Not only in Ukraine, but all over Europe, many people will remember the moment when they learned that Russian tanks were rolling toward Kyiv and Russian missiles hit numerous cities in Ukraine. February 24, 2022, was half a year ago now. Ukraine celebrated its national holiday yesterday in the shadow of the Russian invasion. 31 years ago, on August 24, 1991, the former Soviet republic declared its independence. Brussels also commemorated the occasion. A 30-meter flag of the country was unfurled on the Grand-Place, in the presence of Ursula von der Leyen, among others. Europe stands by Ukraine today and in the long term, the EU Commission President said in a video message in the morning. German Chancellor Olaf Scholz reiterated that Ukraine is part of the EU, and US President Joe Biden pledged further military support. Read more in the News.
The common goal of the member states to save gas has only briefly eased the situation on the energy markets; recently, prices for electricity and gas have risen significantly once again. Now, the Czech Council Presidency has come up with a proposal to tackle the problem of high prices throughout Europe – in the form of a maximum price for energy. The Spanish model of an energy price cap is currently being discussed in the EU, said Patrick Graichen, State Secretary in the German Ministry of Economics yesterday. Experts, however, think nothing of this idea, as Manuel Berkel has found out.
It’s not just the shortage of Russian gas that has the energy markets in turmoil. The drought and extreme heat affect power generation in many European countries. Electricity exporter Norway, for example, has announced that it may halt its deliveries to the EU in the coming months. This is because the Nordic country’s water reservoirs are unusually empty. Troubling news has also come from France and Italy. It is now becoming apparent how vulnerable power supplies are to the effects of climate change, writes Claire Stam. Due to the close interconnection of European energy markets, there is a risk of a domino effect.
Gazprom has once again successfully startled Europe’s capitals. Since the recent announcement of alleged turbine maintenance, the price of gas for December has risen by more than 14 percent, and the price of electricity for the coming year by almost 19 percent. The Czech presidency is now considering calling an extraordinary energy council. This was reported yesterday by the ČTK news agency after a press briefing by the Minister of Industry and Trade, Jozef Síkela. He was just recently hailed for his negotiating success at the end of July, when the EU energy ministers agreed on a common gas savings target.
The markets were only briefly reassured by this consensus. The high energy prices are a Europe-wide problem for which a Europe-wide solution should be found, Síkela is now quoted as saying. The former banker’s proposal raises curiosity: A possible solution would be to set a maximum price for energy. The Czech Republic is certainly one of the countries that would support this path, Síkela said. The next energy council was previously scheduled for October 25.
At previous EU summits, EU-wide price caps had always been rejected. Although the Commission itself suggested national price caps as a possible solution, it only approved subsidies for individual countries on a case-by-case basis and left the fundamental solutions to an ongoing review process.
In France, the first national measures will soon expire again, and in the winter it will be the government’s maximum prices for electricity and gas. The government will not be able to maintain the multi-billion subsidies, a spokesman explained yesterday. President Emmanuel Macron prepared his countrymen for an “end of abundance, carelessness and certainties” in light of the Ukraine war and climate change. In September, Prime Minister Élisabeth Borne plans to present a concept for conserving energy and for the country’s future energy supply.
Since electricity prices have also reached staggering heights on many stock exchanges, some state capitals apparently have begun to eye the special regulations for Spain and Portugal. In June, the Commission approved aid amounting to €8.4 billion. Until the end of May next year, maximum prices apply to gas, and governments are allowed to pay the difference to the market value as subsidies – with consumers financing a large part of the subsidy themselves via a levy.
However, the Commission always portrayed Spain and Portugal as special cases because electricity and gas connections across the Pyrenees are only poorly developed. In other words, the impact on the EU’s internal market would be limited. Now, appetites are growing elsewhere.
Currently, the EU is debating whether the Spanish model can and should be rolled out across Europe, said Patrick Graichen, State Secretary at the Federal Ministry for Economic Affairs and Climate Action, at a public discussion yesterday. The point was to find solutions for the high-price phase of the next 18 to 24 months, the top official added. This can be interpreted as an indication that Berlin intends to stick to the electricity market model for the foreseeable future, which has recently come under heavy criticism because expensive gas-fired power plants set the price for all electricity generation.
