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What happens when a major economy can’t pay its debts in dollars? Russia is about to show us

As of Wednesday Russia has been scheduled to pay investors holding two dollar-denominated government bonds $117m in interest payments. It will likely make the payments, but probably in roubles rather than dollars. Some of Russia’s debt contracts permit such an arrangement; the two bonds in question do not. Russia has a grace period of 30 days within which to make payments in the normal fashion. If it fails to do so, it is likely to be declared in default by its creditor.

Photograph: AFP/Getty Images© Provided by The Guardian Photograph: AFP/Getty Images

Sovereign defaults send shockwaves through the global financial system. They signal that a debtor at the very apex of the monetary system – a government – is either unwilling or unable to meet its obligations. Since, in a modern monetary system, government debt is generally treated as the ultimate safe asset, this is a shock that goes beyond the arena of high finance. Russian defaults have rocked the global financial system twice in modern history. In 1917, the Bolsheviks repudiated the debts of the Tsarist empire, souring relations with Russia’s former allies, most notably France, for decades to come. In 1998, in the financial crisis that defined Vladimir Putin’s rise to power, Russia defaulted on its domestic debt and some Soviet-era foreign debt. The repercussions were significant enough to bring about the meltdown of the LTCM hedge fund, the world’s biggest, in New York.

The current impending default is nothing like either of those occasions. Only a few short months ago Russia was a top-rated sovereign debtor. It had only $38bn in foreign currency debt outstanding, of which only $20bn was owned by foreign investors – a tiny amount for a trillion-dollar economy. The payment that is due now, $117m, is a small fraction of what Russia continues to earn every day for its oil and gas exports. For gas alone, Russia was a fortnight ago earning more than $700m a day.

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Russia will pay in its local currency not because it is unable to find $117m, or because it has unilaterally decided that these debts are odious and should not be serviced. It is not paying its foreign creditors because it is locked in an asymmetrical proxy war with the west, a struggle in which the latter has chosen to weaponise the financial system.

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The defining moment came on Saturday 26 February, with the announcement of central bank sanctions. This sent the rouble plunging, and forced the closure of Russia’s financial markets. In the coming months, inflation in Russia will surge. To contain the price increases, interest rates have been savagely hiked. Russia will have a hard time getting hold of vital imports. Economists estimate that Russia’s economy could contract by 15% or more.

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