As war bites economy, Ukraine seeks to fight Russia with Russia’s money

War-hit Ukraine wants to fight Russia on Russia’s dime.

Kiev is eyeing access to an estimated $50 billion from Russian central bank assets frozen by mostly European banks after Moscow sent troops into Ukraine in February 2022.

If everything goes according to plan, Kiev will effectively be using Moscow’s money to pay its soldiers fighting against the Kremlin’s forces by the end of 2024.

But it is easier said than done.

Bureaucratic red tape has slowed down implementation of an agreement finalised in June by the Group of Seven (G7), an intergovernmental economic forum consisting of the European Union and six big Western economies.

The agreement will allow Kiev to spend annual interest income of between $2.7 billion and $3.3 billion generated by Russia’s central bank assets of roughly $300 billion currently rendered immobilised in European capitals.

Europe’s biggest armed conflict since World War II – now into its 30 months – has put a big dent in the economies of both Russia and Ukraine, but it is the smaller nation which is feeling the pinch more on its economy.

Ukraine will spend half of its total government budget of $87 billion for 2024 on defence.

Experts put the onus on Ukraine’s Western allies to help it financially to keep its economy going amid the prolonged war.

“International partners must ensure that Ukraine has access to sufficient funds to keep its economy afloat, and utilising the profits accrued on the frozen assets could significantly contribute to this effort,” Dr Tinatin Akhvlediani of the Centre for European Policy Studies tells TRT World.

Every central bank buys bonds issued by foreign governments in global reserve currencies like the dollar, the euro and the British pound.

Such investments by central banks count towards their foreign exchange reserves and help ensure stability in currency markets at home.

The G7 agreement sought to give $50 billion to Ukraine as “loans”, which would eventually be paid off by the interest income generated by the frozen Russian assets.

However, the novel method of raising free money for Ukraine may risk the credibility of the global financial system.

Outright confiscation of Russian assets or their profits on the pretext that Moscow is waging war against a Western ally can potentially undermine the willingness of central banks around the world to store their funds with European banks in the long term.

Moscow has repeatedly warned the West against using its frozen assets or their profits to help Ukraine, saying it would be “illegal” and cause “years of litigation”.

But Akhvlediani says the use of earnings accrued on the immobilised assets of the Russian central bank should not harm the credibility of the Western banking system.

“This action is a direct consequence of Russia’s violation of international law… It is crucial to recognise that this is an economy operating in times of war,” she says.

Moscow has already announced that it’ll have “jurisdiction” over American property in Russia in response to the seizure of Russian assets in the United States.

US news outlet Axios reported in May that assets amounting to $290 billion in the form of property, real estate, securities and stakes in Russian companies belonging to American firms and citizens could be confiscated by the Kremlin under the Russian presidential decree.

What’s the hold-up?

While the US has called for outright confiscation of Russian assets, European leaders have agreed to use only the interest part of the immobilised funds to help Ukraine owing to “legal and financial concerns”.

One reason for the slow progress on the G7 plan is Hungary’s reluctance to support any EU-wide decision on support for Ukraine or sanctions against Russia.

An ally of Russia and a member of the EU, Hungary has been holding up approval for the necessary legal measures needed for the realisation of the G7 plan.

Meanwhile, the US has also expressed concerns over the fact that the EU is required to renew the asset freeze every six months.

Bloomberg News reported the US has asked for “more durable assurances” from its European allies that the Russian assets will remain immobilised until Moscow agrees to pay for the damage caused in the war—something that appears far-fetched under the current circumstances.

Ukraine is getting doubly impatient over the slow progress on the G7 plan because a team from the International Monetary Fund (IMF) will visit Kiev next week to review an ongoing loan programme.

In March 2023, the IMF approved a $15.6 billion bailout package for Ukraine. That was the first time in its 80 years of existence that the Washington-based lender approved a loan for a country at war.

Ukraine needs clarity on the G7 plan to unlock the next IMF loan tranche of $1.1 billion. That’s because the expected inflow of profits on Russian assets will help Ukraine meet its budget requirements—an assurance that the IMF demands for continued disbursements of loan tranches under the ongoing programme.

Economy in the doldrums

The Ukrainian economy has suffered since the beginning of the war two and a half years ago.

The World Bank estimates that its growth rate will slow down to 3.2 percent this year from 4.8 percent a year ago, with the country’s economic outlook being “conditional on donor support”.

At least 1.8 million Ukrainians have slipped below the poverty line since the beginning of the war. About one in every four Ukrainians today is living in poverty.

Social support to vulnerable households has become essential. More than six in every 10 households receive social benefits. Meanwhile, only 22 percent of Ukrainian adults employed before the war are currently working, World Bank data shows.

Earlier this week, private international bondholders came together to finalise a debt relief deal for Ukraine in what has been described as “one of the fastest and biggest sovereign debt workouts in modern history”.

Almost all of Ukraine’s private bondholders voted for a deal that will reduce the face value of their loans by more than one-third, freeing up as much as $11 billion over the next three years through reduced interest payments.

The debt relief secured from private global bondholders was also part of Ukraine’s efforts to balance its budget books so it could meet the IMF’s condition for continued support.