As Ukraine prepares to sign a trade agreement with the European Union later this year, Russia is ramping up pressure to draw its former satellite state into a trade area of its own. If Russian president Vladimir Putin’s “Eurasian Union” is to succeed, it can hardly afford to let Ukraine be Westernized.
Despite European doubts about Ukraine’s commitment to political reform, symbolized by the jailing of former prime minister Yulia Tymoshenko in late 2011 on charges of abuse of office, the bloc is eager to finalize an association agreement with the country that would effectively make it part of the European economic area and also serve as a first step toward full membership. Ukraine has more than forty-four million potential consumers for Europe’s products and services, making it a larger market than Poland, currently the biggest former Soviet satellite state in the European Union. It also has access to the Black Sea, is rich in minerals, including iron ore, and one of the world’s premier agricultural producers.
Ukraine seems eager to join Europe. President Viktor Yanukovych insisted in an Independence Day speech last month that “association with the European Union must become an important stimulus for forming a modern European state.”
Yanukovych was seen as more pro-Russian than his predecessor, Viktor Yushchenko, whom he succeeded in early 2010 and also called for “deepening” relations with Russia in the same address. But his actions speak louder than words. Yanukovych has continued the previous administration’s policy of waning Ukraine off its dependence on Russian oil and gas imports by letting in Western companies like ExxonMobil and Shell to develop Black Sea and shale gas reserves rather than Russia’s Lukoil.
Prime Minister Mykola Azarov has been more candid about his country’s intentions, describing the association agreement with the EU as an “historic step” and urging Russia to accept it as a “reality.”
Russia doesn’t seem ready to do so. Last month, it enacted discriminatory border checks on all Ukrainian cargos for several days, delaying exports and thus driving up costs. President Putin warned at the time that a free trade deal between Europe and Ukraine might “squeeze out” Russian goods and would compel other former Soviet Union states to take “protective measures.”
It was not the first time Russia used its trade power to try to pressure Ukraine into a more eastward policy. Disputes over natural gas prices and siphoning have plagued relations since the collapse of the Soviet Union in the early 1990s. The countries fought two “gas wars” in the winters of 2006 and 2009 when Russia suspended delivery. Nearly 70 percent of Russia’s gas exports to the European Union is transited through Ukraine, another reason for the bloc to draw the country into its orbit.
The reason Russia is so apprehensive is that Ukraine cannot simultaneously enter into an association agreement with the EU and join its customs union. It cannot be a member of two competing trade blocs that each protect their own markets.
Moreover, without Ukraine, the most populous of former Russian satellite states, as a member, such a customs union, which is supposed to morph into an “Eurasian Union,” would be more Asian than Western, denying Russia a foothold in Europe.
If Ukraine doesn’t sign up, the bloc will only include Belarus and Kazakhstan besides Russia, as well as Armenia, which announced its intention to join earlier this month. These three countries have little to offer Russia. Belarus receives de facto oil and gas subsidies from Russia every year that amount to between 15 and 18 percent of its gross domestic product while Russian investments in Armenia account for almost a third of that country’s economic output.
Russia’s intimidation is unlikely to pay off, according to Dmitri Trenin, the director of the Moscow Center of the Carnegie Endowment for International Peace. Rather than making Ukraine think twice about entering into a trade agreement with other European states, it risk rekindling Ukrainian nationalism. “By shifting gears abruptly from professions of eternal brotherhood with the Ukrainian people to what amounts to a trade war, Mr Putin effectively works at cross purposes with himself,” he writes. Even if Ukraine doesn’t become a European Union member state, “it will certainly not rejoin Russia.”
At the same time, it can ill-afford to sever relations with Moscow altogether. Ukraine relies heavily on coal, fuel, grain and steel exports. More than 60 percent of its exports go to other former Soviet republics while the country imports some 60 percent of its natural gas and more than 90 percent of its oil — virtually all of it from Russia.
Adam Reichardt, editor of New Eastern Europe magazine, believes Ukraine has painted itself into a corner. He writes at The National Interest that it now has only two options: “choose Europe and expect (maybe) long term growth but at a cost of conforming to European norms, including stronger democratization and more human rights protections, while at the same facing fierce reprisals from Moscow; or don’t sign the pact, join the Russian customs union with very few strings attached but brace for serious political and social backlash by those pro-European (or at least anti-Russian) Ukrainians.”
Ukraine is home to some eight million ethnic Russians, many of whom voted for Yanukovich’s conservative party in the last election. Even many liberal Russians consider the country, which shares the same heritage and Orthodox faith, an extension of their own.
Reichardt nevertheless predicts Ukraine will choose Europe, especially when the alternative could cost it dearly. A 2011 study (PDF) by the Institute for Economic Research and Policy Consulting, an Ukrainian think tank, estimated that the trade agreement with Europa could add almost 12 percent to Ukraine’s GDP in the long term while joining Russia’s customs union would reduce it 3.7 percent. A Kyiv School of Economics paper found that Ukraine’s exports would likely rise 17.9 percent when it joins the customs union whereas a trade agreement with the EU could see exports increase a whopping 46.1 percent.
Russia counters that Ukraine stands to gain $9 billion per year if it joined the customs union because it would enable it to buy Russian oil and gas at the same low price Belarus does. But this is more a threat than an incentive. Russia deliberately keeps the oil and gas supply below demand and both resources overpriced to try to force Ukraine into trading more of its industrial assets for energy and accelerate a process of economic reintegration that stalled under the last government in Kiev. Given Yanukovych’s preference for deals with Western oil companies over Russian ones, it can be assumed that even he doesn’t want Ukraine to become a proper satellite state of Russia’s again.
The Russians do have a point, according to Forbes‘ Mark Adomanis, when they warn that Ukraine’s foreign account deficit will widen when it integrates its economy with Europe’s. The country has almost no foreign currency reserves and a poor credit rating, inhibiting its ability to borrow cheaply. If European product sales to Ukraine increase, the country runs the risk of running out of money to pay for them and defaulting on its debt obligations — something that especially worries Russia which is the major holder of Ukrainian sovereign debt.
In the long term, however, Adomanis agrees that it makes sense for Ukraine to become part of the European single market. This would compel Ukraine to further liberalize its economy which should draw in more foreign investment — to the likely detriment of Russian companies.
“The question, then,” he suggests, “is not if Ukraine should integrate with the EU but how much of an economic disaster is going to happen in the meantime.” The country might require quite of bit of financial support to make the transition — at a time when Western European electorates are already extremely frustrated about having to bail out fellow European states.