The Ticking Time Bomb of Ukrainian Debt (That the West Will Have To Pay)

The G7 recently made the headlines by agreeing to lend Ukraine $50bn which will be repaid using the yearly interest accrued on $329bn of confiscated Russian sovereign foreign exchange reserves. When it is finally structured, the loan will consist of a series of loans by G7 member countries, with the US topping up the fund by the required amount so it hits the $50bn mark.

Taking a step back from the legality of, effectively, expropriating another country’s sovereign assets to repay a rival country’s debt, what does this mean for Ukraine? Figures vary, and the Ukrainian government is increasingly coy about releasing economic data sets, but the Ukraine’s economy is currently around $180-190bn in size.  To put that into context, that is around 11 times smaller than Russia’s economy and 131 times smaller than the US economy.

$50bn, therefore, represents around 27% of Ukraine’s yearly GDP.  That is a huge figure for a single loan. But the problem is that Ukraine has been borrowing this amount every year since the war started.  According to politico, Ukraine borrowed $58bn in 2022, $46bn in 2023 and is set to borrow $52bn in 2024. So, in just three years, Ukraine will have borrowed 82% of GDP.

Ukraine needs to borrow this much because its government spends almost twice as much each year as it receives in income from taxation and other sources. To put that into context, the European Union sets a limit that Member States cannot run a budget deficit of more than 3% of GDP.  Ukraine, which aspires to join the EU, has been running a yearly budget deficit of 25% since the war began. And in addition to that, with Ukraine running a deficit on its current account each year – the difference between how much it exports and imports – it also needs capital to stop its currency going into meltdown.

And here’s the thing, Ukraine will probably need to borrow even more this year than what is currently forecast. Obviously, Ukraine’s massive spending spree is driven by the war effort, which, in 2023 at least, accounted for one third of total economic output.   The official defence budget for 2024, at $28.6bn is around half of what Ukraine actually spent on defence in 2023.  (Ukraine adjusted its original 2023 defence budget up from $39.4bn – still more than the 2024 budget – to $56.3bn).

So, with Ukraine taking on 25% of its GDP in debt each year, and its economy currently no larger than before the war started, its debt mountain will continue to spiral out of control.  The EU forecasts that Ukrainian debt is growing by 10% of GDP each year since the war started, but I view these forecasts with a heavy dose of scepticism. Even if Ukraine’s economy grew by 5.5% in 2023, it remains smaller than it was in 2021, before the war started. More realistically, Ukraine’s debt is growing by 15-20% of GDP each year.

So, Ukraine’s debt will hit 100% of GDP in the current financial year (if it hasn’t already).  And the really worrying thing is that there are no plans to repay any of it.  Because Ukraine isn’t making debt repayments each year to tamp down its debt growth.  In fact, Ukraine stopped making payments in its existing external debt in 2022 when the war started.  For those who remember the onset of the Ukraine crisis in 2014, Ukraine immediately refused to pay a debt of $3bn that Russia had given it as part of the deal with Yanukovich to stay out of the EU Association Agreement.

Fuelled by hubris and self-righteousness, Ukraine has become addicted to taking on debt and then refusing to make payments on that debt.  Since the start of the war, Zelensky has been pressing for the $329bn in frozen Russian assets to be given his Ukraine. The G7 loan of $50bn marks an alarming shift in that direction. It assumes that Ukraine itself will never need to repay the debt itself, even though it’s Ukraine’s debt. But when the war ends, if this needless war ever ends, who will repay the G7 countries their loans then? The Americans seem to believe that it would be possible to continue to freeze Russia’s frozen reserve assets even after war finished.

If that be so, what motivation, then, for Russia to stop fighting if it feels that massive sanctions and the theft of its assets will continue? As I said at the top, Russia’s economy is 11 times larger than Ukraine’s. Russia is also bringing in healthy amounts of capital each year as its exports continue to exceed its imports.  Put simply, Russia gains a surplus of around $50bn each year in its exports, which roughly equates to what Ukraine borrows each year to prop up the war effort.  While Putin has offered a peace deal – or at least, terms for peace negotiations to restart – Russia has sufficient resources to keep fighting, even if the fighting results in a barely shifting stalemate.

So, in economic terms at least, winning the war doesn’t matter to Russia right now, even if he and the Russian people would prefer an end to it all.  Because the longer the war continues, the more indebted and delinquent Ukraine becomes. Putin knows that practically all of the foreign money that Ukraine borrows comes from western countries that are bankrolling Ukraine’s fight. And we have already seen the sands shift in western support with pure hand-outs transitioning to actual loans.  So, over time, the west will increasingly offer Ukraine debt rather than freebees.

And it is pure fantasy to believe that Russia will repay this debt, as Russia wants its frozen money back. A one-sided peace will not be possible in which the west continues to punish Russia, including economically, after the cannon fire stops. Indeed, stealing Russia’s assets will only lead to potential further escalation, prolonging Ukraine’s suffering, and ramping up its unsustainable debt still further. This war will end when Putin feels that there are economic incentives to stand his troops down and to negotiate a lasting peace.

Until then, the west is holding a ticking time bomb of debt that Zelensky doesn’t believe that he should have to pay.  Or, to put it another way, he is paying for this war using credit cards; except that they are our credit cards, not his.

Ian Proud is a former British diplomat and was the Economic Counsellor at the British Embassy in Moscow from July 2014 to 2019.  While in Russia, Ian advised UK Ministers on Russia’s political economy, and that of neighbouring former Soviet states, including Ukraine. He recently published his memoir, a Misfit in Moscow: how British diplomacy in Russia failed, 2014-2019.