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When John Kerby, Britain's old-Etonian director of the European Bank for Reconstruction and Development, received a document in October from Whitehall asking him to support a loan for the purchase of Romania's steel industry, he thought it no more than routine.

The briefing note, drafted by officials at the Department of International Development where Mr Kerby himself served as a senior civil servant, said Britain should support the granting of a £70m loan to the buyer of a rundown Romanian steelworks because "the project was a good project".

Four days later at a meeting of the EBRD's 23 directors, Mr Kerby voted alongside his colleagues to support the loan to help sell Romania's state-owned Sidex steelworks to Lakshmi Mittal. Little did he know that the "routine" instruction from officials working for Clare Short, the Secretary of State for International Development, would embroil him in a scandal involving the relationship between a Labour Party donor and the Prime Minister.

At the meeting where Mr Mittal's loan was agreed, Mr Kerby joined other national representatives in discussing the need to privatise Romania's ailing steel company and to sell it to a buyer who would inject the funds needed to guarantee its future.

Mr Mittal, an Indian steel billionaire with homes throughout the world, was already known to the bank after it granted him a $150m (£105m) loan to buy Kazakhstan's steel works in 1996. The bank was told Mr Mittal was meeting his schedule of repayments on the loan and was investing according to the deal's terms in the Kazakhstan plant.

The Romanian deal was said to be similar in aim and structure, although the bank was told that Mr Mittal did not yet have the cash or backing from commercial banks to pay the full $400m (£280m) required in the contract over time.

He needed the EBRD loan to pay a $50m (£35m) deposit to the Romanian government and begin pumping money into the outdated plant. The contract said he would have to pay a further $351m (£245m) over the next five years and ensure that staff levels were not reduced below those at privatisation.

In the hour-long debate, America formally registered its objection to the loan, while directors from other nations expressed reservations about an overcapacity of steel production that could lead to a loss of jobs in other steel-producing countries. Officials at the European Bank, in London, had already rigorously checked Mr Mittal's financial record to ensure that he could repay the money.

What the EBRD would have been aware of was that Mr Mittal's London-based company, ISPAT International, had seen its credit rating slip steadily over the years to below investment grade. The company, registered in the Dutch Antilles, had seen its official credit rating by Standard & Poors slip from BB to BB- to B+ at the time the loan was approved.

But this did not turn the bank against Mr Mittal. And with the Department of International Development's instructions on his desk, Mr Kerby, a former director the department's Eastern Europe and Western Hemisphere division, knew which way he should vote.

The cash helped Mr Mittal win control of Sidex, which was also being coveted by a French competitor, just months after he had paid £125,000 to Labour Party funds. Yesterday, Downing Street was dragged into the debate about the loan and forced to deny that it had been involved in recommending that the Department of International Development back the deal.

Ms Short's department said no ministers had been involved in writing the letter of approval or the assessment of whether to back the EBRD loan. But officials at the Treasury and Department of Trade and Industry were consulted by the Department of International Development about whether to recommend the loan. The Government could not say last night whether the British embassy in Bucharest had also been asked for its opinion.

The Department of International Development's assessment was made on the basis of whether the sale of the steel works was worthwhile, and whether a loan should be granted to ensure the privatisation went through. A spokeswoman said: "What was recommended was that the project was a good project. It was routine. We always send a note to the EBRD on these things."

Tony Blair's official spokesman said: "Clare Short is particularly livid that the integrity of her people is being called into question over this."