However, the Ministry of Economics does not rule out an EU-wide electricity price cap. Graichen said that all proposals were being looked at very closely.
Economists, however, still consider a price cap like the one in Spain to be the wrong signal. “The intervention has several side effects; for example, some of the subsidized electricity is exported,” says Lion Hirth of the Hertie School. For the instrument to work reasonably well, at least three conditions would have to be met, according to the electricity market expert.
There should only be a limited pipeline capacity in neighboring countries, the additional gas required for power generation must actually be able to be procured via imports, and electricity trading must essentially take place on the short-term spot market. “All three conditions are reasonably met in Spain – none in Germany. I therefore consider an application of the Spanish instrument in Germany or even in the entire EU to be extremely problematic,” says Hirth.
Criticism also comes from economic expert Veronika Grimm of the University of Erlangen-Nuremberg. “Reducing fuel costs through subsidies is not expedient in the current situation. This unnecessarily fuels the consumption of expensive fossil fuels and thus runs counter to the need to save gas,” Grimm told Europe.Table yesterday. “It would be better to refund customers the price difference for a basic consumption through one-time payments and let the high prices take effect.”
According to the experts, the gravity of the situation has still not sunk in: “If we want to put ourselves in a position to cope with a Russian gas supply freeze without a gas shortage, then we really have to pull out all the stops when it comes to saving gas. Any measure that runs counter to gas-saving efforts will do harm. Hardships can certainly be mitigated without influencing prices.”
The only question is how long economies will be able to cope with the high energy prices. Market participants do not expect a return to the former situation in 24 months, as Secretary of State Graichen did. Electricity for the calendar year 2026 was traded on Tuesday for over €200 per megawatt hour. Although this is far lower than the price for 2023, which was last quoted at over €600, even these expectations are still a long way from the past prices of well below €100. With dpa, rtr
It’s another piece of bad news for European consumers: Norway, a major exporter of electricity, has announced that it may suspend its energy exports to the EU in the coming months. The reason: Unusually empty water reservoirs that feed the country’s 1700 hydroelectric plants. They generate more than 90 percent of the country’s power.
According to the Norwegian Water Resources and Energy Directorate (NVE), the reservoirs above the dams were recently 68.4 percent full, around ten percent lower than usual. Reservoirs in the southwest of the country are only about 50 percent filled. However, the country supplies a large part of its electricity to its neighbors from this very region. Norway could thus declare an emergency in the winter – and stop its exports for a longer period.
The reason for the water shortage is the exceptionally low rainfall over the past two years. The drought that currently dominates large parts of Europe (Europe.Table reported) thus directly affects the European energy market. In addition to the gas crisis, the continent could now face exploding electricity prices (see the previous article in today’s issue).
The case of Norway, like quite a few others, shows just how susceptible the power supply is to the effects of climate change. “Climatic conditions affect generation,” says Thibault Laconde, engineer and head of Callendar, a company specializing in climate risks headquartered near Paris. Heat and lack of precipitation affect hydroelectric and nuclear power production, but also coal generation because coal is transported via waterways.
Extremely high temperatures even affect solar energy: “A drop in efficiency and production has been observed in photovoltaic systems due to the heat waves,” says Gregorio Fernández, project manager at the Spanish research center CIRCE.
Climatic conditions impact electricity generation in several European countries. In Italy, the effects of the drought are severe, especially because the country is heavily dependent on hydropower, says Michele Governatori, head of the electricity and gas program at the Italian think tank Ecco. This accounts for about one-third of the country’s total installed renewable energy capacity of 65 GW.
In France, hydropower accounts for only 10 to 15 percent of the country’s energy mix. However, “it has a more important role than this percentage might suggest, namely as a storage,” says Thibault Laconde. Hydropower can compensate for unforeseen impacts on the energy supply relatively quickly, he says. It also allows for regulating water level of rivers, which can be useful for nuclear power plants, for example.
Paris has already suspended the temperature limit that prohibits power plants from releasing the river water they use to cool their reactors. The heated water has negative effects on wildlife and plants. This emergency measure was taken to reduce the burden on electricity production. Due to the shutdown of more than half of the nuclear power plants for maintenance, it is under enormous stress as it is (Europe.Table reported). Nuclear power accounts for 70 percent of the energy mix in France.
