Saving Ukraine

Putin’s second invasion of Ukraine began on 24 February 2022. A month or two later, I was invited to participate in a small group of former US Treasury officials formed to advise the Ukraine government on several urgent international finance issues. I felt like a fifth wheel in this group because others had mostly held Assistant Secretary-level positions and remained active as investors and advisors. I was included, it seems, because of the book I had written on “sovereign debt restructuring” (published by Brookings in 2003). It reflected 25 years of experience with this topic, but I have done virtually no work in this area since then.

Debt Relief

When the group was formed, the most urgent international finance issue facing Zelensky’s government was getting relief on the debt payments it owed to international lenders.  It needed the money to buy weapons to fight the Russians. This issue was quickly settled, however, when the creditors agreed to a 2-year suspension of debt payments. My expertise (to the extent that it remained) was not needed. (See Note at the end about how this issue has once again become a priority.)

Aid Commitments

The next most urgent issue was getting the Western governments to disburse the funds they had committed to supporting Ukraine’s defense of its territory. As usual, the commitments came quickly, and the disbursements were slow in coming. Our group had few useful contacts with European governments, so our efforts were focused on the US Government (Treasury Department, State Department, and National Security Council) with the thought that getting the USA to disburse quickly would put pressure on the European governments to do likewise.  A year later, the flow was adequate and there was optimism about Ukraine’s ability to push back the Russian forces. Our group had little impact on this issue, and it remained a backburner issue for us in 2024 even as optimism about Ukraine’s defense faded due to delays in the delivery of weapons to Ukraine by the USA.

Our group has had some good contact with the International Monetary Fund, which plays a central role in providing crucial balance-of-payments financing for Ukraine and in defining its overall external financing requirements. Here we have weighed in on the side of critics of the IMF over the high interest charges it had required Ukraine to pay on its large amount of borrowing of IMF resources.

Frozen Russian Central Bank Assets

The big issue our group has focused on for the past year has been using frozen Russian assets to pay for reconstruction of the damage caused by the Russian attacks on Ukraine. In particular, there is credibly upwards of $300 billion of frozen Russian central bank assets in the Western countries that have been supporting Ukraine, most of which are held in the Euroclear payments institution based in Brussels. Our group has worked closely with members of the US Congress to produce the REPO legislation that was part of the $61 billion package of aid to Ukraine signed by President Biden on 24 April 2024. Our group contributed text to the drafting committees in the House and Senate that authorizes the President to disburse these assets ideally but not exclusively through a multilateral mechanism to fund reconstruction activities. We have argued against the kind of indirect funding that the G7 governments appear close to adopting at their mid-June Summit meeting in Italy. This would produce a flow of funds to Ukraine of around $3 billion from the interest earned on the frozen Russian central bank assets held by Euroclear. We will continue to press the US Government and its European partners where we also have some good contacts to get these funds flowing for the benefit of Ukraine as easily and as soon as possible.

Land Value Capture

I do not have strong views on the frozen assets issue, but I have injected a financial issue into this group that it was not expecting. From work I have done—most notably in connection with Indonesia’s decision to build a new capital in East Kalimantan province (on the island historically known as Borneo)—I have argued that much of the financing required for the reconstruction of Ukraine could come from “Land Value Capture” (LVC).

The LVC concept can be explained simply but is not simple to implement. Most readers of this post will be familiar with cases where rich and powerful people buy up land cheaply before some related infrastructure or commercial project is publicly announced and then they sell it at a much higher price after the project is finished, pocketing windfall profits without having done anything to contribute to the project.

The LVC concept has evolved over the past 50 years as a set of measures to capture the increase in the value of the land so that it can be used to finance (through the repayment of loans in many cases) the construction costs of the project. A classic example is where a city builds a new subway line and purchases land around future stations before construction starts. When the line is in operation, this land is then sold at much higher prices to investors who will build offices and stores and apartments around the new stations, and the proceeds of the sale in effect repay the construction costs.

Readers can find the May 2020 post where my co-author and I laid out the benefits of using LVC in Indonesia’s new capital project in the “Indonesia and Other Countries” section of this website. The same benefits should be available for the Ukraine government in reconstructing the damage caused by Russia. LVC has the potential of vastly reducing the amount of foreign financing required for reconstruction, which would otherwise leave large amounts of land in the possession of foreigners or saddle the government with large amounts of debt owed to foreigners.

I have been pleasantly surprised by the amount of interest in LVC among the members of this small working group. We have introduced the subject to a number of Ukraine senior officials but have not yet gotten anyone there to focus seriously on using LVC tools. It is also frustrating that we have been unable to engage staff members at the IMF and World Bank in a discussion of implementing LVC in Ukraine.

Personally, the more I have learned about LVC the more attracted I have been to the broader issue of land taxation, including some fascinating history related to the “single tax” proposed by Henry George in the USA in the 1880s. I have come to believe that a good part of the income inequality in the USA could be reduced by taxing land separately from the improvements on the land instead of applying the same tax rate to both as is done almost everywhere in the USA.

PS on Ukraine and NATO. There has been a vigorous debate for more than 30 years over the pros and cons of bringing Ukraine into NATO. From the beginning, I’ve been on the con side, believing that bringing Ukraine into NATO would be an unnecessary geopolitical irritant. It could only be seen by Russians as a provocative move. It’s the kind of move in international relations that I see as part of the pattern of “making enemies” that the US government has excelled in over the past 50 years (in my opinion). 

Note on Sovereign Debt Restructuring:  The 2-year suspension on debt service payments ends in August 2024. Consequently, the Ukraine government is now in active negotiation with its international creditors on its future payment obligations. Both sides seem to agree that extending the suspension is the least desirable way forward. The difficult choice is between a one-step deal and a two-step deal. The former would be designed to reduce Ukraine’s debt-service obligations to a point where no further relief would be required following the end of the conflict. The latter would reduce these obligations to a low level (interest only, perhaps) until the end of the conflict, at which point a definitive write-down would be negotiated.  Ukraine has obligations to both the public sector (foreign government agencies like the US Export-Import Bank) and the private sector (mostly bondholders and some banks). The key to the solution will be the negotiation with the bondholders. Whatever is acceptable to them will be duplicated by the banks and the public sector lenders. Our group has consulted with both sides and concluded that it should be possible to conclude an arrangement by August without any pushing by us. We did, however, caution the Ukraine authorities to avoid letting the IMF define a “debt sustainability” level that would be difficult for the bondholders to accept.