EconoMonitor

Thoughts From Across the Atlantic

Is Postponing the EU Trade Agreement Harmful to Ukraine?

The Parliament of Ukraine and the European Parliament are both expected to ratify the EU-Ukraine association agreement in a simultaneous session today. However, last week it was announced that the entry into force of the deep and comprehensive free trade area (DCFTA) between the EU and Ukraine, initially planned for November of this year, will be postponed until the end of 2015. It has already been described as another victory for Russia in its attempts to keep Ukraine within Russia’s sphere of influence and a clear loss for Ukraine. In this short post, we would like to analyse whether that is really the case. We look both beyond claims made by Russia regarding the DCFTA and the claims that postponing the entry into force of the agreement is harmful to Ukraine.

The Russian opposition to the EU trade agreement is well known. However, the formal claim by Russian officials that a Ukraine-EU trade agreement would allow cheap EU goods to flood the Russian market by re-exporting them to Russia duty free does not withstand closer  scrutiny. The current Commonwealth of Independent States free trade agreement (CISFTA), that includes Russia and Ukraine, could easily deal with this potential problem. Russia excludes imports of white sugar from Ukraine from the zero-tariff provisions of the CISFTA, and other goods could be added if they created a problem. The current CIS agreement also allows Russia to apply anti-dumping provisions if goods are imported into Russia at “dumped” prices or restrictions if imports threaten the stability of its balance of payments. In fact, Russia has already restricted the import of a number of goods from Ukraine. However, the paradox is that Russia in the CISFTA has maintained export duties for a significant number of goods, mostly raw materials and mineral goods, while import duties have been maintained just for white sugar. Thus, imports into Russia had not been of concern when drafting the CISFTA. It is also worth noting that to our knowledge other members of CISFTA have not voiced concerns about future reexports of EU goods to their countries through Ukraine.

Should imports of EU goods through Ukraine for some reason become a problem for Russia after Ukraine implements the free trade agreement with the EU, the most common method for dealing with re-exports in a free trade agreement is to specify a minimum level of regional value- added to qualify for tariff exemption. Such rules are, for example, set forth in the North American free trade agreement (NAFTA). Russia and the other parties to CISFTA could agree that imports from a partner would be exempt from tariffs only if they contained at least 70% (or any other percent) regional value added from the CISFTA countries.

The issue of possible re-exports of cheap EU goods to Russia through Ukraine can be solved relatively easily. It thus appears that the real reason for objecting to the DCFTA is something different from the above formal claim. It could be that the Russian leadership views it as a symbolic first step of Ukraine leaving Russia’s sphere of influence (Putin’s concept of „near abroad”) or something still different. Russia is, however, unlikely to derive any economic gain from the postponed entry into force of the DCFTA.

Now, is postponing the entry into force of the DCFTA bad for Ukraine? It has already resulted in some loss of political capital for the new president. Mr. Poroshenko will have to explain why allowing Russia to influence an agreement between Ukraine and the  EU is not an attack on Ukraine’s sovereignty. Ukraine’s Deputy Foreign Minister, Danylo Lubkivskiy, resigned over the delay. Pro-Western Ukrainian rivals announced their opposition to the delay, and they promised to press the issue in the parliamentary elections October 26th. EU Trade Commissioner Karel De Gucht earlier stated that giving Russia a veto over an EU-Ukraine agreement would set a bad precedent.

However, from a purely economic point of view the agreement entering into force one year later is not necesarily bad for Ukraine. It will be a loss for Ukrainian consumers who will continue paying higher prices for many goods produced in the EU due to import tariffs. At the same time Ukrainian businesses are already facing several shocks, including a substantial rise in energy tariffs and credit constraints. Although these are partly offset by the negative effect that the depreciation of the hryvnia has on imports, immediate entry into force of the DCFTA would still be likely to place most domestic producers at a disadvantage compared to their more efficient counterparts in the EU. Now, however, given that the EU has agreed to unilaterally lower its tariffs against Ukraine’s goods, Ukrainian businesses can benefit from them for another year while at the same time Ukraine can keep higher tariffs against imports from the EU. It would give Ukrainian businesses another year to improve productivity and energy efficiency before being exposed to full competition from the EU. For some businesses it might even help them to survive by postponing the shock of elimination of import tariffs until 2016. If so, this would result in additional long term benefits as a live business is worth more than the sum of the assets of a bankrupt business and this is even more true in a country where the insolvency procedures are still far from fair and efficient. Provided that this additional year is used wisely not only by the businesses but also by the government for carrying out urgent reforms to improve the business environment, the positive effects would accrue and multiply once the DCFTA enters into force in 2016. EU, on its part, can play a constructive role by encouraging reform.  Mr. Poroshenko has described the terms of the EU agreement as a roadmap for Ukrainian reform.

Conclusion

The negative symbolic value of postponing the entry into force of the DCFTA should not be underestimated, and it is already being interpreted by both official Russia and some forces inside Ukraine as a concession by  the new Ukrainian government to Russia. However, if the time between now and 2016 is used by both the government and the businesses in Ukraine to deal with the imminent shocks and improve business environment, energy efficiency and productivity, the economic result from postponing the entry into force of the DCFTA for Ukraine might actually be positive.

References

Web-portal of Ukrainian government. Договор о зоне свободной торговли http://www.kmu.gov.ua/document/244693335/Dogovor-1.pdf

Wall Street Journal. 2014. „Delay to EU Deal Triggers Backlash in Kiev”. September 15.

Wall Street Journal. 2014. „EU, Ukraine, Russia Reach Deal on Association Agreement.” September 12.

5 Responses to “Is Postponing the EU Trade Agreement Harmful to Ukraine?”

DiranMSeptember 17th, 2014 at 5:10 am

Is a country that is bankrupt, under IMF tutelage and in civil war a proper candidate for an EU free trade agreement? What are the limits of EU expansion into eastern Europe and the implications on Russian relations?

The EU is very mismanaged and problematic with the worst economic performance of developed economics.

So I find this analysis suffering from Ivy Tower isolation from reality. The guyes just do not have any common sense, which is characteristic also of most Brussels bureaucrats, too.

ThomasGrennesSeptember 17th, 2014 at 5:30 pm

From the time of independence from the USSR, Ukraine has been an economic and political failure. The best case one can make in favor of Ukraine is that they have the potential to make necessary reforms and do what Estonia, Latvia, Lithuania, and Poland have already done.

The EU does have major problems, and the fact that the UK is considering dropping out reflects the problems. Decision-making in a union of 28 members is cumbersome. As for further expansion, all the remaining candidates (except (Turkey) are poorer than the poorest current members.

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