Discussions are already underway on the topic of the looming Ukraine reconstruction conference due to be held in London in June, 2023. The conference is a continuation of the first similar conference held last summer in Lugano which aimed to focus minds on the challenge of both ensuring Ukraine has the financial resources to fund the war effort but also beginning to think about winning the peace thru ensuring succesful post war reconstruction.
So we have to look elsewhere if we, as the West, collectively, think Ukraine’s successful reconstruction, is mission critical, to our own defence.with a passion, I think it is.
And reviewing my own earlier pieces, as noted above, I conclude that Russia absolutely has a moral, and I think will eventually will have a legal, responsibility to pay.
It has the resources - it is a rich economy by comparison to Ukraine. It’s GDP is fifteen times the size of Ukraine, and it generates huge foreign exchange earnings each year from the sale of commodities, including hydrocarbons. In 2022 alone, and partly through the impacts of the war, Russia generated a current account surplus of over $225 billion.
Russia still claims to have close to $600bn in CBR FX reserves and close to 10% of GDP in its various fiscal reserves. It has a lowly public sector debt ratio of below 20% of GDP. Russia’s per capita GDP is still on par with that of Poland, and now some ten times that of Ukraine. Russia is no Weinmar republic and we should not be fearful that reparations for the war will somehow bankrupt Russia.
Putin created Fortress Russia economic policy settings before the war, because he planned for this war, so Russia has fiscal and FX buffers, a balance sheet that can absorb more debt to pay for reparations, and a strong export revenue stream to cover war reparations.
It is beyond doubt that Russia is responsible for this war. Russia has illegally invaded another sovereign nation, breaking every UN principal and convention. It’s missiles are causing the damage to Ukraine - Ukrainian missiles are not raining down on Russian cities. Russia is responsible for the damage to Ukraine (no doubt) and it should be made to pay reparations.
So Russia should pay because a) it is responsible; b) it has the resources to pay; c) if it knew it would have to pay reparations it would perhaps be less willing to wreak the damage in the first place.
And remarkably here the West has access to large amounts of Russian assets, frozen in Western jurisdictions - perhaps as much as $400bn. Such sums can go a long way to meet Ukraine’s rebuild costs. They can be an upfront payment with additional sums paid thru levies on future Russian export earnings - similar to how Iraq paid reparations to Kuwait after the first Gulf war.
Lots of legal arguments are being made as to why the above cannot be done. One such argument is that there is currently no legal basis to transfer such assets from Russia to Ukraine, and any such action in the West would be a blatant attack on the sanctity of private property rights, the rule of law, and sovereign immunity.
The fear I think is also that by confiscating these assets from Russia and transferring them to Ukraine, by decree in effect, that bad precedent would be set, and any owner of assets deposited in Western jurisdictions, particularly authoritarian regimes, would fear similar treatment and pull their assets from the West. There is a fear that this would somehow destabilise Western financial systems.
All these arguments are weak in my mind.
First, and on the latter point, the assets have already been frozen and put out of reach of Russia likely at least for the duration of the war. The assumption surely already by Russia and indeed, other authoritarian regimes, is that Russia will never see these assets again.
Authoritarian regimes will already have got the message and if they are minded to follow Russia in invading a neighbouring country then they will surely already have pulled their assets from Western jurisdictions. The money will already have left. But if they don’t invade other countries then they have nothing to fear.
Second, it’s a joke to think that the confiscation of Russian assets will somehow undermine perceptions of the rule of law in the West. Seemingly here it was fine in the first place for Western juridications to accept these assets over the past two decades of clearly kleptocractic rule by Putin - it was already crystal clear that they were the product of kleptocracy.
If Western rule of law principals were so sacrosanct why were n’t more questions asked when these monies were coming in? The reality is the West was complicit in laundering these funds for the kleptocratic Putin regime. So now claiming to be holier than thou rings very hollow.
And, as has recently proven the case with the Swiss action to save CS, and the much criticised decision to bail in AT1 creditors, when national security is at stake, extraordinary measures can and should be taken in Western jurisdictions. Needs must - and needs must now.
Herein I would argue that Western governments should ask themselves a series of questions: a) is it mission critical to Western defence that Ukraine’s reconstruction is successful? b) Is there a risk of a populist backlash in the West if our tax payers/pensioners (creditors of Ukraine) are made to pick up the tab for Russia’ war in Ukraine? c) has Russia’ invasion of Ukraine created an existential threat to the survival of Western liberal democracy?
I would argue that on all three counts the answer is absolutely yes. Putin has waged war on Ukraine, but also us, our system of Western liberal market democracy. We are at war with Putin, and the gloves need to come off.
If Ukraine is not funded it could lose the war, and fail in reconstruction to the point that it cannot defend itself (and us, given Ukraine is our frontline defence now) against future Russian attacks. If Russia takes Ukraine, the security of the West will be in peril. If
Western tax payers are made to pick up the tab for reconstruction we could see a revolt in the West, and new populist and pro Russian political forces emerge which will weaken the West from within. We could easily win the war but lose the peace here, beyond Ukraine.
