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29 November, 2011  ▪  Volodimir Kuznetskiy,  Dmytro Vovnianko

Till the Cows Come Home

Tough political reality could shatter handsome economic deals within the CIS

The recent Free Trade Zone (FTZ) agreement signed by CIS leaders in St. Petersburg raised many eyebrows. Kyiv and Moscow wasted over a decade trying to work out an interpretation of the old FTZ agreement drafted in 1993 that would suit both. Ukraine insisted on its purely economic purpose, particularly the greatest possible liberalization of trade, while Russia was largely interested in its political aspect that was to set up supranational bodies. On 17 October 2011, Ukraine and Russia reached an unexpected compromise and signed the FTZ agreement the following day. The only original copy in Russian sits at the CIS Executive Committee while the signatories have, or are supposed to have, notarized copies. Meanwhile, the draft FTZ agreement has leaked into the mass media. According to Russian and Ukrainian politicians, as well as messages and interpretations offered by the media, for the most part, it is identical to the original agreement. The first impression the document leaves is that it has been expertly drafted and is not purely declarative.  Outlining the terms of the trade association between Ukraine, Armenia, Moldova and Kyrgyzstan, which are WTO members, and its potential members, first and foremost Russia and Uzbekistan, is a super-challenging task. The experts who drafted the FTZ agreement seem to have done a fairly good job. However, the agreement has been crafted professionally not only in terms of its legal aspects. If this is the same document that was signed in St. Petersburg, it means that the FTZ agreement in fact includes a customs union, at least partially, if not a full version thereof, that entails the unification of custom duty rates. Among other things, the FTZ agreement contains mechanisms to coordinate customs policy regarding third parties and some restrictions in members’ rights to regulate settlements in foreign currencies. In essence, the trade regime, which could have been fixed in St. Petersburg on 17 October, was something in between an FTZ and a customs union. The agreement can be implemented if ratified by member parliaments.

Does the agreement benefit Ukraine? Yes. If implemented, it will not affect trading within the WTO from a purely economic perspective. This scenario is unlikely, though, given the prospect of political integration into a Eurasian Union recently outline by Premier Vladimir Putin.

ECONOMIC ASPECT

Art. 2 is a key one in the FTZ agreement. “The Party shall apply no customs duty or other fees equivalent to a customs duty on goods exported onto the customs territory of another Party  and/or goods imported from the customs territory of another Party, other than in cases listed in Add. 1, which is an integral part hereto,” the Article says. Addendum 1 lists items covered by the customs duty. The list is short compared to the effective trade restrictions between Ukraine and Russia, yet contains some very significant items.

First and foremost, based on 2010 results, it covers fuels that account for 73.4% of Ukraine’s imports from CIS countries. According to the State Statistics Committee, this cost Ukraine USD 19.6bn. Russia was a monopolist supplier of natural gas worth USD 9.4bn. Oil and oil products imported totaled USD 8.1bn including USD 4.1bn from Russia and USD 1.5bn from Belarus. Under Add. 1, Russia is going to clear fuels within the limits established by the FTZ agreement using a “special formula,” the same goes for Belarus.  As a result, trade liberalization will not make gas or oil any cheaper for Ukraine. Art. 2.15 entails the gradual reduction of export duties listed in Add. 1 until they are fully cancelled. But Ukraine will probably have to enter a political marriage of convenience for this economic promise to be fulfilled.  

All other items important for Ukraine are “fully or partially” in the agreement. The FTZ agreement will benefit Ukrainian steelworks. Pipe manufacturers exporting 71.2% of their output to CIS countries will be the luckiest. Moreover, export restrictions barely extend to raw materials for steelworks, as well as semi-finished and finished steel goods. Ukraine will restrict exports of chrome nickel steel, stainless steel billets and copper matte but their share in total exports is under 0.1%. Therefore, restrictions in this market will not affect the economy.  Apparently, export tax on the above-mentioned goods is intended to first and foremost protect the domestic market.  

The best news for all parties to the agreement is the exemption of customs duty for exporting and importing producers of mechanical, road-building and electric equipment, machines, mechanisms, vehicles and so on. The benefit this gives Ukraine equals or tops that from duty-free exports for steelworks.

