Russia’s attack on Ukraine in February 2022 contravened the most important principles of the UN charter. The G7 must continue giving strong economic, political, and military support to Ukraine, enabling it to defend itself. This benefits the Ukrainian people and is critical to the long-term security of G7 countries themselves.
But confiscating $300 billion of sanctioned Russian state assets to help pay for this support is a more complex question. It is not certain that the benefits to the G7 will outweigh the costs it will bear. Financing support for Ukraine through normal public expenditure, at least for the time being, is likely to be the better option.
The benefits
The main benefits of asset confiscation are relatively well defined and quantifiable. First, G7 governments could use the proceeds to pay for Ukraine’s immediate needs (such as arms supplies) or make them available over time for long-term reconstruction finance.
This would make a significant dent in future expenditures: total bilateral support to Ukraine stood at some $278 billion as of January 2024, ahead of the latest US package. The cost of reconstructing Ukraine has been estimated at nearly $500 billion (although much of this will be financed by the International Financial Institutions and private sector).
Moving now to confiscate the assets could also lock in financial support for Ukraine ahead of the uncertainties of a potential Trump presidency in the US.
Second, confiscating state assets would increase the definitive price that Russia is paying for its aggression. It is highly unlikely to persuade Russia’s president to end the war – losses to the Russian military and damage caused by economic sanctions are already enormous. But it could help deter other countries from contemplating similar actions – at least those with assets within the reach of G7 governments.
Against this are uncertain but potentially very large costs.
The financial costs
First is the impact on global financial markets of moving from indefinite freezing of the assets to outright confiscation.
At present, there is no practical alternative to the US dollar and other fully convertible Western currencies as a location for the bulk of the world’s $12 trillion in foreign exchange reserves.
China’s renminbi can potentially work as medium of exchange or unit of account, but the combination of capital controls and the perceived risk of political interference by Chinese authorities rules it out as an international store of value – whether for use by China itself or other countries.
High volatility and the threat of regulatory suppression rule out crypto currencies, while physical mass and lack of financial return make gold impractical.
But permanently confiscating $300 billion of Russian foreign exchange reserve assets (2.5 per cent of the global total) held in countries which are not at war with Russia would increase the risk perceived by several other countries. Significant examples would include China, India and Saudi Arabia, which are currently very substantial holders of such assets.
They would fear that at some point they could be subject to similar measures, even though the likelihood that they will cross the political threshold set by Russia’s attack on Ukraine might be low.
This ‘chilling’ effect is likely to be higher the greater the legal precedents set – particularly if some G7 countries make changes in their laws that significantly alter the implementation of sovereign immunity. The legalities of repurposing sanctioned state assets are far from straightforward.
And it will likely result in higher yields on Western currency assets and an acceleration in efforts to develop alternative means to facilitate international transactions and store value.
The size of these impacts is extremely hard to judge. But even a very small additional general risk premium, of say 5 basis points, on G7 government debt of $60 trillion would cost $30 billion a year. And if this continued indefinitely the total net present value (NPV) cost to the G7 would easily exceed the savings from repurposing sanctioned assets.
There is also a risk that the financial costs could be much higher, with the damage spreading into the real economy.
This could happen if action to confiscate Russian state assets combines with retaliation by the Russian authorities against Western-controlled private or multilateral assets still in Russia and broader developments threatening to constrain global capital flows.
These include proposals on outward investment screening designed to limit the flow of Western technologies to China, and widespread concerns over geopolitical risk.
The result could be a tipping point in financial markets, similar to the ‘ great bond massacre’ of 1994. In that case an apparently innocuous decision by the US Federal Reserve to increase interest rates triggered a massive reaction in bond markets leading to losses of $1.5 trillion.
It could be argued that the damage has already been done by the decision to freeze Russian state assets indefinitely. But it is equally plausible that markets will perceive a significant difference between actions to freeze assets (in such a way that they may eventually be restored in whole or part under a negotiated cessation of hostilities) and permanent confiscation.
Ending the war
This highlights a second cost from asset confiscation, namely the impact it could have on achieving an end to the war on acceptable terms for Ukraine.
It is unlikely that one side or the other will be completely defeated, and so hostilities will need to be brought to an end through negotiations. At that stage the G7 should support Ukraine in seeking compensation for the enormous damage caused by Russia’s aggression, as well as human rights abuses.
Having frozen Russian state assets available to play into these negotiations will increase G7 and Ukrainian leverage and flexibility. Assets need only be unfrozen if Russia agrees to compensation.
But in the (not inconceivable) event that a new post-Putin reformist Russian government is in office, there will be scope to respond by using the assets flexibly in the negotiations.
By contrast, permanently confiscating Russian state assets now removes these options: it is highly improbable they could be restored once the money is spent.
Several ideas have been proposed to extract some value from the frozen state assets for Ukraine’s short-term benefit while limiting the immediate legal risks and in some cases preserving the assets as a bargaining chip for future settlement negotiations.
These include the European Union’s decision to set aside windfall gains on the frozen assets to support Ukrainian reconstruction and a proposal for Ukraine to borrow from the G7 and collateralize the loan with a claim for war damages on frozen Russian state assets.
It has also been suggested that Ukraine could sell future war damage claims collateralised by frozen state assets to private investors.
As a general rule, however, the more value realized for Ukraine now, the higher the legal uncertainty and risk of far-reaching financial market costs – and the lower the flexibility to deploy frozen assets in future negotiations.
The better course is to maintain the status quo, including the threat of confiscation as a last resort, reserving the treatment of frozen assets for maximum effect in support of Ukraine when negotiations to end the war eventually begin.
Creon Butler, Director, Global Economy and Finance Programme.