This is a joint post by Mark Weidemaier and Mitu Gulati.
Reports indicate that the IMF's package of financial aid to Ukraine could be in trouble if Ukraine can't or won't pay its $3-billion-plus debt to Russia. The reason is that IMF policy forbids "lending into arrears" to official bilateral creditors. In theory, the policy gives Russia a potential veto over the rescue package. We think the IMF can't--well, certainly it shouldn't, and probably it won't--allow Russia to exercise that veto.
The IMF has waffled on whether Russia is an official creditor. A debt isn't "official" just because it is owed to another government. Governments invest for commercial reasons, and they also make investments that, while not motivated by the search for profit, aren't exactly motivated by altruism. On the "official" side of the ledger, Russia lent money at below-market interest, ostensibly to help a friendly neighboring government. On the "non-official" side, the investment was made by Russia's sovereign wealth fund, the relevant part of which exists to support Russia's pension system--in other words, to make a profit. (In case you were wondering, the fund reportedly had to violate its investment guidelines.) Plus, in Ukraine's telling, the loan was to prop up a pro-Russian kleptocrat and enhance Putin's political stability. Although those sound like official motives, the IMF can't be eager to let the maker of such a loan veto a Fund rescue package.
We don't think the IMF needs to publicly declare that Russia is not an official bilateral creditor. It simply needs to communicate to the Russians that the IMF board is prepared to make an exception to the general policy against lending into official arrears unless the Russians strike a deal with Ukraine. Below the jump, we explain why the IMF should make this threat, and carry through with it if necessary. Simply put: (1) There are strong arguments that the rescue package does not implicate the Fund's lending into arrears policy and (2) these arguments are based on such a unique set of circumstances that an exception would not undermine the IMF's general policy in the slightest.