I think many of the people in Western Treasuries are complacent, and just do not get what is at stake. This is the same complacency in Western governments which got us to the point to allow Putin to invade Ukraine. We simply did not take the risk from Russia seriously.
Now I get that legal hurdles need to be jumped, which could take time. But this all just needs to be done, laws need to be changed. This issue is too important at this stage.
And in the interim, I think innovative solutions can be thought up to bridge financing for Ukraine until Russian assets are confiscated and legally transferred to Ukraine.
Some of my ideas herein:
· Requisition bonds - reports suggest that while the EU might be uncomfortable with the formal confiscation of Russian assets, it might be legally possible to transfer returns made on Russian assets while they are frozen on account in the West. The conservative assumption here is that Russian assets will be invested say in US Treasuries or Bunds, and the yields then transferred to Ukraine. Doing the math, say $400bn invested at 4%, could yield $16bn a year for Ukraine reconstruction. Not bad, but again it hardly touches the sides given possible reconstruction needs of closer to $1 trillion. Further then if this is the “fix” surely the objective then should be to earn the maximum yield or return on these Russian assets. Why invest in low yielding USTs or Bunds, why not invest them then in higher yielding global assets? Say Turkish dollar bonds paying a yield of 10%, Tunisia with a yield of 35%, or why not Ukrainian Eurobonds yielding 50% plus? Even better why not launch a specific Ukrainian Requisition Bond series and using frozen Russian assets to buy these newly issued instruments? The monies earned at issuance can be used directly for Ukraine reconstruction, and they continue to give to Ukraine reconstruction funds by paying back an annual yield. If ultimately Russia fails to pay in full for Ukraine reconstruction Ukraine can that point opt to restructure these instruments, imposing a hair cut. But Russia will still have an asset here, albeit its value will depend on its behaviour in the conflict and peace.
· Frozen Russian assets can perhaps be used as collateral in future borrowing by the Ukrainian state - investors/creditors in effect could receive a claim against Russia as a clip on any future Ukrainian issuance. One could imagine such new issuance bonds secured in such a way as Russia has to pay the claim to investors in these bonds as a first call, before being able to service any future debt issuance by Russia. Contracts could be written that investors in such issues also have first claim on Russian export receipts. But such issues are structured to preclude Russian market access until it agrees to service such claims in full.
So Western tax payers should not pay for Ukraine’s reconstruction, Russia should. But what about Western creditors? What about the case for debt relief?
It’s easy to think of Western creditors as some opaque blob, and they do have an image problem as typically “creditors” are viewed as some evil group of people who always think they should be paid first, driving individuals, companies and countries into bankruptcy, poverty and destitution as a result.
Creditors are though a pretty diverse group, comprising official bilateral and multilateral creditors, and then private creditors which are also diverse ranging from hedge funds, to real money asset managers, pensions funds, sovereign wealth funds and banks.
It’s a bit of a generalisation but official creditors are essentially tax payers, and in Ukraine’s case this group mostly comprise Western tax payers.
Private creditors include a range of end owners, but the bulk comprise pensioners/shareholders, and in Ukraine’s case mostly Western pensioners and shareholders.
Often when countries go into default and restructuring it is because of imprudent lending (bad credit calls) on the part of creditors - and equally I would argue corruption, bad policy choices by many debtor countries, and imprudent borrowing to hide policy failures at home.
But in this particular case Ukraine’s creditors are not responsible for Russia’s war in Ukraine, Russia is. Indeed, in the years leading up to the war, mostly Western creditors lent money to Ukraine quite cheaply now with hindsight given the risks, which enabled it to double its defence spending to over 4% of GDP in the period 2018-2022.
They were indeed encouraged by their Western governments to lend to Ukraine. Ukraine responded by well managing its public finances and public debt - cutting the debt/GDP ratio to just over 40% at the onset of the war, from double this in 2015.
Russia’s full scale invasion of Ukraine happened from February 2022, and in August 2022 Paris Club creditors and private creditors agreed a 24 month moratorium on Ukraine’s debt service. This has since been extended to three years by the Paris Club.
The idea then was to allow Ukraine to prioritise defence and current spending, over debt service, to enable it to win the war, and to be then in a position to better service its debts in the longer term. The operation bought Ukraine time.
A year on and the Ukrainian government and the IMF, in its recent $15 billion EFF, has suggested the need for further debt treatment to ensure Ukraine’s debt is sustainable and Ukraine is given the fiscal (and BOP) space to help its post war reconstruction. This is entirely understandable.
Practically though it’s very difficult to design any programme of future debt relief until the war ends, and it is then possible to produce a macro framework to run a DSA and to figure out what debt burden is sustainable to Ukraine. I think when the war ends, creditors will be understanding.
