What is default and how does it affect ordinary citizens

What is a default and why is everyone talking about it

Default is the failure to fulfill obligations under loan agreements. It may be about late payment of interest or principal. This term is used in relation to individuals, companies or states. But in everyday life it is more often associated with countries, since the consequences of such an event affect many people. There is also a technical default where the debtor fails to bankrupt and in general can pay off debts, but specifically now, on time, he did not do this.

Talks about a potential default of Russia have been going on since the end of February. The external debt of the Russian Federation is about 450 billionAssessment of the external debt of the Russian Federation as of April 1, 2022 / Central Bank US dollars. For the country, this is not so much, that is, the state can still cope with its obligations. But it is important not only the availability of money, but also the ability to transfer it to the addressee.

May 25 US Treasury did not extendNotice on Russian Harmful Foreign Activities Sanctions General License 9C / U.S. Department of the Treasury Russian license, which allowed to service external debt. In turn, the Russian Ministry of Finance secured itself and listedThe Ministry of Finance of Russia has fully fulfilled its obligations to pay coupon income on Eurobonds / Ministry of Finance of the Russian Federation money on coupon income on Eurobonds on May 20. However, they did not reach the recipients. The last day when the funds could be with investors is June 26, but the bondholders did not receive the transfer. Abroad they believe that this is a default, in Russia - that NoThe Ministry of Finance of Russia has fully fulfilled its obligations to pay coupon income on Eurobonds maturing in 2026 and 2036 / Ministry of Finance of the Russian Federation. And while "at the top" are arguing, it is worthwhile to figure out how this will affect ordinary citizens.

What is dangerous default

A government default lowers its credit ratings. This means that it will be harder for the country to attract borrowed funds, and this hinders the development of the economy. If the state (and enterprises within it) will be able to borrow money, then at a higher interest rate than before. That is, more funds will be spent on servicing loans, and this is under an optimistic scenario. Rising inflation, weakening of the national currency, banking crisis and so on are possible. Citizens may face an increase in unemployment, a decrease salaries, cuts in government benefits.

In each case, the outcome may be different. Much depends on the policy of the state and its reputation.

How did countries survive default?

Russia in 1998

The prerequisites were a deficit budget, in which they tried to include populist spending, as well as desperate attempts to contain inflation and prevent the ruble from falling. Money for all these purposes was attracted through government short-term bonds, highly profitable for investors and, accordingly, very expensive for the country. Budget revenues, however, were not high. For example, taxes chronically underachieving.

This precarious structure was shaken by the Asian financial crisis in 1997. Everything was complicated by the confrontation in the economic and political higher circles of the country. On August 17, 1998, the Central Bank and the government of the Russian Federation announced a technical default. The price of the ruble was first allowed to trade within the currency corridor, and then they stopped supporting it altogether, as a result of which the dollar rose from 6.2 rubles in July to 19.9 rubles in December.

Inflation, according to some amounted toHow the 1998 default determined the monetary policy of the 2000s / Vedomosti 80%. The default was followed by bankruptcies of companies and a banking crisis. Employees of commercial organizations were left without work, and state employees did not receive a salary for months.

Over time, new jobs appeared, production facilities opened. Russian enterprises have become more competitive in the world market. Many foreign companies have come to the country. Although, of course, all this was not all at once, the first few years had to be spent on dealing with the consequences of the default.

Argentina in 2001

On December 26, 2001, Argentina defaulted on an external debt totaling $93 billion. The country has been moving towards this event since the 1990s. In short, the same thing happened to her as to any negligent borrower: in order to repay old debts, she had to take on new ones at higher interest rates. As a result, the load became unbearable.

As a result, foreign investment fled the country, and capital inflows into Argentina almost completely stopped from 2001 to 2003. The peso quadrupled against the dollar. Inflation increasedJ. F. Hornbeck Argentina’s Defaulted Sovereign Debt: Dealing with the “Holdouts” / Congressional Research Service by more than 40%, GDP in 2002 fell by 11%, and the number of poor among the population increased.