By taking this measure, the government has significantly mitigated the decline in power generation, says Thibault Laconde. However, he notes that this is merely a temporary solution. “September is usually the period when water levels are at their lowest. This period can extend into November, which indicates possible restrictions for nuclear power plants,” the engineer said.
Laconde also emphasizes France’s “very high temperature sensitivity” due to the high percentage of electric heaters in the country. Sensitivity refers to the change in electricity consumption caused by a drop in temperature. “In France, we have an increase (in consumption) of 1900 MW per degree, which is equivalent to activating two additional nuclear reactors,” he explains.
However, this scenario assumes a functioning nuclear power plant park, which is currently not the case in France. As a result, France turned from an electricity exporter to an electricity importer this summer. “The fact that we were able to survive the summer is thanks to our neighbors. It is not certain that this scenario will continue,” says Laconde.
In this context, he highlights the interdependence of national energy markets and the risk of a domino effect: “You have to keep in mind that the price of gas was capped by law in Spain, so oddly enough, France buys cheaper energy in Spain and imports it.” This is why the export capacity from Spain to France was exhausted in July 2022, which had not been the case in February 2022, for example, says Gregorio Fernández.
This domino effect increases the risk of an electricity shortage for European consumers. This cannot even be offset by a drastic price increase.
Fingrid Oyj, the operator of Finland’s electricity transmission system, for example, has recently issued a statement urging the Finnish people to prepare for possible power shortages next winter. “The war in Europe and the exceptional situation on the energy market have increased uncertainties regarding the availability of electricity,” the statement said.
The European Network of Transmission System Operators for Electricity (Entso-E), did not express a lot more optimism. “The gas and hydro storage accumulation for winter months will be thoroughly monitored during the summer,” the organization states soberly in its 2022 Summer Outlook Report. “Forecasts over hydrological conditions are not optimistic, which could influence the adequacy situation for winter 2022-2023 in this region. Hence, close monitoring is essential in the coming weeks and months.”
Michele Governatori of the Italian think tank Ecco also does not rule out possible energy shortages next winter, as funds for government support measures could soon be exhausted. “The government has long relied on new gas sources and infrastructure instead of activating energy-saving measures.”
Estimates of Ukraine’s postwar reconstruction costs vary widely. Ukrainian Prime Minister Denys Shmyhal recently put the likely bill at $750 billion, while European Investment Bank President Werner Hoyer thinks the country may need $1.1 trillion. Every day that the war continues, the figure increases.
Ukraine will need to rebuild power stations, electricity grids, and critical water, sanitation, and transport infrastructure. Industry will require investments, and houses will need to be rebuilt and repaired before the winter – although many cities, towns, and villages have been completely destroyed.
But Ukraine will not be able to finance such a massive investment program on its own and should not count on reparations from Russia. Financing must therefore also come from multilateral development institutions such as the World Bank, the European Investment Bank, and the European Bank for Reconstruction and Development. Western governments will have to contribute as well, as will the European Union.
The biggest problem is that Ukraine will need the money as soon as the war is over. Because the country does not have sufficient reserves of its own, it will have to borrow. But its sovereign creditworthiness will be at rock bottom after the war, even though Fitch Ratings recently upgraded Ukraine from RD (restricted default) to CC.
Furthermore, Western governments will not be able simply to transfer an initial $100 billion overnight to Ukraine. Their finances are still reeling from fiscal measures to counter the effects of the COVID-19 pandemic and the newfound realization that they need to spend more on defense. Germany alone intends to invest an additional €100 billion ($101 billion) in its military.
But innovative financing mechanisms can help to bridge at least some of Ukraine’s massive funding gap. Policymakers should consider two recent precedents in particular.
One promising option is to set up an International Finance Facility for the Reconstruction of Ukraine (IFFRU). This would be modeled on the International Finance Facility for Immunization (IFFIm), which was established in 2006 by several donor governments under the leadership of the United Kingdom to provide up-front money to vaccinate children in the world’s poorest countries.
