WASHINGTON — The Biden administration will start blocking Russia from paying American bondholders, increasing the likelihood of the first default of Russia’s foreign debt in more than a century.
An exemption to the sweeping sanctions that the United States imposed on Russia as punishment for its invasion of Ukraine has allowed Moscow to keep paying its debts since February. But that carve-out will expire on Wednesday, and the United States will not extend it, according to a notice published by the Treasury Department on Tuesday. As a result, Russia will be unable to make billions of dollars of debt and interest payments on bonds held by foreign investors.
The move represents an escalation of U.S. sanctions at a moment when the war in Ukraine continues to drag on, with Russia showing few signs of relenting. Biden administration officials had debated whether to extend what’s known as a general license, which has allowed Russia to pay interest on the debt it sold. By extending the waiver, Russia would have continued to deplete its U.S. dollar reserves and American investors would have continued to receive their guaranteed payments. But officials, who have been trying to intensify pressure on Russia’s economy, ultimately determined that a Russian default would not have a significant impact on the global economy.
Treasury Secretary Janet L. Yellen signaled how the Biden administration was leaning at a news conference in Europe last week, when she said that the exemption was created to allow for an “orderly transition” so that investors could sell securities. It was always intended to be for a limited time, she said. And she noted that Russia’s ability to borrow money from foreign investors has already essentially been cut off through other sanctions imposed by the United States.
“If Russia is unable to find a legal way to make these payments, and they technically default on their debt, I don’t think that really represents a significant change in Russia’s situation,” Ms. Yellen said. “They’re already cut off from global capital markets, and that would continue.”
Although the economic impact of a Russian default might be minimal, it was an outcome that Russia had been trying to avoid and the Biden administration’s move represents an escalation of U.S. sanctions. Russia has already unsuccessfully tried to make bond payments in rubles and has threatened to take legal action, arguing that it should not be deemed in default on its debt if it is not allowed to make payments.
“We can only speculate what worries the Kremlin most about defaulting: the stain on Putin’s record of economic stewardship, reputational damage, the financial and legal dominoes a default sets in motion and so on,” said Tim Samples, a legal studies professor at the University of Georgia’s Terry College of Business and an expert on sovereign debt. “But one thing is rather clear: Russia was keen to avoid this scenario, willing even to make payments with precious non-sanctioned foreign currency to avoid a major default.”
Sanctions experts have estimated that Russia has about $20 billion worth of outstanding debt that is not held in rubles. It is not clear if the European Union and Britain will follow the lead of the United States, which would exert even more pressure on Russia and leave a broader swath of investors unpaid, but most of the recent sanctions actions have been tightly coordinated.
The prospect of a Russian default has already saddled some big U.S. investors with losses. Pimco, the investment management firm, has seen the value of its Russian bond holdings decline by more than $1 billion this year and pension funds and mutual funds with exposure to emerging market debt have also experienced declines.
In the near term, Russia has two foreign-currency bond payments due on Friday, both of which have clauses in their contracts that allow for repayment in other currencies if “for reasons beyond its control” Russia is unable to make payments in the originally agreed currency.
Russia owes about $71 million in interest payments for a dollar-denominated bond that will mature in 2026. The contract has a provision to be paid in euros, British pounds and Swiss francs. Russia also owes 26.5 million euros ($28 million) in interest payments for a euro-denominated bond that will mature in 2036, which can be paid back in alternative currencies including the ruble. Both contracts have a 30-day grace period for payments to reach creditors.
The Russian finance ministry said on Friday that it had sent the funds to its payment agent, the National Settlement Depository, a Moscow-based institution, a week before the payment was due.
The finance ministry said it had fulfilled these debt obligations. But more transactions are required with international financial institutions before the payments can reach bondholders.
Adam M. Smith, who served as a senior sanctions official in the Obama administration’s Treasury Department, said he expected that Russia would most likely default sometime in July and that a wave of lawsuits from Russia and its investors were likely to ensue.
Although a default will inflict some psychological damage on Russia, he said, it will also raise borrowing costs for ordinary Russians and harm foreign investors who were not involved in Russia’s invasion Ukraine.
“The interesting question to me is, What is the policy goal here?” Mr. Smith said. “That’s what’s not entirely clear to me.”
Alan Rappeport reported from Washington, and Eshe Nelson from London.
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