When Moscow gave Kyiv a $3 billion loan in 2013 as part of incentives to keep its distance from the European Union, many Ukrainians regarded it as a poisoned chalice and a further reason to get rid of then-President Viktor Yanukovych.
Now, they are seeing just how dangerous the gift was, as Russia threatens to block future International Monetary Fund (IMF) funds to Ukraine if it does not fully pay back the loan when it comes due in December.
The loan has long stayed quietly in the background of the upheaval in Ukraine, seeming to pose no particular problems for Ukraine despite its controversial origin. The $3 billion was the first tranche of a $20 billion Russian bailout intended to woo Kyiv away from signing an Association Agreement with the EU and to join Russia's own regional trade bloc instead.
But while the first tranche was paid to Kyiv in December 2013, the rest of the bailout package was suspended after Yanukovych fled the country last year during the Euromaidan protests.
Since then, Ukraine has continued to make interest payments on the loan, despite relations between Kyiv and Moscow being ripped to shreds. But now Moscow appears to have suddenly found a new use for the loan as a tool to exert further pressure on Ukraine at a time when Kyiv is reeling from Russia's annexation of Crimea, from the Russian-backed separatist rebellion in eastern Ukraine, and the loss of a fifth of its economy.
'Official' Or 'Commercial'?
The pressure over the loan comes as Ukraine seeks to lessen an overall debt burden that its leaders have put at $72 billion. As part of an IMF-backed plan to stabilize its economy, a group of creditors agreed in August to accept a reduction to the amount of principal Kyiv owes them, from $19 billion to $15.5 billion.
However, Moscow has said it views its loan to Kyiv as government-to-government lending -- and therefore outside the debt-reduction talks. It also has said that if Ukraine defaults on its debt, Moscow could oppose further IMF loans to the country.
The threat is credible because both Moscow and Kyiv are part of the IMF, and IMF rules state that the institution cannot make new loans, or release additional tranches of funds under existing loan programs, to any member that is in arrears in its debts to another. Stopping IMF loans would bankrupt Ukraine because the country is dependent on IMF loans to stay afloat when international financial markets no longer regard it as creditworthy.
The IMF has not taken a position publicly in the standoff. One reason may be that the IMF has yet to decide whether it regards the Russian loan as state-to-state and therefore official, as Moscow claims, or in fact commercial, as Ukraine describes it.
"A loan isn't 'official' just because it is owed to another government," says Mark Weidemaier, a professor at the University of North Carolina and a specialist in sovereign debt. He says the loan has traits of both state and commercial lending.
One reason Russia calls the loan state-to-state is that it lent Ukraine the money at 5 percent interest, well below commercial rates of 12 percent at the time. Yet the Eurobond was purchased as an investment by Russia's sovereign wealth fund, which in part supports Russia's pension system. That suggests it was expected to make a profit and is commercial.
Time To Pay Up?
How the IMF will respond to this ambiguity is hard to predict. Some of the early voices in what could become an increasingly loud public debate say the IMF's own goal of reducing Ukraine's debt burden would be best served by privately pushing Moscow to abandon its demand for full repayment and negotiate a lower sum with Kyiv.
"The IMF surely is aware that one of the things it can do to make a deal happen is leave uncertain how it is going to treat this loan," says Weidemaier, who comments for Credit Slips, an academic blog about financial-policy issues.
"If the Russians are given 100 percent certainty that the IMF will treat this as an official loan and allow Russia to veto further IMF disbursements, then Russia has no incentive to negotiate whatsoever," Weidemaier says.
But other commentators say the IMF should urge Ukraine to pay up in full, thus neutralizing the issue as a lever over Kyiv.
"Russia is never going to agree to the IMF-imposed debt [reduction] operation and I think that ultimately the IMF will tell Ukraine to pay it and in the medium to long term that is probably in Ukraine's best interest," says Adam Swain, a professor of economic geography at the University of Nottingham, who recently commented on the issue for the Financial Times.
Swain adds that Ukraine has no clear third choice. If it simply refuses to pay the full amount or suspends payment, it automatically falls into default on a Eurobond, a status that would delay its prospects for returning to international commercial-lending markets in 2017, something it needs to again grow its economy.