Russiais one of the largest markets for Ukrainian food producers. Ukraine sells much more food to CIS countries than it buys from them. In 2010, Ukraine imported pork worth USD 200.8mn, not one kilogram of which came from the CIS, while exporting produce worth USD 2.4mn to Russia alone. Figures differ slightly for poultry and other meats, grain, etc. Given the situation on the global food market, liberalized trade in agricultural products within the CIS opens vast opportunities for farmers. For instance, Russia exported 18.5mn tons of wheat in the previous marketing year landing 4th among the top 10 exporters, according to IMF data, while Ukraine ended up 6th having exported 9.3mn tons, followed by Kazakhstan with 7.87mn tons. Coordinating interests, which is an inevitable result of opening markets within the CIS, will allow all parties to strengthen their positions on the global market, let alone the European one, particularly compared to the total wheat supply from USA and Canada at 42.9mn tons and 22.1mn tons from the EU for the same period. However, earlier experience inspires little optimism in this context. Who can guarantee that the domestic market will not sink in agflation in a race for the image of a bread basket or simply cash in the global market? This refers to Russia and Kazakhstan, not only Ukraine. Food prices have been rising for several years in a row now, with wheat price growing 84% in 2010 alone, coupled with increasing official and hidden unemployment. The risks, not just the potential of integration, are plain to see.

The CIS market is a Klondike for Ukrainian cheese producers, bringing them USD 425.5mn of the total USD 426.8mn earned in 2011, with exports to Russia amounting to USD 367.3mn; chocolate and confectionaries with a net profit of USD 667.3 of USD 756.4mn of total earnings; and alcohol-producers earning USD 300.7mn of total revenues worth USD 380.3mn. Only Kazakhstan and Kyrgyzstan have restricted the import of Ukrainian vodka in the FTZ agreement. This does not include sugar, as Belarus, Kazakhstan, Moldova, Tajikistan and Russia have imposed a duty of USD 340 per ton for sugar imported from Ukraine. Kyiv paid them back by imposing a duty of 50% of the invoice amount. But this requires a separate analysis, bearing in mind the fact that sugar prices grew 55% in 2010, a trend that is continuing.

Political background

An important point is how the FTZ agreement conforms to Ukraine’s WTO commitments. It should be understood that they are listed in a series of bilateral and multilateral agreements with other states, detailed down to specific goods.  Liberalized custom borders within the CIS could turn out as both a pleasant and an unpleasant surprise for many Ukrainian partners. This does not mean that Ukraine’s membership in the WTO prevents it from joining the FTZ with Russia. Moreover, FTZ agreement provisions are based on WTO principles and support them in many aspects. However, questions could arise at the FTZ agreement implementation stage, since it contains some awkward requirements. One is called “unauthorized re-export” to third parties referring to exporting goods without a written consent from a relevant authority of the country of origin.  So far, though, this obstacle is purely hypothetical because the inspiring economic deals within the CIS could eventually be shattered against tough political reality.  

The FTZ agreement contains no political provisions. Still, the flavor of politics can be felt in the background. Russia has been reluctant to make any economic concessions regarding Ukraine for 17 years, thus protecting its domestic market. Meanwhile, Kyiv has been offered alternative political projects, such as the Eurasian Economic Union, Single Economic Zone, and the Customs Union. Having no economic content whatsoever, these abbreviations and combinations of words have been an irritant to Ukraine’s patriotic elite all this time. The signing of the FTZ agreement continues this course of the Kremlin. It has now come up with a new idea called the Eurasian Union. It is inspired by Russian Premier Vladimir Putin who, in one of his October TV interviews, said outright: “The Soviet Union has collapsed. But what was the Soviet Union? It was Russia, only with a different name.” It appears that Kyiv has heard the innuendo.

“The signing of the FTZ agreement within the CIS and the Free Trade Agreement with the EU are two items of one agenda, intended to open Ukraine’s economy to foreign markets,” said Ukraine’s Premier Mykola Azarov after he closed the deals in St. Petersburg. “This is necessary to maintain the sustainable economic development of our country.” Such accents might be interpreted as Kyiv’s attempts to revive the multivectored strategy used by Leonid Kuchma. The Kremlin does not appear happy with this. “I think the threat to the FTZ agreement comes primarily from the draft Free Trade Agreement with the EU that Ukraine is currently working on,” commented Sergei Glazev, Executive Secretary of the Customs Union Committee and Deputy Secretary General of Eurasian Economic Union, making sure everyone understood that this message was specifically intended for Ukraine.

Under these circumstances, the FTZ agreement that is of overall benefit to Ukraine, will most probably be shelved for a very long time. 


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