EU and Russian perspectives on pros and cons of imminent FTA reflect their respective political agendas.
Mid-October 2013
Russia and the EU are Ukraine's leading partners for trade, investment and remittances. In the lead-up to the crucial summit of the EU's Eastern Partnership, at which an EU-Ukraine free-trade agreement (FTA) will probably be signed, the EU and Russia have presented sharply divergent visions of the likely impact on Ukraine, as they each emphasise different stages of the trade-liberalisation process. Also, both leave out aspects of the story inconsistent with their preferred narratives. Ukraine may have more options for dealing with intensified competition than suggested by Russia, but implementation of EU business rules in Ukraine is likely to prove tougher than implied by the EU.
Russia and the EU are Ukraine's leading partners for trade, investment and remittances. In the lead-up to the crucial summit of the EU's Eastern Partnership, at which an EU-Ukraine free-trade agreement (FTA) will probably be signed, the EU and Russia have presented sharply divergent visions of the likely impact on Ukraine, as they each emphasise different stages of the trade-liberalisation process. Also, both leave out aspects of the story inconsistent with their preferred narratives. Ukraine may have more options for dealing with intensified competition than suggested by Russia, but implementation of EU business rules in Ukraine is likely to prove tougher than implied by the EU.
Ukraine is set to be admitted to the EU's so-called deep and comprehensive free trade area (DCFTA) at the end of November, after more than five years of negotiations. This is an integral part, and perhaps for Ukraine the key attraction, of the country's fast-developing integration into the EU. There are two main aspects to the deal. The first removes most trade tariffs and quotas for imports and exports between the two sides, while allowing Ukraine a more gradual elimination of trade restrictions in some "sensitive" Ukrainian segments in industry and agriculture to give local producers more time to adapt to the step-up in competition. The second is the reform of commercial laws and regulations to bring them into line with EU norms. Besides these, the DCFTA should chip away at non-tariff barriers, improve food safety and animal welfare, simplify trade administration and develop mechanisms for solving trade disputes. The deal will permit the extension of the liberal trade regime to new businesses and provides for the gradual incorporation of public procurement into the arrangement. These last are among the "unprecedented" measures behind the EU's use of the "deep and comprehensive" label.
Divergent visions
While trying to tug Ukraine into their respective economic blocs, the opinions of the EU and Russia differ on what Ukraine might expect from the opening of its markets and harmonisation with EU rules. For the EU, the DCFTA sets a framework for the modernisation of Ukraine's trade and economic development, which will boost real GDP and the population's buying power. It points, for example, to an immediate yearly net gain of €100m for Ukraine from the elimination of trade duties alone. Russia, by contrast, following a recent step-up in its efforts to block the westward drift of a number of former Soviet states, has issued dire warnings about the destructive economic and political impact that the DCFTA will inevitably have on Ukraine, leading Sergei Glazyev, a Russian presidential aide, to label the step "suicidal". As Ukraine's poor-quality products will fail to compete on EU markets, Russia's argument goes, its exports will fall and its large external deficit expand. With funds scarce and reserves low, this could trigger a currency crisis and macroeconomic destabilisation, leading to financial catastrophe and perhaps even, it has been suggested, the collapse of the Ukrainian state. Russian officials have made it clear that inauguration of the EU FTA may not only lead to a more permanent disruption of Ukrainian exports to Russia, but may also render void their existing border treaties. By highlighting the potential political and social costs for Ukraine, Russia has implied that it might stir up unrest, and perhaps separatist sentiment, in areas of Ukraine dominated by ethnic Russians, such as Crimea and the Donbas.
Under the weather
The Ukrainian economy is certainly in bad shape. Because of this, it remains vulnerable to external shocks and destabilisation. In April-June 2013 real GDP fell year on year for a fourth successive quarter. In July and August, industrial output and exports continued to decline. In these months, the current-account deficit widened markedly, taking it to US$10.2bn in January-August, only a little down from US$10.5bn in the same period of 2012, a year in which the largest imbalance in the post-Soviet era was recorded. Reflecting these developments, the rise in international borrowing costs to emerging markets, following indications in May of a possible wind-down of the US Fed's bond-buying programme, has been especially sharp for Ukraine. This forced the central bank to use its own reserves to meet a series of substantial debt repayments. By August, foreign-exchange reserves had dropped by US$3.7bn compared with April, to US$19.8bn. This was probably one factor behind a rise in devaluation expectations and an increase in foreign-currency demand among the Ukrainian population, prompting a return to intervention in currency markets in September. As a result, reserves climbed only modestly in that month, despite the receipt of a cheap loan from Russia's Sberbank.
The long and the short of it
Both the EU and Russian narratives about the DCFTA's impact on Ukraine have some truth to them, but look at different time frames. Over the longer term, by encouraging specialisation in areas in which Ukraine is least inefficient compared with the EU, Ukraine should make economic gains—gains maximised by the status of the EU as the world's largest single market. The Ukrainian population should also benefit from a wider range of products of better average quality, lower prices and, eventually, through a degree of wage convergence, higher living standards. Moreover, the quality of the country's own products should increase, sharpening their competitiveness in non-EU markets. The harmonisation of business rules should attract greater levels of foreign investment.
However, in the short run, as competition diverts resources to stronger sectors, Ukraine could again be subject to another period of disruptive economic adjustment, involving business closures and job losses. In Poland and Croatia, for example, the shipyards were hit under similar circumstances, and many of Latvia's engineering business suffered a similar fate. Further, the groups of people who lose out in the short run may not be the same ones that benefit eventually, owing to skills mismatches. Finally, greater adherence to EU norms of trade administration, safety and labour conditions is likely to be more costly than maintaining the status quo.
Off the radar
At the same time, there are important considerations missing from either scenario. Although Russia is keen to emphasise the precariousness of Ukraine's external-trade position, it does not mention that a key reason for this is the high price that it charges Ukraine for gas. Moreover, Ukraine still has the option of currency devaluation, which should discourage imports and boost foreign sales, narrowing the trade gap. On financing, large loans are likely to be forthcoming from Western institutions as long as Ukraine is able to agree—as seems prudent—to a new programme with the IMF. As for the ideal scenario of trade liberalisation on which the EU's promises depend, it is likely to come up against the hard reality of Ukraine's political economy, as it has developed since independence. This has seen a weak state gradually overcome by business-political associations whose typical modus operandi is to sustain profits by preventing market entry of competitors (rent-seeking). In principle, the provisions of the DCFTA on competition, public procurement and working conditions promise fundamental challenges to this system. It will be interesting over the next few years to see how they fare.
