On March 17th, 2022 the United States Treasury allowed frozen Russian assets to be used to pay a $117 million coupon payment to Citibank, which was processed by JPMorgan. This scenario is likely to playout again as more Russian debt obligations come due in the face of ever-increasing sanctions.
The US Treasury clarified its stance on the legality of US financial institutions receiving debt payments from Russian entities. If the trade was initiated before February 24th of this year, then they may receive the interest and principal payments. Given the authorization from the Treasury to use frozen assets for payment, and the sheer number of frozen Russian assets in the US financial sector, the thawing of Russian assets for western debt payment is likely to become standard practice.
For scale, Russia ended 2021 with nearly $480 billion in external debt, representing 39.5% of the nation’s GDP. According to CNBC and Bloomberg, Russia has $2.6 billion in debt payment due between now and the end of May.
Do not let the defrosting of a White House estimated $80 billion in Russian funds for debt payments be mistaken for economic leniency. The use of these funds to fulfill financial obligations to US banks is a prudent financial and economic policy.
Allowing Russia to default on these obligations does little to enhance the already robust sanctions imposed on the nation. Russia has continued to see its credit rating decline at a record pace. Prior to the pandemic, their S&P rating was BBB-; shortly after the invasion it fell to BB+, and now sits at a CC. None of these downgrades were the product of defaults. Rather, these downgrades are the product of the dismal forecasts for the Russian economy and the consensus that global sanctions and asset restriction have eroded Russia’s future ability to repay debt.
By the Treasury allowing US Banks who lent to the Russian government in good faith prior to the invasion of Ukraine unthaw US-held Russian reserves, they are protecting vital financial systems from undue stress. The payments US banks are collecting are damaging the Russian ledger as they are reducing the nations overall reserves, frozen or otherwise.
Functionally, future tax revenue is the payment mechanism for public debt. Though, future tax revenues are not an asset class. In public basic financial statements, this creates a balance sheet where we see massive liabilities, such as OPEB and Pension obligations with little to no assets to offset them, on a GAAP basis. This forces rating agencies to judge public agencies by a different benchmark than the private sector. For governments, rating agencies focus on the strength of future tax revenues, the economic forecast, and access to cash reserves. Global sanctions have effectively restricted these three criteria.
The natural gas and oil embargo have constrained Russia’s primary source revenue. International trade restrictions have drastically reduced importation and exportation tax streams. Once consistent sources of cash to Moscow have dried up.
The expulsion of Russian banks and businesses from the world’s largest economies have dragged down Russian economic forecasts. The nation’s inability to access global raw material markets will reduce production. Its status as an international pariah only serves to darken its trade prospects.
The removal of the largest Russian banks from SWIFT has shut-off the Russian government from half of its reserves. The freezing of their assets has further removed any potential to access underlying liquidity. This action has cut Russia’s reserves in half.
If US banks were barred from unfreezing Russian assets, the only effect would be a weaker domestic banking system. Current repayments serve little to bolster confidence in future Russian debt offer and certainly won’t stop the continued decline in Russia’s credit rating.
The current sanctions have done their part to completely erode Russia’s ability to borrow, and they should remain firmly in place. By allowing the use of frozen Russian assets to pay debt, the US Treasury is protecting its domestic banking industry while not undermining the severe sanctions put on Russia.