In Ukraine, Putin may fear more default than defeat

Russia surprised many observers last week by honoring its obligation to pay interest on dollar-denominated government bonds. Coupon payments in the amount of 117 million Conditions of the offers.

While the US has blocked most transactions by American institutions with Russia’s central bank and Treasury, a temporary Treasury waiver allows Russia to make those debt payments until May 25.

The question of whether Russia will continue to honor its contractual foreign currency borrowing obligations goes beyond considering its financial standing as a nation or even its ability to justify defaulting in the face of severe Western sanctions. Fear of failure in the global financial arena has haunted Russian leaders ever since the Soviet government suspended external debt servicing in January 1918 and rejected all bonds issued under the Tsarist government — some with maturities 80 years in the future.

In the early Soviet years, Marxist “workers’ paradise” policies caused such economic devastation that Vladimir Lenin was forced to restore certain aspects of market capitalism, including limited private ownership of agriculture and retail, in order to salvage the future of Bolshevism. The Soviets introduced a gold-backed currency, the chervonets, in 1922 to combat hyperinflation. But Western creditors and governments despised the Soviet Union for denying its national debt in violation of international law.

Joseph Stalin spurned Western rejection by proclaiming his own nation’s financial superiority; In March 1950, the Soviet government declared the ruble the “most stable currency in the world” even though it was not convertible into Western currencies. Abel Aganbegyan, a former economic adviser to Mikhail Gorbachev, recounts how Stalin ordered state statisticians to calculate the purchasing power of the dollar against the ruble – only to frown, cross out their number with a pencil and substitute his own exchange rate assessment: 1 ruble equals $4.

Reality hit hard in the post-Soviet 1990s, when Russia’s chronic budget deficits continued to wreak havoc on its financial profitability and borrowing ability. In the previous decade, Mr. Gorbachev had settled British claims on defaulted Tsarist bonds to enable Soviet entry into world financial markets; his goal was to rebuild the Soviet economy with Western finance capital. But the underlying problem of declining productivity and over-reliance on energy revenues plunged Russia into bankruptcy and political crisis.

In mid-1998 Boris Yeltsin was struggling to save the ruble and stem capital flight; Interest rates on government bonds rose to 150%. On July 29, Yeltsin replaced his head of the Federal Security Service with Vladimir Putin.

The consequences of Russia’s total financial collapse less than three weeks later, on August 17, were devastating. The Russian government devalued its currency, defaulted on its domestic debt and imposed a moratorium on payments to foreign creditors. From January to August 1998, the Russian stock market lost more than 75% of its value. Inflation hit 84% while real gross domestic product fell 4.9%. Meanwhile, efforts by the Russian central bank to defend the currency had exhausted Russia’s foreign exchange reserves; The ruble lost more than two-thirds of its value against the dollar by the end of September.

Mr Putin’s perspective on the link between currency stability, sovereign debt and access to foreign capital arose in this melting pot of financial desperation and national humiliation. It still influences his thoughts and actions today.

Finance Minister Anton Siluanov insisted that the West is trying to force Russia into an “artificial default” by freezing its foreign exchange reserves held abroad, announcing on April 16 that “we’ve got the money, we’ve made the payment; now the ball is primarily in the hands of the American authorities.” On the same day, Mr Putin claimed that the US and the European Union had “announced the most real default in their own commitments to Russia” by imposing sanctions on Russia’s foreign exchange reserves .

Does it matter that Mr. Putin seems to respect the rules of international finance more than the rules of war? What can we learn from the perverse pride of a former counterintelligence officer striving to avoid a hard default on Western currencies?

It’s hard to fathom the psyche of a person who rejects the territorial integrity of independent states and brutally attacks civilians, while at the same time seems obsessively concerned about being seen as financially sophisticated. But it is important that, for strategic reasons, we try to understand Russia’s leader – his motivations and goals, his primal fears and his self-important ambitions. As Sun Tzu advises, know your enemy.

Western policymakers need to understand the threat level of freezing Russia’s international reserves from a Russian perspective. “There is nothing left to support the ruble,” former Russian Prime Minister Mikhail Kasyanov tweeted in late February. “Turn on the printing press. Hyperinflation and economic catastrophe are just around the corner.” The threat becomes personal for Mr. Putin when the blame falls on him, not the West. “These are all Putin’s criminal acts,” Mr. Kasyanov added in his tweet.

It would take a psychiatrist to delve into the depths of Putin’s sense of vulnerability in the face of an imminent default – technical or real – on his foreign-currency-denominated sovereign debt. Russia would not be the first nation to equate economic ruin with an act of war. According to a 2009 Strategic Studies Institute report on Japan’s actions in 1941, “Americans underestimated the role of fear and honor in Japanese calculations and overestimated the effectiveness of economic sanctions as a deterrent to war.”

Mr Putin put Russia’s nuclear forces on alert the day after sanctions blocked Russian access to its foreign currency reserves held abroad. Failure to make future payments constitutes a default if not remedied within 30 days. This gives a new meaning to the term grace period.

Ms. Shelton, Senior Fellow at the Independent Institute, is the author of The Coming Soviet Crash: Gorbachev’s Desperate Pursuit of Credit in Western Financial Markets (1989).

Review & Outlook: Joe Biden and NATO are still too cautious when it comes to dismissing Russia’s war with Ukraine. Images: AP/Kirillovka. Ukr via Storyful Composite: Mark Kelly

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