The IFFIm received legally binding multiyear pledges totaling over $6 billion from highly rated governments, enabling it to obtain an AAA rating and start borrowing in international bond markets. The borrowed funds – the IFFIm’s first bond issue amounted to $1 billion – were sent to Gavi, the Vaccine Alliance to finance immediate large-scale immunizations.
The tax-exempt IFFRU would be based outside Ukraine and function in accordance with best-practice operational and governance standards. And rather than diverting huge sums of money out of their current budgets, many Western governments will be able to make legally binding commitments over 20 years. If correctly structured, the sums would be included in the respective government budgets only in the year they are due.
Depending on the donor countries’ credit ratings and the facility’s financial policies, the IFFRU could have a rating of AA or better. That would enable it to tap international bond markets and front-load financing for Ukraine, disbursing money as and when the country needs it. In this way, infrastructure and desperately needed housing for Ukraine’s displaced population can quickly be rebuilt.
A second possibility is for Ukraine to issue Brady bonds, following the example of some emerging markets – including several Latin American countries, Bulgaria, Morocco, Nigeria, Poland, and the Philippines – when they defaulted on commercial bank loans three decades ago. To resolve the crisis, the banks accepted a haircut, or certain loss, on the loans, and the remaining debt was converted into tradable sovereign bonds, with principal repayments collateralized and thus secured by specially issued government securities.
In the case of dollar-denominated Brady bonds, the US Treasury issued special 30-year zero-coupon securities to provide such collateral, making the bonds attractive to investors.
Ukraine, whose CC rating will prevent it from tapping international debt markets on its own, could use a similar structure to kick-start its bond-issuance program. The government would be responsible for paying the interest on its Brady bonds – with the necessary foreign exchange coming from the country’s taxpayers – and the principal repayments would be collateralized or guaranteed by zero-coupon bonds issued by highly rated governments, the EU, or other entities. Ukraine would have to purchase these zero-coupon bonds, or governments wishing to support the country’s reconstruction could donate them.
Rising interest rates and tight government budgets mean that the large sums needed to rebuild Ukraine cannot be raised in one go. But creative financing mechanisms can help to reduce the strain and accelerate the country’s reconstruction.
In cooperation with Project Syndicate.
Not only in Ukraine, but all over Europe, many people will remember the moment when they learned that Russian tanks were rolling toward Kyiv and Russian missiles hit numerous cities in Ukraine. February 24, 2022, was half a year ago now. Ukraine celebrated its national holiday yesterday in the shadow of the Russian invasion. 31 years ago, on August 24, 1991, the former Soviet republic declared its independence. Brussels also commemorated the occasion. A 30-meter flag of the country was unfurled on the Grand-Place, in the presence of Ursula von der Leyen, among others. Europe stands by Ukraine today and in the long term, the EU Commission President said in a video message in the morning. German Chancellor Olaf Scholz reiterated that Ukraine is part of the EU, and US President Joe Biden pledged further military support. Read more in the News.
The common goal of the member states to save gas has only briefly eased the situation on the energy markets; recently, prices for electricity and gas have risen significantly once again. Now, the Czech Council Presidency has come up with a proposal to tackle the problem of high prices throughout Europe – in the form of a maximum price for energy. The Spanish model of an energy price cap is currently being discussed in the EU, said Patrick Graichen, State Secretary in the German Ministry of Economics yesterday. Experts, however, think nothing of this idea, as Manuel Berkel has found out.
It’s not just the shortage of Russian gas that has the energy markets in turmoil. The drought and extreme heat affect power generation in many European countries. Electricity exporter Norway, for example, has announced that it may halt its deliveries to the EU in the coming months. This is because the Nordic country’s water reservoirs are unusually empty. Troubling news has also come from France and Italy. It is now becoming apparent how vulnerable power supplies are to the effects of climate change, writes Claire Stam. Due to the close interconnection of European energy markets, there is a risk of a domino effect.
Gazprom has once again successfully startled Europe’s capitals. Since the recent announcement of alleged turbine maintenance, the price of gas for December has risen by more than 14 percent, and the price of electricity for the coming year by almost 19 percent. The Czech presidency is now considering calling an extraordinary energy council. This was reported yesterday by the ČTK news agency after a press briefing by the Minister of Industry and Trade, Jozef Síkela. He was just recently hailed for his negotiating success at the end of July, when the EU energy ministers agreed on a common gas savings target.
