Ukraine needs a durable commitment of support from the G7

The long-awaited agreement by the G7 democracies to use earnings from the $300 billion in frozen Russian Central Bank reserves to channel aid to Ukraine was a welcome development. Signed on June 13 at the 2024 G7 Summit in southern Italy by President Joseph R. Biden, Jr. and the leaders of Canada, France, Germany, Italy, Japan, the United Kingdom, and the European Commission, the agreement provided an important historical coda to the commemoration of the 80th anniversary of the D-Day landing in Normandy the week before.

The G7 action will lend $50 billion to Ukraine to be repaid from interest payments on the frozen assets. The funds are to be disbursed by the end of this year; in the interim, details about each country’s share of the financing and how the loans will be guaranteed will be finalized.

The new funds are critically important and will help cover Ukraine’s current financing gap. But the $50 billion loan is essentially a stopgap measure covering Ukraine’s immediate needs in what has become a grinding war of attrition. More will be needed in coming years to finance Ukraine’s current operations and economic reconstruction, during the war and after it ends.[1] If the Russian attacks persist, the G7 members may be forced to revisit the much-debated question of whether to seize outright the $300 billion of Russian reserves immobilized since the start of the war.

The difficulties of getting agreement on helping Ukraine are of course being watched carefully by President Vladimir Putin of Russia, who is betting that Western countries will tire of supporting Ukraine over time and that he will ultimately win a protracted war of attrition. Growing isolationism in US and European politics, and the possible return of Donald Trump to the White House, indicate possible emerging cracks in G7 support for Ukraine in coming years. Because Russia’s relative size compared to Ukraine and resources (replenished by large inflows of energy export earnings) would inevitably wear down its victim, Ukraine needs substantial and durable support from the G7 countries to hold off the Russian assault. The G7 provision of substantial financing for Ukraine cannot be a one-off event.

Most of the frozen Russian assets are under European control, held at Euroclear, a Belgium-based financial services company. The legal authority of the United States to seize the reserves is clear.[2]. But in Europe, lawyers contend that seizing sovereign assets would violate international law, while politicians worry that seizing sovereign assets could have reputational risks and set precedents that might apply to past abuses by their governments, and some others are nervous about Putin’s nuclear threats.

As a practical matter, the Russian Central Bank assets are unlikely to be repatriated. Once the war ends, compensation claims for the damages inflicted on Ukraine will likely exceed the value of the frozen reserves. The statement issued by G7 financial officials in Stresa in late May confirmed that “Russia’s sovereign assets in our jurisdiction will remain immobilized until Russia pays for the damage it has caused to Ukraine.” No doubt Russian financial officials already have written off the assets for all intents and purposes.

Still, there is strong opposition in Europe to confiscating Russian sovereign assets because of the possible consequences of such action on specific enterprises and the international financial system. The crux of the concerns relates to compliance with international law, the impact on the international role of the dollar and the euro, and the likely retaliation against Western firms doing business or with investments in Russia. These arguments are worth taking seriously but are rebuttable.

To begin with, time-tested norms of war in the modern era reinforce the idea that a blatant violation of international law, such as Russia’s invasion of a sovereign country, justifies restitution. International law holds that confiscation of Russian reserves is legitimate if it is part of international countermeasures against the Russian aggression. This argument is made persuasively in a comprehensive analysis by Lawrence Tribe and other top legal scholars from Harvard, Chicago, Georgetown, and Michigan law schools that supports transferring Russian sovereign assets to Ukraine pursuant to the doctrine of third-party countermeasures (Tribe et al. 2023, p. 9). Former World Bank president Robert Zoellick argues that seizing the Russian reserves is “elegant justice” and would signal that countries “cannot conquer and annex their neighbors without losing access to their global reserves.”

