia, weakening economies and “reckless spending” are among the factors that can lead to defaults. Countries can also run into problems if they borrow in a currency other than their own. This means that if their budget is insufficient, their central bank cannot print more money to fill the void.

What can happen after a fault?

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

Foreign investors holding Russian bonds – government debt – could only recover 35-65% of the value of their investment, rating agency Moody’s has warned.

Rating agencies assess a debtor’s ability to repay its debt. Since the invasion of Ukraine, Russia’s ratings have gone from very credit worthy to junk status.

When countries have a bad credit rating, it is difficult for them to go into debt. In the case of Russia, most government bonds are now worth a fraction of their former value.

Chart showing total sovereign debt.
Investors in government debt include the International Monetary Fund, China, private creditors, and foreign currency bonds and bank loans. Image: Bank of England

Would the world be affected?

The last Russian debt crisis, in 1998, involved domestic debt – bonds denominated in Russian ruble. 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 heavily invested in Russian government bonds, Long-Term Capital Management, over fears its collapse could trigger a broader financial meltdown.

This time, the IMF doubts that a Russian default is globally destabilizing. It says the banks owe about $120 billion to Russia. That sounds like a lot, but it’s not enough to cause the financial system to fail.

Historical background – has this ever happened?

Since 1960, 147 governments have defaulted, according to a sovereign debt database maintained by the Bank of Canada and the Bank of England. That’s more than half of the world’s 214 state governments.

Chart showing sovereign debt levels.
Russia could default on its debt repayment. Emerging economies are generally the most exposed to the risk of default. Image: Bank of England

COVID-19 has worsened debt overhang, especially in low-income countries and emerging market economies, according to the IMF. Argentina, Ecuador, Lebanon and Zambia are some of the countries that have recently sought to restructure their debts.

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