The markets were only briefly reassured by this consensus. The high energy prices are a Europe-wide problem for which a Europe-wide solution should be found, Síkela is now quoted as saying. The former banker’s proposal raises curiosity: A possible solution would be to set a maximum price for energy. The Czech Republic is certainly one of the countries that would support this path, Síkela said. The next energy council was previously scheduled for October 25.
At previous EU summits, EU-wide price caps had always been rejected. Although the Commission itself suggested national price caps as a possible solution, it only approved subsidies for individual countries on a case-by-case basis and left the fundamental solutions to an ongoing review process.
In France, the first national measures will soon expire again, and in the winter it will be the government’s maximum prices for electricity and gas. The government will not be able to maintain the multi-billion subsidies, a spokesman explained yesterday. President Emmanuel Macron prepared his countrymen for an “end of abundance, carelessness and certainties” in light of the Ukraine war and climate change. In September, Prime Minister Élisabeth Borne plans to present a concept for conserving energy and for the country’s future energy supply.
Since electricity prices have also reached staggering heights on many stock exchanges, some state capitals apparently have begun to eye the special regulations for Spain and Portugal. In June, the Commission approved aid amounting to €8.4 billion. Until the end of May next year, maximum prices apply to gas, and governments are allowed to pay the difference to the market value as subsidies – with consumers financing a large part of the subsidy themselves via a levy.
However, the Commission always portrayed Spain and Portugal as special cases because electricity and gas connections across the Pyrenees are only poorly developed. In other words, the impact on the EU’s internal market would be limited. Now, appetites are growing elsewhere.
Currently, the EU is debating whether the Spanish model can and should be rolled out across Europe, said Patrick Graichen, State Secretary at the Federal Ministry for Economic Affairs and Climate Action, at a public discussion yesterday. The point was to find solutions for the high-price phase of the next 18 to 24 months, the top official added. This can be interpreted as an indication that Berlin intends to stick to the electricity market model for the foreseeable future, which has recently come under heavy criticism because expensive gas-fired power plants set the price for all electricity generation.
However, the Ministry of Economics does not rule out an EU-wide electricity price cap. Graichen said that all proposals were being looked at very closely.
Economists, however, still consider a price cap like the one in Spain to be the wrong signal. “The intervention has several side effects; for example, some of the subsidized electricity is exported,” says Lion Hirth of the Hertie School. For the instrument to work reasonably well, at least three conditions would have to be met, according to the electricity market expert.
There should only be a limited pipeline capacity in neighboring countries, the additional gas required for power generation must actually be able to be procured via imports, and electricity trading must essentially take place on the short-term spot market. “All three conditions are reasonably met in Spain – none in Germany. I therefore consider an application of the Spanish instrument in Germany or even in the entire EU to be extremely problematic,” says Hirth.
Criticism also comes from economic expert Veronika Grimm of the University of Erlangen-Nuremberg. “Reducing fuel costs through subsidies is not expedient in the current situation. This unnecessarily fuels the consumption of expensive fossil fuels and thus runs counter to the need to save gas,” Grimm told Europe.Table yesterday. “It would be better to refund customers the price difference for a basic consumption through one-time payments and let the high prices take effect.”
According to the experts, the gravity of the situation has still not sunk in: “If we want to put ourselves in a position to cope with a Russian gas supply freeze without a gas shortage, then we really have to pull out all the stops when it comes to saving gas. Any measure that runs counter to gas-saving efforts will do harm. Hardships can certainly be mitigated without influencing prices.”
The only question is how long economies will be able to cope with the high energy prices. Market participants do not expect a return to the former situation in 24 months, as Secretary of State Graichen did. Electricity for the calendar year 2026 was traded on Tuesday for over €200 per megawatt hour. Although this is far lower than the price for 2023, which was last quoted at over €600, even these expectations are still a long way from the past prices of well below €100. With dpa, rtr
It’s another piece of bad news for European consumers: Norway, a major exporter of electricity, has announced that it may suspend its energy exports to the EU in the coming months. The reason: Unusually empty water reservoirs that feed the country’s 1700 hydroelectric plants. They generate more than 90 percent of the country’s power.
