Global Credit rating agency Standard&Poors (S&P) reported on April 11 that the Russian Federation has defaulted on its foreign loans after it attempted to pay bondholders in rubles instead of dollars.

S&P has lowered Russia’s credit rating to a “selective default” after it offered to use rubles to pay two dollar-denominated Eurobonds that matured last April 4. The agency explained the rationale behind the credit rating downgrade despite Russia’s attempt to pay using its home currency:

“We currently don’t expect that investors will be able to convert those ruble payments into dollars equivalent to the originally due amounts or that the government will convert those payments within a 30-day grace period,” S&P said in a statement.

Moscow has a 30-day grace period to provide payments of capital and interest, but S&P believes it will probably receive more sanctions in the coming weeks as it continues its war on Ukraine. This will hamper “Russia’s willingness and technical abilities to honor the terms and conditions of its obligations to foreign debtholders,” said the agency.

If this continues, Russia will see its first full foreign currency default since the aftermath of the 1917 revolution, which put the Bolsheviks in power over a century ago. Last week, Russian Finance Minister Anton Siluanov tried to reassure creditors that they would get paid.

“We will do everything so creditors receive their invested money from the Russian Federation,” Siluanov said.

Siluanov maintains Russia has consistently tried to pay its foreign creditors in “good faith.” He blames the “deliberate policy of Western countries” to force Moscow into a “man-made default.”

According to the Russian Finance Minister, Moscow’s external debt makes up roughly 20% of its total public liabilities, which sits at around 21 trillion rubles or $261.7 billion.

“If an economic and financial war is waged against our country, we are forced to react while still fulfilling all our obligations,” Siluanov said. “If we are not allowed to do it in foreign currency, we do it in rubles.”

Unreachable Russian Reserves

Russia boasts one of the largest foreign currency reserves in the world. It has been stockpiling foreign currency since its annexation of Crimea in 2014. Since then, Russia’s holdings of gold and foreign currency have nearly doubled from $368 billion to $630 billion.

Foreign reserves are government holdings in the form of bullion, foreign currency, and foreign loans, which are usually denominated in dollars and other major economic currencies. These reserves are useful to combat domestic inflation and the rising prices of goods, as the central bank can trade foreign reserves to manage the value of their currency.

“Large stockpiles of foreign reserves just are very useful for helping to insulate yourself from global economic shocks,” nonresident fellow Emma Ashford at Modern War Institute at West Point said.

It is entirely possible that the Kremlin stockpiled foreign reserves to prepare for economic sanctions.

However, their strategy had a vital flaw. Around half of its money is deposited overseas, and with the introduction of financial restrictions, it cannot access it. Holding reserves overseas is a common strategy to avoid taxes and fees on international transactions.

During the start of the invasion of Ukraine, the Russian central bank tried to tap its reserves to prop up the ruble. However, the country’s prompt removal from the SWIFT financial system likely caught Russia off guard.

There is around $315 billion in Russian foreign reserves that it cannot access due to economic sanctions. It could use some of its frozen assets in the United States until last week, but it is now blocked by the Biden administration as part of another round of sanctions against Russia.

Taking Legal Action

Moscow intends to take its case to court if they are forced into a sovereign debt default.

“Of course, we will sue because we have taken all the necessary steps to ensure that investors receive their payments,” Siluanov said.

“We will show the court proof of our payments to confirm our efforts to pay in rubles, just as we did in foreign currency. It won’t be a simple process,” he added. The Minister, however, did not disclose who they intended to sue.

Kremlin spokesman Dmitry Peskov admits Russia is forced to pay in rubles as it cannot access its dollars.

“Significant amounts of our reserves are blocked in foreign countries, so if this blocking continues and these transfers are blocked from the blocked amounts, then they will be serviced in rubles,” he said in a press conference last Wednesday. “If this is not possible, then, in theory, of course, a default situation can be organized.”

However, Peskov continued to argue that if a default were to happen, it would be “artificial” given that Moscow has enough money to pay; it just cannot retrieve them.

“There are no grounds for a real default,” Peskov said. “Not even close.”