How the West will use frozen Russian assets to back Ukraine

G7 leaders plan to use interest from $300 billion in frozen Russian assets to support Ukraine. The funds will serve as collateral for a substantial loan to Kyiv, bolstering its defense against Russia.

Funding Ukraine's fightback against Russia's invasion has gone from a must-do to a political hot potato in nearly two and a half years. The world has already committed €297 billion ($321 billion) in aid to Ukraine. But the country clearly needs more.

In April, a $61 billion (€56 billion) aid package to Kyiv was finally approved by the United States Congress after months of infighting over whether the money could be better spent on domestic issues. Similar themes played up during last weekend's EU election, which saw the bloc shift towards the hard right.

The US and European Union have also struggled to agree on what to do with some $300 billion in assets from Russia's central bank that were immobilized as part of Western sanctions shortly after Russian tanks rolled into Ukraine.

Washington wanted to use the seized money to bankroll Ukraine's war effort. As most of the funds seized took place in Europe, Brussels said no, due to the huge legal black hole created by freezing assets when the West is not directly at war with Russia.

"These funds will never be given back to Russia, at least as long as Vladimir Putin is president," Jacob Kirkegaard, a senior fellow at the Brussels office of the German Marshall Fund think tank, told DW. "However, there is no political or legal willingness to say that out loud,"

After two years of wrangling, a compromise has been found and G7 leaders are expected to outline how they'll use those frozen funds.

G7 plans new one-off loan to Kyiv
Instead of spending the $300 billion principal amount, the new plan will utilize the interest made on those assets — estimated to be a few billion a year — as collateral for a one-off loan of up to $50 billion for Ukraine.

"Ukraine runs a huge fiscal deficit in the order of 20-30% of GDP," Yuriy Gorodnichenko, a Ukrainian economics professor at the University of California, Berkeley, told DW. As a comparison, Greece's fiscal deficit at the height of its debt crisis reached 13.5%.

"A deficit like Ukraine's is very hard to finance internally. We don't have developed financial markets, the economy is not doing well and many asset prices are depressed. We need international support for this war," he added.

Gorodnichenko noted that Ukraine's government, which requires $100-150 billion annually to run the country and the war, received almost zero aid in the first two months of the year. That, he said, "created a great deal of uncertainty about how much you have to fund weapons and domestic needs."

Worse still, the Ukraine Support Tracker, compiled by the Kiel Institute for the World Economy, recently revealed that only half of the latest $61 billion committed by the Biden administration will go directly to Ukraine. The rest will boost the US Department of Defense's coffers. There is also a large disparity about what countries have promised and delivered.

Compromise ties up Russia's frozen capital for years
While this additional $50 billion will be most welcome in Kyiv, even the compromise solution has presented challenges for policymakers, as it will require several years of interest payments on the frozen assets to repay the loan.

"If you securitize and issue a bond based on those future returns today, you have to guarantee that the underlying assets remain frozen for, say, 10-20 years," Kirkegaard said. "So someone needs to guarantee that these assets will not be given back to Russia in the meantime. So are we outright saying that Russia won't get its money back and does that constitute backdoor confiscation?"

Kirkegaard added that it could be difficult to unfreeze the principal amount after the war to help fund Ukraine's reconstruction as it will be used for more than a decade to backstop this new loan.

"If you believe that Ukraine will ultimately prevail and will need to be rebuilt at some point, then these assets, if they remain locked or frozen for 10 years, may not be available when reconstruction begins in, say, three to five years," he said.

Vital to make Ukraine aid Trump-proof
The one-off loan does, however, help the West out of a huge funding shortfall. The EU has struggled to make up for the delay in US funding over the past few months. In the short term, this compromise will make the aid to Ukraine somewhat Trump-proof. The former US president previously vowed to cut support to Kyiv if reelected in November but has recently toned down his rhetoric around the funding issue.

"The US election results may be not particularly favorable for Ukraine, so they [G7 leaders] want to secure funding for at least one more year. Ultimately though, our European partners need to make a political decision about whether they want to touch the principal [sum] of these Russian assets or not," Gorodnichenko said.

Ukraine's need for aid is likely to remain high for several years, including billions for the reconstruction of damaged power infrastructure during the conflict, and the rebuilding of cities once it is over.

Kyiv has no option but to hike taxes
In the meantime, Ukraine's government is running out of funding options. Having been hesitant to raise taxes in the middle of a conflict, which can depress an already weak economy, Kyiv is now preparing hikes to income tax, excise duties, sales tax and other indirect levies.

Russia too has been raising taxes to continue funding its war machine. But analysts believe the Kremlin will face serious budget constraints within the next two years, reigniting calls for Washington and Brussels to give Ukraine the advantage by using all $300 billion that was frozen in 2022.

"One way or another, Russia is going to be held responsible for what they do in Ukraine. We can either wait 10 years and then transfer money to Ukraine, or you can do it now and be effective," Gorodnichenko said.