From Russia With Interest

By Stefan Koopman, Senior Macro Strategist at Rabobank

The G7 is a forum where Europe holds a clear numerical advantage over the United States. However, the geopolitical vulnerabilities and precarious political positions of Sunak, Scholz, and Macron compelled them to toe the line of the United States. Consequently, the communique following the summit in Italy incorporated hawkish language on China, mentioning the country 29 times. The G7 said their intention was not to thwart China’s development, but will “continue to take actions to protect our businesses from unfair practices, level the playing field, and remedy ongoing harm”. Additionally, the G7 endorsed the deal proposed by President Biden three weeks ago regarding Israel, which includes a ceasefire, a hostage-prisoner exchange, and Gaza reconstruction, but did not condemn Israel for some of its recent military actions.

The G7’s decision to extend a USD 50 billion loan to Ukraine, backed by immobilized Russian assets, was this summit’s most significant step forward. This loan structure reflects a typical compromise between the US and Europe. While the straightforward solution would involve seizing all of Russia’s frozen assets (estimated at USD 280 billion) to directly fund Ukraine’s war efforts, European countries – particularly France, Germany, and Belgium – continue to shy away from this, viewing it as too aggressive and fearing Russian reciprocation. Instead, they opted for using the interest on matured assets, which amounts to only a few billion dollars per year. The first option would be a game changer, whereas the second option falls embarrassingly short.

True, asset seizure is not without costs. Concerns about weaponizing the Western financial system drives interest in alternative financial infrastructures and spur de-dollarization initiatives. However, we’ve repeatedly argued that this is easier said than done. Another risk lies in the West and Ukraine losing some of their coercive leverage in future negotiations with Russia, potentially complicating conflict resolution. But if anyone thinks Putin’s in it for the money, they’re still not getting it.

That said, Europe’s position still really mattered. Almost all of Russia’s immobilized reserves are held by European custodians, primarily in Belgium. So, the cunning compromise involves redirecting and pulling forward all future interest income from the Russian reserves trapped in these custodians while leaving the principal untouched. Details are still being fleshed out, but the argument is that this approach acts as a punitive tax on the windfall profits made on the immobilized assets held in Europe. Consequently, the interest on the loan will be covered by the Russian assets, not by Ukraine. And if Ukraine defaults, Russia will be on the hook.

Despite the USD 50 billion loan (following the US approval of USD 60 billion in military aid), it may not be a game changer. Estimates suggest that this fresh funding would only cover approximately six months of Ukraine’s requirements. While it may help Ukraine navigate the upcoming political transitions in Europe and the United States, further funding will likely be necessary from mid-2025 onwards. The possibility of Trump returning to the presidency adds uncertainty – this is in fact our base case scenario. This weekend he said, again, that he will put an immediate end US funding for Ukraine. As has been a near-constant theme throughout the war, the West tends to do the right thing only when the alternative is even worse. Given that risk, the G7 may have to revisit this deal later this year.