Has Argentina's economy recovered in 20 years? Not reallyHow Argentina lives in constant expectation of defaults that sometimes happen / Forbes. key rate in the country is now 52%, and this is not a historical maximum. Inflation is high. And Argentina, in general, constantly lives in anticipation of a new default.

Greece in 2015

On July 1, 2015, Greece did not transfer the 1.54 billion euros that it owed to the International Monetary Fund. The creditor recognized its technical default. The country did not refuse obligations, it simply asked to adjust the deadlines.

The problem arose due to the fact that after joining the European Union and introducing the euro into circulation, the country embellished financial statistics for several years. The truth surfaced in 2009, and Greece was on the verge of bankruptcy. The budget was in deficit, the national debt grew. The country's situation was also worsened by the global financial crisis of the late 2000s, as it is dependent on tourism. The European Union provided financial assistance to the state in 2010, 2012 and 2015, but the money actually went to service loans, and not to improve the economic situation.

As a result, thanks to EU funds in 2015, Greece managed to pay off its current debts and avoid a full-fledged default. However, to do this, the authorities had to agree to internal reforms and to external monitoring of the state of the budget from some EU countries.

Since 2017, the Greek economy has been growing (with a break for the 2020 pandemic). Now rating agencies are looking at it rather with optimism. For example, in Fitch noteFitch Revises Greece's Outlook to Positive; Affirms at ‘BB’ / Fitch Ratingsthat economic activity in the country is recovering faster than expected by the company. And, apparently, will continue to do so next year. At the same time, in the ranking of EU countries in terms of financial well-being before the spread of coronavirus, Greece occupiedEuropean Consumer Payment Report 2019 / Intrum last place, and the pandemic is essential worsenedEuropean Consumer Payment Report 2021 / Intrum situation for ordinary Greeks.

What default threatens the Russians now

In short, nothing. More precisely, the probability is high that the economic situation will worsen, but this has nothing to do with the default.

Fitch Ratings back in March downgradedFitch Downgrades Russia to 'C' / Fitch Ratings Russia's rating is up to C (default is inevitable), Moody's is up to pre-default CaMoody's downgraded Russia's rating for the second time in a week / RBC. Then they stopped monitoring the activities of Russian companies. Quite a few foreign enterprises have announced that they will stop investing in domestic business for ideological reasons or have left the market altogether. Far from everyone is also ready to import goods and components for production.

Central Bank expects inflation in 2022 in 14–17%The Bank of Russia decided to cut the key rate by 150 bp to 9.50% per annum / Bank of Russia, although a little earlier I spoke about 18-23%. However, in January the forecast was 4%, which is significantly less. As it will be in reality, it is too early to say.

Regional authorities report backGovernor Kuyvashev announced a sharp reduction in unemployment / Ura.ru about reducing unemployment. However, at the same time, enterprises sendSverdlovsk plant sent workers to downtime due to sanctions Ura.ru employees in idle time (give ⅔ salary) and translateConsequences of sanctions: it became known how many residents of the Ural Federal District were transferred to part-time work / Vedomosti Ural part-time (paid according to hours worked). That is, officially people do not lose their place, but in fact their income is significantly reduced. It should also be taken into account that the unemployed are counted by the number of people registered to the labor market. Many do not do this, because the allowance is small, but it is impossible to have additional financial sources.

The ruble has risen in price against the dollar, which seems to be good, but it doesn’t really change much. It’s just that demand has fallen: imports have decreased, it’s hard for people to get foreign currency inside the country legally. That is, the dollar has fallen in price, but you can’t buy it and you won’t be able to buy something with it, because they don’t sell it. If the situation changes, it will be reflected in the course.

At the same time, there is no real risk that the state will go bankrupt. So default is not something to worry about too much. Whether the country is able to pay off its external debts or not, the negative consequences are already here anyway. The rest can be observed purely from academic interest.