On the Road to Total Divorce

2 February 2015, 18:57

In one year, on January 1st 2016, the economic part of Ukraine’s Association Agreement with the EU is to take effect. Meanwhile, the “compromise” reached in September in Brussels that delayed the agreement in exchange for Russia cancelling its trade war against Ukraine really did nothing to solve the problem, but simply postponed it.

To demonstrate the seriousness of its intentions, Moscow prepared a government resolution for the automatic introduction of a package of restrictive measures against Ukrainian goods that would take effect immediately after the economic part of the EU Association Agreement came into force. Russia threatens that within 10 days of the implementation of the agreement, it will raise duties on Ukrainian meat, dairy and baked goods, fruits and cereals, as well as beer, wine, alcohol and cigarettes. The list also includes cars, buses, refrigerators, clothing, shoes, ferrous metal products, glass, cement, concrete, plastic, mineral fertilizers, passenger and cargo ships, machinery, cosmetics, textiles, furniture, and sporting equipment.

The EU has been energetically ratifying Association Agreements for several years. In addition to the European Parliament, several countries have already completed the process, including Hungary, Slovakia, Czech Republic, Poland, Bulgaria, Romania, Estonia, Lithuania, Latvia, Sweden, Denmark, Croatia and Malta. While it was previously predicted that all EU member states would achieve ratification by 2016 or even 2017, current forecasts stating mid- to late-2015 are more optimistic. Thus, it would be strange to further postpone the initiation of the economic part of Ukraine’s agreement with the EU.

This means that both Kyiv and Brussels should immediately take preparatory measures to minimize the negative effects of Russia’s projected trade blockade. Moreover, in mid-December Russian Prime Minister Dmitry Medvedev again threatened Ukraine with losses of USD 15 billion annually once the economic part of the deal finally comes into effect.

The popular misconception that Russia or its Customs Union constitute the largest markets for Ukrainian companies has long been far from reality. Over the past three years, Ukraine’s dependence on the Russian market has decreased dramatically. The structure of domestic commodity exports has diversified, while sales in emerging markets in Asia and Africa have expanded and exports to the European market increased after the introduction of EU unilateral preferences for Ukrainian suppliers.

The loss of export capacity in the Donbas and Russia’s constraints on Ukrainian goods have created the conditions for a relatively painless departure from the Russian market. In August-September 2014, the percentage of Ukraine’s total exported goods sold to Russia dropped to 16.9%. If we include satellite economies that became members of the Eurasian Economic Union on 1 January 2015 (Kazakhstan, Belarus and Armenia), that number becomes 23%. This trend continued: in October, exports to Russia fell to 15.7% (21.7% including Eurasian Union countries) and 14.7% (19.8%) in November.

Today, completely different markets have become priorities for Ukraine. For the first 11 months of 2014, the largest share of exports was sold on the markets of the Mediterranean (24.3%, increased to 26.5% in November), including several EU member states (Italy, Spain, Greece, etc.). Another 23.2% (22% in November) of exports were sold in other EU countries. We now can see that Russia and its partners in the Eurasian Economic Union are only in third place.

Moreover, in November, Ukraine’s exports to China and other countries in the Far East (Japan, South Korea and Taiwan) were only five percent less of its total exports than those to Russia (9.4% vs. 14.7%). With deliveries to these markets growing rapidly in recent years while exports to Russia decrease, they may soon be more important for Ukraine. Other important consumers of Ukrainian products include South Asian countries (India, Pakistan and Bangladesh), which in the first 11 months of 2014 amounted to 4.4% of exports (up to 6.4% in November), and countries of the Persian Gulf (Iran, Iraq, Saudi Arabia, the United Arab Emirates and Oman), with 5.3% of exports (4% in November).

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At this point, the loss of even the entire Russian market would be less painful than the loss of that market that the Ukrainian economy has already endured over the past three years. For example, in the 3rd quarter of 2014, exports to Russia amounted to USD 2.4 billion, while in the same period of 2011 they totaled USD 5.4 billion. In November 2014, the corresponding figures amounted to USD 0.59 billion and USD 1.68 billion, so Russia’s threat of a loss of USD 15 billion is absolutely unrealistic considering that the total prospective Ukrainian exports to Russia in 2015—even without additional restrictions on its part—will not exceed USD 5.6 billion. This is especially clear given the substantial fall of the ruble and Russia’s projected economic downturn. And by the time Ukraine’s free trade agreement with the EU comes into effect (on 1 January 2016) and Russia’s likely cancellation of Ukraine’s free trade agreement with the CIS occurs, Russia’s share of Ukrainian exports may well be reduced to a non-critical 10-12%.

Ten commodity groups remain most dependent on the Russian market, with exports of these products to Russia exceeding USD 50 million annually and amounting to more than 20% of their total output. These include machinery and equipment (excluding electrical), railway locomotives, some chemical products, plastics and polymers, paper and cardboard, ceramic products, automotive components, and furniture. The total volume of these goods delivered to Russia from August to October 2014 was 7.3% of Ukrainian exports worldwide. These commodities accounted for 14.5% of Ukraine’s total industrial output from January to October 2014. This is where Ukraine’s government needs to step in to help determine which industries should be allowed to die, and which should be reoriented toward alternative domestic or foreign markets. Finally, manufacturers of machinery and equipment (52.2%), railway locomotives (61.6%), and automotive components (77%) rely on exports heavily, yet their share in the country’s industrial output is moderate (respectively 2.5% and 1% 0.5%).

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Currently, the supply of most Ukrainian food products to the Russian market has been effectively blocked. In May, Russia’s “Federal Service for Veterinary and Phytosanitary Surveillance” limited imports of Ukrainian meat, adding potatoes and corn in June, along with increased documentation requirements for the import of animal products. In July, the Russian sanitary service completely banned the import of dairy, fruit and vegetable products, canned fish, and juice. Pork, potato products, and beer were also banned. In August, the service blocked Ukrainian shipments of soybeans, sunflowers, cornmeal, and soybean meal. The producers of these goods now have nothing left to lose. Instead, they are seeking to increase exports to alternative markets. For example, the European market is certifying Ukrainian agricultural suppliers. According to the Agriculture Ministry, as of December 1st, 2014, 211 Ukrainian businesses were certified to export the following food products to EU member countries: poultry and meat products, eggs and egg products, fish and fish products, and honey and other bee products.

Ultimately, when it comes to its trade war against Ukraine, Russia no longer has the support of its satellites in the Customs Union, whose markets supplied one quarter of Ukraine’s exports to the CU. At a meeting of the Eurasian Economic Commission in the summer of 2014, Belarus and Kazakhstan rejected Russia’s proposal to increase duties on Ukrainian products. For them, this politically motivated step was not necessary. For Belarus specifically, the consequences of introducing restrictions on Ukraine’s imports of its products could be potentially disastrous and difficult for Russia to rectify under the current circumstances. Therefore, in his relations with Kyiv, Belarusian president Alexander Lukashenka often tries to take an independent stance from the Kremlin. After the collapse in oil prices and fall of the ruble, Lukashenka even urged his government to immediately seek new markets and no longer look at Russia as the main buyer of Belarusian goods.

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