Second, critics of seizing sovereign assets have voiced concerns about adverse international financial impacts, affecting the willingness of countries to hold dollars or euros in their international reserves. But these concerns seem exaggerated. Dollar and euro markets have not suffered since Russian assets were frozen and sanctions targeted major Russian financial institutions and trading entities. China continues to hold about $3 trillion in international reserves. There have been longstanding concerns that China would dump these holdings in favor of other currencies, but China does not have good options to diversify the composition of its holdings.[3].

Third, fears about Russian retaliation against Western firms are real but overblown. Russia already has and will continue to retaliate against Western firms within its reach, inflicting relatively minor damage. Many Western firms reduced their exposure in Russia soon after sanctions were imposed in 2022 by selling (at distressed prices) or writing down the value of their Russian holdings. EU banks still doing business in Russia should have done the same instead of seeking short-run windfall profits that are now about to disappear. These firms are not innocent victims but risk-takers on the losing end of a bad bet.

European countries still strongly oppose seizing the Russian reserves, and their “vote” is what matters since they control the bulk of the immobilized resources. For that reason, G7 officials have undertaken an innovative bit of financial engineering to loan Ukraine about $50 billion that will be repaid from the interest income from the immobilized reserves that legally belongs to Euroclear and not Russia.[4]. The loan to Ukraine would not require a change in ownership or seizure of the Russian reserves, nor would it tie up the reserves as collateral, thus avoiding the legal concerns noted above. Importantly, US Treasury Secretary Janet Yellen emphasized that “it would not foreclose taking additional actions on these assets together with our partners in the future.”

Under the plan, the details of which are not yet finalized, the G7 countries’ loan to Ukraine would be financed by the expected accrued interest over a fixed term from the immobilized Russian reserves. Such a loan would “pay forward” to Ukraine part of the compensation expected to be owed by Russia once hostilities end.

Participation in the loan syndicate would likely require authorization in most G7 countries. Appropriating funds is never easy, but a loan is easier to justify than a grant, especially when it is secured by the earnings from the large Russian reserves under the control of the G7 countries. The reserves themselves still could be used in the future to settle compensation claims once the war ends.

Before the loan can be finalized, however, G7 officials need to resolve two technical issues related to the revenue stream that will service the debt.

First, the European Union can reallocate the accrued interest on the immobilized Russian reserves under its Russia sanctions, but that authority needs to be renewed every six months and that requirement is unlikely to be waived by an unanimous vote of the 27 EU member states. If the EU authority to collect and redistribute the accrued interest on the immobilized reserves lapsed, the income to service the loan would be in doubt.

Second, interest rates fluctuate, and lower rates would yield reduced earnings from the immobilized reserves, which may not be sufficient to repay the loan over the set maturity term. Here again, financial gurus can devise fixed or floating rates linked to the interest earned from the immobilized reserves. Alternatively, accrued interest could be rolled up into the principal due at maturity to avoid debt servicing shortfalls.

The bottom line is that the G7’s $50 billion loan to Ukraine is a big deal that provides a critically important lifeline for Ukraine in its war of attrition with Russia. It is innovative and “elegant justice” that the loan is financed from earnings on the frozen Russian reserves. But it is a process that unfortunately may need to be repeated in future years if Russia continues to pursue its military intervention in Ukraine.

Notes

1. Reconstruction is not a futuristic goal; it is an essential component of the current war effort in which Russian missiles target public utilities and civilian infrastructure.

2. The new US Rebuilding Economic Prosperity and Opportunity (REPO) for Ukrainians Act clearly authorizes actions against Russian sovereign assets; so, too, does the International Emergency Economic Powers Act of 1977 once the president declares a national emergency from unusual threats “to the national security, foreign policy, or economy of the United States,” which President Biden already has done.

3. Brad Setser astutely notes that China’s “real option is holding fewer reserves, not diversification.”

4. Much of the Russian reserves were invested in bonds that have subsequently been redeemed since the start of the war. EU sanctions prevented Russia from accessing the proceeds. Under Euroclear’s contractual terms, the income from those cash proceeds belongs to Euroclear’s shareholders. As of mid-February 2024, 99.7 percent of those interest earnings will go to the European Commission.