According to the Norwegian Water Resources and Energy Directorate (NVE), the reservoirs above the dams were recently 68.4 percent full, around ten percent lower than usual. Reservoirs in the southwest of the country are only about 50 percent filled. However, the country supplies a large part of its electricity to its neighbors from this very region. Norway could thus declare an emergency in the winter – and stop its exports for a longer period.
The reason for the water shortage is the exceptionally low rainfall over the past two years. The drought that currently dominates large parts of Europe (Europe.Table reported) thus directly affects the European energy market. In addition to the gas crisis, the continent could now face exploding electricity prices (see the previous article in today’s issue).
The case of Norway, like quite a few others, shows just how susceptible the power supply is to the effects of climate change. “Climatic conditions affect generation,” says Thibault Laconde, engineer and head of Callendar, a company specializing in climate risks headquartered near Paris. Heat and lack of precipitation affect hydroelectric and nuclear power production, but also coal generation because coal is transported via waterways.
Extremely high temperatures even affect solar energy: “A drop in efficiency and production has been observed in photovoltaic systems due to the heat waves,” says Gregorio Fernández, project manager at the Spanish research center CIRCE.
Climatic conditions impact electricity generation in several European countries. In Italy, the effects of the drought are severe, especially because the country is heavily dependent on hydropower, says Michele Governatori, head of the electricity and gas program at the Italian think tank Ecco. This accounts for about one-third of the country’s total installed renewable energy capacity of 65 GW.
In France, hydropower accounts for only 10 to 15 percent of the country’s energy mix. However, “it has a more important role than this percentage might suggest, namely as a storage,” says Thibault Laconde. Hydropower can compensate for unforeseen impacts on the energy supply relatively quickly, he says. It also allows for regulating water level of rivers, which can be useful for nuclear power plants, for example.
Paris has already suspended the temperature limit that prohibits power plants from releasing the river water they use to cool their reactors. The heated water has negative effects on wildlife and plants. This emergency measure was taken to reduce the burden on electricity production. Due to the shutdown of more than half of the nuclear power plants for maintenance, it is under enormous stress as it is (Europe.Table reported). Nuclear power accounts for 70 percent of the energy mix in France.
By taking this measure, the government has significantly mitigated the decline in power generation, says Thibault Laconde. However, he notes that this is merely a temporary solution. “September is usually the period when water levels are at their lowest. This period can extend into November, which indicates possible restrictions for nuclear power plants,” the engineer said.
Laconde also emphasizes France’s “very high temperature sensitivity” due to the high percentage of electric heaters in the country. Sensitivity refers to the change in electricity consumption caused by a drop in temperature. “In France, we have an increase (in consumption) of 1900 MW per degree, which is equivalent to activating two additional nuclear reactors,” he explains.
However, this scenario assumes a functioning nuclear power plant park, which is currently not the case in France. As a result, France turned from an electricity exporter to an electricity importer this summer. “The fact that we were able to survive the summer is thanks to our neighbors. It is not certain that this scenario will continue,” says Laconde.
In this context, he highlights the interdependence of national energy markets and the risk of a domino effect: “You have to keep in mind that the price of gas was capped by law in Spain, so oddly enough, France buys cheaper energy in Spain and imports it.” This is why the export capacity from Spain to France was exhausted in July 2022, which had not been the case in February 2022, for example, says Gregorio Fernández.
This domino effect increases the risk of an electricity shortage for European consumers. This cannot even be offset by a drastic price increase.
Fingrid Oyj, the operator of Finland’s electricity transmission system, for example, has recently issued a statement urging the Finnish people to prepare for possible power shortages next winter. “The war in Europe and the exceptional situation on the energy market have increased uncertainties regarding the availability of electricity,” the statement said.
The European Network of Transmission System Operators for Electricity (Entso-E), did not express a lot more optimism. “The gas and hydro storage accumulation for winter months will be thoroughly monitored during the summer,” the organization states soberly in its 2022 Summer Outlook Report. “Forecasts over hydrological conditions are not optimistic, which could influence the adequacy situation for winter 2022-2023 in this region. Hence, close monitoring is essential in the coming weeks and months.”