However, mindful of the commentary above, Ukraine’s creditors are typically the same tax payers, pensioners, et al who might end up stumping up the bill for Ukrainian reconstruction if the cost ends up falling on Western governments.
In that case the same argument can be made to say why are Western creditors, as tax payers/pensioners/shareholders, being forced to stump up the bill for Ukraine reconstruction, while Russia, the aggressor, is getting off free - and clearly Russia has the ability to pay?
Creditors, and particularly private creditors, will ask for Russia to be bailed in to cover Ukraine reconstruction costs, before them. As noted above, I think they will look for any future debt restructuring to be smoothed/facilitated with use of frozen Russian assets.
Important here that the public sector, at London style reconstruction conferences, mindful that Western governments, and tax payers, will be unlikely to stump up significant sums for reconstruction, are always very eager to push out sound bites about getting the private sector involved in reconstruction. But I think there is a need here to think clearly about what pre-requisites will be required to ensure maximum private sector participation.
Obviously the private sector will want to see the war substantially end, and security significantly assured. Western assurances therein will be important - is the West committed to Ukraine, long term, and not going to cut and run as it has previously in Vietnam, Iraq, and more recently Afghanistan?
The private sector will want to believe in the Ukraine recovery story (I do, see below), but access to financing will be key/critical. And therein the IMF et al are right in that Ukraine’s debt sustainability will have to be determined, debt treatment agreed and rolled out.
But an early agreement with international creditors around a debt treatment will be key to ensuring Ukraine’s speedy return to market access - critical for the public sector, but particularly the private sector. I think though the private sector will want to see proper burden sharing by Russian (through use of frozen Russian assets) as the price to offering debt relief and agreement therein in a speedy manner.
So the upshot, when the public sector talks about its ambitions for private sector involvement in the reconstruction of Ukraine, there needs to be joined up thinking about future debt treatment, but also burden sharing to involve Russia. Again Russia absolutely can afford to pay here.
3. What is the best institutional setting for Ukraine’s reconstruction?
I don’t want to recreate the wheel here, having written extensively on this subject in the past, I simply copy in my past comments.
But suffice to say I think Ukraine and donors needs to create a sovereign wealth fund structure to manage the whole reconstruction effort. I have thrown out the idea of an Agency for Ukrainian Reconstruction and Accession (to the EU) - AURA.
4. Can Ukraine be successful?
Absolutely, but is has to be, for the survival of Western democracy.
But why am I so optimistic about Ukraine being able to succesfully recover and rebuild?
First, the base is very low. Ukraine has lost 30-40% of real GDP, and dollar GDP has collapsed from $180bn to perhaps $120bn. Past experience from 2014-15 suggests the post war/crisis rebound could be extreme, beating expectations. Remember here Ukraine will benefit from a wave of refugee returns, and a likely very significant reconstruction spend - perhaps something up to $50bn a year.
I think it is is entirely possible to imagine the first couple of years after the war ends yield real GDP growth of 5-10% pa, and real FX appreciation which will being rapid dollar GDP growth.
Second, Ukraine’s macro financial stability through this conflict has been proven - note above my comments that this was because of the reforms instigated from 2015 - 2022, at the NBU, banks and the MOF.
Third, the incredible innovation, resilience and drive shown by Ukrainians in the conduct of this war suggests they have a great future. I call this Ukraine’s State of Israel moment - in a hostile environment it has no choice but to prosper and gain strength. It has to succeed or it loses its ability to defend itself and survive.
Fourth, I think the war has shown to many that there is no return to the old oligarch dominated order. The population have fought a bitter war of survival, they will demand real change.
Oligarchs are finally on the backfoot. And, while we thought they were on the way out after the Orange Revolution and the Euromaydan, I just think the huge amount of blood shed by Ukraine through this means that people will not tolerate a return the old oligarchic ways.
Fifth, Ukraine, finally has a real EU accession perspective, and we have seen with other countries in Emerging Europe (the Copenhagen Treaty of 1994 was instrumental in delivering the remarkable reform we have now seen across Emerging Europe, from Poland to the Czech Republic and the Baltics) that once the decision is set, the template of reform, is so powerful of forcing countries to reform to meet EU accession targets.
There is no longer any debate about Ukraine’s way forward and orientation and what need to change to ensure EU accession. Laws just need aligning with the acquis.
Sixth, Ukraine has some great sectors in food and agriculture, IT, military and defence, and lots of low hanging fruit in areas such as energy - energy efficiency, renewables (wind and sun).
Seventh, many refugees will return home with new, fresh ideas, new training, new skills, and capital.
Eighth, I think international big business will embrace Ukraine’s reconstruction - assuming the right institutional setting (see above) given that likely this is the biggest, and most exciting development/investment opportunity in the region in generations. I would argue that this is as big as the collapse of the Berlin Wall. Imagine the allure of a $1 trillion reconstruction project in Ukraine.
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