The European Commission has proposed using frozen Russian assets to help fund a €140 billion loan programme to Ukraine. Dennis Shen argues that given the scale of funding Ukraine requires, the activation of Russian reserves is now the only viable option.
One of the key items on the agenda for the European Council meeting on 23 October will be whether frozen Russian assets can be used to help support Ukraine. The reason why activating more of the seized Russian reserves is now so important is that there are no longer any viable alternatives.
Western creditors originally assumed the Russia-Ukraine war would be over by this stage. As an example, the IMF funding programme for Ukraine originally assumed the conflict would have wound down by the end of 2024. Remember too that €321 billion of funds have already been allocated to Ukraine by western governments since 2022. The IMF loan programme approved in 2023 was the first time the Fund agreed to finance a country at war. So, there have already been plenty of exceptions made for Ukraine and goodwill on display.
But instead, with no end to the war in sight, the Fund estimates additional foreign financing of $65 billion will be needed by the end of 2027. On top of this, another $60 billion is needed for military assistance. At this stage, budget deficits for Ukraine of nearer to 20% of GDP a year may endure for longer. All told, Ukraine must secure around $50 billion a year from its allies. One estimate points to more than $200 billion being needed to sustain defence and financial requirements by the end of the decade.
The West does not have the resources to bankroll an indefinite war. Instead, fatigue has risen – notably in the United States – for continuing to finance Ukraine. There is a curtailed capacity to deliver on loans and grants when many western governments face political and budgetary turmoil themselves.
Government debt is increasing for governments such as those of Germany, France, Poland, the United Kingdom and the US, particularly for those governments expanding budget deficits to achieve 3.5% of GDP military expenditure targets by 2035. The capacity to fund Ukraine for longer using western money is simply no longer there.
Ukraine can no longer rely on the United States to deliver any sustained financing. This means the European Union – already Ukraine’s single largest financier – will have to foot much of the bill. But there may be a voter backlash within the EU if the military funding of Ukraine comes at the expense of domestic spending. The only realistic resource at this stage is the Russian assets.
Is there a growing consensus around using Russian assets?
Using frozen Russian assets to fund Ukraine is controversial. However, as the war has dragged on, there has been a growing recognition that it is necessary. It would ensure Russia would pay for the war it has waged and loosen the straitjacket around western taxpayers. The transition to this view began with the announcement of the G-7 Extraordinary Revenue Acceleration (ERA) loan programme last year, which uses the interest on the frozen assets. But the resources of the ERA programme are nearly depleted.
There is legitimate apprehension about the further activation of Russian reserve money – questions around sovereign immunity, reserve-currency status and Russian reprisals such as the seizure of foreign assets. Nevertheless, there is no alternative at this stage. The Russian assets are the only option presently for funding Ukraine and the collective defence of Europe.
Against this backdrop, the European Commission has made an innovative proposal to use the frozen assets to help fund a loan programme to Ukraine. The plan is legally complex as the EU is trying to avoid the reputational damage to the financial system and the euro that could come with directly seizing Russian funds – as well as seeking to sidestep potential legal challenges. Ensuring Russia retains its legal claims on the assets will help mitigate the divisive politics that have delayed the fuller activation of the reserves until now.
Will the Commission’s plan for Russian assets go ahead?
The Commission’s plan is to use the available cash balance generated by the frozen Russian assets, which amounts to around €140 billion. The plan would see the substitution of the balance generated by matured Russian assets with zero-coupon short-term EU bonds. The cash balance would be disbursed as zero-interest “reparations” loans to Ukraine that would be conditional on reforms and repayable only if Russia ceases the war and compensates Ukraine for the damage it has suffered.
Given it is unlikely Russia would ever pay Ukraine for this damage unless the former loses the war, the zero-coupon loans to Ukraine would serve effectively as grants – minimising the adverse effects for Ukraine’s finances (Figure 1). In addition, the Commission wants to use a qualified majority of EU member states to decide on any renewal of the immobilisation of the frozen assets, rather than the unanimity presently required, to preclude potential future vetoes that may scupper the programme.
Figure 1: Ukraine’s public and publicly guaranteed debt (% of GDP)
Note: Scope Ratings and IMF projections are for the public and publicly guaranteed debt stock of Ukraine including the ERA loans. June-2024 IMF projections were made before the August-2024 Eurobond debt restructuring. Source: IMF, Scope Ratings.
Belgium has requested strong guarantees ensuring it would not be left alone to cover potential litigation costs from Russia. But this can be worked out. Inviting global partners that have frozen Russian assets to participate in the suggested instrument has been prudent. The British government has already presented a scheme for repackaging around £25 billion of Russian assets as loans.
A proposal from German Chancellor Friedrich Merz that the funds should only be used by Ukraine for procuring military equipment, and not for general budgetary purposes, reflects an overly narrow focus. Ukraine faces a significant financing gap for non-military expenditure – such as for covering the costs of pensions, public-sector wages and humanitarian aid.
The EU aims to reach political agreement on the plan at the European Council meeting on 23-24 October and thereafter begin work on a legal proposal for a mechanism releasing money by the second quarter of 2026. The expectation is that some form of agreement around using the Russian money will be achieved within the coming period given the lack of alternatives.
A potential downside of the plan is that guarantees from willing governments would act as a contingent liability, lifting the implicit liabilities of participating countries. Nevertheless, given the significant funds Ukraine requires from its allies, if the EU does not use the Russian assets it would need to fund Ukraine through an alternative mechanism that would potentially put even more strain on already stretched national budgets.
Note: This article gives the views of the author, not the position of EUROPP – European Politics and Policy or the London School of Economics. Featured image credit: European Union
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