January 24, 2019

Considering Sanctions on Russian Sovereign Debt

By Sam Dorshimer

As the new Congress begins, legislators will have to decide whether to place sanctions on new issuance of Russian sovereign debt. Last year, the Senate considered sanctioning new Russian sovereign debt in the Defending American Security from Kremlin Aggression Act of 2018 (DASKAA). However, DASKAA would have required new sanctions without a clear set of policy objectives. The legislation was introduced even after a report from the Treasury Department found that sanctions on Russian sovereign debt could have significant spillover effects for financial markets. While sovereign debt sanctions are a potentially potent deterrent tool that Congress should include in new sanctions, policymakers should also articulate clear policy goals alongside the imposition of sovereign debt sanctions to best take advantage of their disruptive impact.

Last year, the formal proposal by the U.S. Congress of sanctions on sovereign debt caused Russian bond yields to spike and sent the ruble tumbling. Similar to the sanctions on EN+ and Rusal that caused major disruptions in markets in April, new sovereign debt sanctions would cause a substantial sell-off in existing Russian debt. According to the Russian Central Bank, nonresidents hold nearly 25 percent of Russian domestic bonds (OFZs) and nearly half of Russian Eurobonds. Many of these investors would want to avoid the risk and hassle of continuing to hold Russian debt, even if only new debt is sanctioned. The ruble would also likely take a major hit. It fell over 4 percent on the day the EN+ and Rusal sanctions were announced, and a similar drop would likely accompany sovereign debt sanctions.

The Russian government may still continue its current policies, but this cannot discourage U.S. lawmakers from policy action.

At the same time, the Russian government has a number of buffers against sovereign debt sanctions. This means that U.S. sanctions on Russian sovereign debt might not deliver the punch lawmakers intend, but also that they may not be as radically disruptive as predicted. Russia has a very low debt-to-GDP ratio of only 15.3 percent, and the Bank of Russia has been able to maintain substantial international reserves of nearly $470 billion as of the end of 2018. Moreover, Russia recently issued more Eurobonds in late November, in part to help move away from reliance on the dollar. All of this provides the Russian government some fiscal breathing room and protection from the worst effects of sovereign debt sanctions.

But make no mistake, new sovereign debt sanctions would still be damaging. They would certainly hurt Russia’s economic growth prospects and raise the Russian government’s funding costs.

Given the strength of sovereign debt sanctions and the disruption they are likely to create in markets, Congress should consider them the substantial deterrent that they are likely to be. The Russian government may still continue its current policies, but this cannot discourage U.S. lawmakers from policy action. Lawmakers should adopt this strong response to address continued election interference and escalation in Ukraine. They must be vigilant, however, to link imposition of sovereign debt sanctions to clearly articulated goals to manage the consequences and a very rocky relationship with Russia.

Sam Dorshimer is the Research Assistant for the Energy, Economics, and Security Program at the Center for a New American Security.

Read the full CNAS "U.S. Strategies to Counter Russia" commentary series below:

Embedding Sanctions in U.S. Russia Strategy

Prospects for Transatlantic Cooperation on Russia Policy

Russian Domestic Politics and Greater Russia-China Cooperation

Russia’s Macroeconomic Vulnerabilities

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