Michele Governatori of the Italian think tank Ecco also does not rule out possible energy shortages next winter, as funds for government support measures could soon be exhausted. “The government has long relied on new gas sources and infrastructure instead of activating energy-saving measures.”
Estimates of Ukraine’s postwar reconstruction costs vary widely. Ukrainian Prime Minister Denys Shmyhal recently put the likely bill at $750 billion, while European Investment Bank President Werner Hoyer thinks the country may need $1.1 trillion. Every day that the war continues, the figure increases.
Ukraine will need to rebuild power stations, electricity grids, and critical water, sanitation, and transport infrastructure. Industry will require investments, and houses will need to be rebuilt and repaired before the winter – although many cities, towns, and villages have been completely destroyed.
But Ukraine will not be able to finance such a massive investment program on its own and should not count on reparations from Russia. Financing must therefore also come from multilateral development institutions such as the World Bank, the European Investment Bank, and the European Bank for Reconstruction and Development. Western governments will have to contribute as well, as will the European Union.
The biggest problem is that Ukraine will need the money as soon as the war is over. Because the country does not have sufficient reserves of its own, it will have to borrow. But its sovereign creditworthiness will be at rock bottom after the war, even though Fitch Ratings recently upgraded Ukraine from RD (restricted default) to CC.
Furthermore, Western governments will not be able simply to transfer an initial $100 billion overnight to Ukraine. Their finances are still reeling from fiscal measures to counter the effects of the COVID-19 pandemic and the newfound realization that they need to spend more on defense. Germany alone intends to invest an additional €100 billion ($101 billion) in its military.
But innovative financing mechanisms can help to bridge at least some of Ukraine’s massive funding gap. Policymakers should consider two recent precedents in particular.
One promising option is to set up an International Finance Facility for the Reconstruction of Ukraine (IFFRU). This would be modeled on the International Finance Facility for Immunization (IFFIm), which was established in 2006 by several donor governments under the leadership of the United Kingdom to provide up-front money to vaccinate children in the world’s poorest countries.
The IFFIm received legally binding multiyear pledges totaling over $6 billion from highly rated governments, enabling it to obtain an AAA rating and start borrowing in international bond markets. The borrowed funds – the IFFIm’s first bond issue amounted to $1 billion – were sent to Gavi, the Vaccine Alliance to finance immediate large-scale immunizations.
The tax-exempt IFFRU would be based outside Ukraine and function in accordance with best-practice operational and governance standards. And rather than diverting huge sums of money out of their current budgets, many Western governments will be able to make legally binding commitments over 20 years. If correctly structured, the sums would be included in the respective government budgets only in the year they are due.
Depending on the donor countries’ credit ratings and the facility’s financial policies, the IFFRU could have a rating of AA or better. That would enable it to tap international bond markets and front-load financing for Ukraine, disbursing money as and when the country needs it. In this way, infrastructure and desperately needed housing for Ukraine’s displaced population can quickly be rebuilt.
A second possibility is for Ukraine to issue Brady bonds, following the example of some emerging markets – including several Latin American countries, Bulgaria, Morocco, Nigeria, Poland, and the Philippines – when they defaulted on commercial bank loans three decades ago. To resolve the crisis, the banks accepted a haircut, or certain loss, on the loans, and the remaining debt was converted into tradable sovereign bonds, with principal repayments collateralized and thus secured by specially issued government securities.
In the case of dollar-denominated Brady bonds, the US Treasury issued special 30-year zero-coupon securities to provide such collateral, making the bonds attractive to investors.
Ukraine, whose CC rating will prevent it from tapping international debt markets on its own, could use a similar structure to kick-start its bond-issuance program. The government would be responsible for paying the interest on its Brady bonds – with the necessary foreign exchange coming from the country’s taxpayers – and the principal repayments would be collateralized or guaranteed by zero-coupon bonds issued by highly rated governments, the EU, or other entities. Ukraine would have to purchase these zero-coupon bonds, or governments wishing to support the country’s reconstruction could donate them.
Rising interest rates and tight government budgets mean that the large sums needed to rebuild Ukraine cannot be raised in one go. But creative financing mechanisms can help to reduce the strain and accelerate the country’s reconstruction.
In cooperation with Project Syndicate.
