« New and Improved Warren & Westbrook, now with Porter & Pottow! | Main | Insurance Capital Games and PMI Reinsurance Kickbacks »

Negating Russia's Veto Over Ukraine's IMF Package

posted by Mark Weidemaier

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.

Our starting premise is that the Fund wants the rescue package to go through and will get a serious black eye if, having announced the package, it lets the Russians veto it. More important, the lending into arrears policy may not be implicated at all:
  • First, it isn't clear that the loan qualifies as official arrears. The IMF probably won't put much weight on the fact that the loan was made to a kleptocracy. (Too many skeletons in that closet.) But Russia made the strategic choice to have a profit-seeking state instrumentality structure the investment as an ordinary--well, mostly ordinary--eurobond. At the time, the Russians probably thought they had found a clever way to benefit from both official and private creditor status. But the choice dilutes their claim to official status, and the uniqueness of the transaction means that, if the IMF makes an exception to its official arrears policy, the exception won't set a precedent for future cases involving typical bilateral credits. [Update: here's a link to an event hosted by the Peterson Institute for International Economics concerning the IMF's aid package for Ukraine. Anna Gelpern discusses the "official" versus "commercial" debt question at the 39-minute mark.]
  • Another reason to question whether the Russian loan is official debt: If the Russians viewed the loan that way, we assume they would have reported the debt to the Paris Club. But the Paris Club's 2013 annual report [caution: large file] lists only $1.2 billion USD due from Ukraine (see p. 64). So it seems the Russians didn't report the debt as official. Hmm...
  • Even if Ukraine's debt to Russia is official, Russia's military involvement in Ukraine and annexation of Crimea have seriously damaged Ukraine's economy, to the detriment of both official and private creditors. There are competing narratives about who is more to blame for the conflict, but these are irrelevant. It would be quite extraordinary for the Fund to allow one of its members to block a rescue package when the member is involved in armed conflict with the recipient government. And again, the unusual circumstances mean that the IMF needn't fear that an exception in this case would set a broader precedent.
  • Even if Ukraine doesn't pay, it may not be in arrears. To our knowledge, the IMF has not had to decide whether its policy takes into account amounts owed by countries claiming to be official creditors. That's because it's normally clear when a potential recipient of IMF funds is a net debtor to another government. Not so here. First, Ukraine might have a claim under international law based on Russia's annexation of Crimea, which it is entitled to set off against its debt to Russia. Second, Ukraine may have defenses to the enforcement of the debt, such as prevention or impracticability. It would take some fancy legal footwork for Ukraine to prove these in court. But this is due as much to procedural hurdles, and to the understandable reluctance of courts to wade into such politically-charged waters, as it is to the merits of the arguments available to Ukraine.  The IMF isn't a court, and it won't adjudicate these claims and defenses or make formal judgments as to their validity. By the same token, nothing prevents it from letting the novelty of this situation guide its application of Fund policy. It is uncertain whether Russia is a net creditor of Ukraine. That uncertainty is quite unusual. It both justifies denying Russia the blocking position normally afforded to an official creditor and ensures that the Fund can make an exception without seriously undermining its policies.

All in all, the IMF has plenty of reason to make an exception to its general policy against official arrears. Ideally, the threat of an exception would induce the Russians to adopt a more cooperative stance. If not, we think it would be rather shameful to allow Russia to block an aid package under these extraordinary circumstances.

Comments

Deduct the damage Russia has done by annexing Crimea and starting a war in Ukraine and there won't be much a a debt left.

The comments to this entry are closed.

Regulars

Occasionals

Current Guests

Follow Us On Twitter

Like Us on Facebook

  • Like Us on Facebook

    By "Liking" us on Facebook, you will receive excerpts of our posts in your Facebook news feed. (If you change your mind, you can undo it later.) Note that this is different than "Liking" our Facebook page, although a "Like" in either place will get you Credit Slips post on your Facebook news feed.

News Feed

Categories

Bankr-L

  • As a public service, the University of Illinois College of Law operates Bankr-L, an e-mail list on which bankruptcy professionals can exchange information. Bankr-L is administered by one of the Credit Slips bloggers, Professor Robert M. Lawless of the University of Illinois. Although Bankr-L is a free service, membership is limited only to persons with a professional connection to the bankruptcy field (e.g., lawyer, accountant, academic, judge). To request a subscription on Bankr-L, click here to visit the page for the list and then click on the link for "Subscribe." After completing the information there, please also send an e-mail to Professor Lawless (rlawless@illinois.edu) with a short description of your professional connection to bankruptcy. A link to a URL with a professional bio or other identifying information would be great.

OTHER STUFF

Powered by TypePad