Ukraine, Georgia, and Moldova have signed the Association Agreement (AA) and the Deep and Comprehensive Free Trade Agreement (DCFTA) with the European Union (EU). Strategically, this means that three post-Soviet states have made a clear choice in their future development. The example set by the countries of Central Europe and the Baltics, which long ago chose European integration, is more attractive to these three countries than participation in the (primarily) political union with Russia.

Ukraine’s, Moldova’s, and Georgia’s choice of European integration is bound to complicate further their relations with Russia. Both, Russia and the EU have maintained that AA/DCFTAs are incompatible with membership in the Russia-sponsored Eurasian Customs Union (EACU). This argument may be technically correct (as will be explained later), but it leads to bad policy prescriptions. Ukraine is not aiming for membership in the EACU 1, but may benefit from continuing its current membership in the CIS free trade area (FTA), which is compatible with its AA/DCFTA singing. Ukraine could follow the example of Serbia, which is well on the way to becoming a member of the EU and has a free trade agreement with Russia.  In reality, given a measure of political good will, the relationship between the DCFTA and CIS FTA can be adjusted to the benefit of both sides and especially of the three countries whose fortunes are most at stake in the tug of war between Russia and the EU.

Russian Claims about the Dangers of DCFTA

A closer look at Russian arguments against Ukrainian, Georgian, and Moldovan AA and DCFTA signing offers no basis to the claim that Russia that these three countries’ pursuit of economic integration with the EU is a blow to Russian economic interests. More likely, Russian policy is driven by the desire to punish the three countries for their political choice.

Although Russian officials have frequently expressed contradictory views on the subject, the official Russian position can be summed up like this: an AA and DCFTA with the EU pose significant threats to Russian economic interests. According to President Vladimir Putin, “the proposed agreements do not allow for the participation of Ukraine in other agreements besides association with the EU.” However, Article 39 of the DCFTA states clearly that “this Agreement shall not preclude the maintenance or establishment of customs unions, free trade areas or arrangements for frontier traffic except insofar as they conflict with trade agreements provided for in this Agreement.”

This point calls for a technical explanation: countries rely on several forms of bilateral and multilateral agreements to facilitate foreign trade. The two most common are Free Trade Areas (FTAs) and Customs Unions (CUs). In an FTA member-states agree to eliminate all (or the bulk) of tariffs on each other, but maintain individual tariff policies vis-a-vis third parties. Thus, when countries join an FTA, they do not commit to cooperate with each other in setting their import tariffs. A CU is a closer and more sophisticated form of international cooperation whose main feature is the establishment of the supra-national authority to which the members of the CU delegate their power to decide upon joint import tariff regime (including rates). CU members are not allowed to join another as it may lead to regulatory conflicts.

Following the disintegration of the USSR, the ex-Soviet republics (excluding Baltics) agreed to establish a free-trade area among them. This agreement was codified in the 1994 CIS FTA Treaty, as well as in several bilateral FTA agreements. The Treaty was subsequently revised several times, and its latest version was signed in October 2011. The terms of the CIS FTA allow member-states to enter into the FTA agreements with other countries, as well as to join/create custom unions (Article 18).

In 2007, Russia, Belarus, and Kazakhstan have agreed to establish a EACU that came into existence in 2010. The tariff policy within the EACU was delegated to the supra-national agency (initially Commission of the CU, since July 2012—Eurasian Economic Commission). As a result, Russia, Belarus, and Kazakhstan are not able to change their tariff rates alone but need to coordinate steps with two other members of the EACU. The EACU Treaty also prohibits its members to join other CUs.

Ukraine, Moldova, and Georgia have never officially applied for the membership in the EACU. Moreover, by signing AA/DCFTA they did not join the European CU either. Thus, their current status as members of the CIS FTA does not limit them in signing any other FTA (including the EU DCFTA) and does not create any regulatory conflicts. According to Article 39 of the EU DCFTA “shall not preclude the maintenance or establishment of customs unions, free trade areas or arrangements for frontier traffic except insofar as they conflict with trade arrangements provided for in [the EU DCFTA].” That means at least in theory Ukraine may join the Russian-sponsored CU, albeit with conditions 2.

Another Russian argument against Ukraine signing a DCFTA is that “If [Russia] maintain[s] a zero rate and Ukraine opens its market to European goods, then all European goods will transit through Ukraine into [Russia’s] customs territory, which [Russia] cannot allow.” These concerns may be justified, but there exists a common international solution to this problem: namely country of origin certificates and special clauses in trade agreements. Such clauses exist in both CIS FTA (Article 4) and in the DCFTA signed by Ukraine and the EU.

Furthermore this Russian concern is hypothetical in nature and has not been tested in practice. The accepted practice in FTAs is to analyze customs statistics for evidence of “a rapid increase, without satisfactory explanation, in imports of goods exceeding the usual level of production and export capacity of the other Party that is linked to objective information concerning irregularities or fraud.” 3 If this happens in Ukrainian-Russian trade Russia has the right to impose import tariffs on Ukrainian imports at the level agreed to the WTO rules 4.

According to President Putin, he warned former President of Ukraine Viktor Yanukovych about the problem of European goods flooding the Russian market through the free trade arrangement with Ukraine when they discussed this issue in November 2013, on the eve of the Vilnius Summit, where the signing of the AA and DCFTA was set to take place. However, Prime Minister Medvedev was ambiguous in his statement on this issue and said only that the impact of Ukraine’s signing an AA and DCFTA was uncertain.

Expanding on Putin’s grim forecast, Russian chief negotiator in the World Trade Organization Maksim Medvedkov, has focused on a possible threat to the Russian economy as a “domino effect,” whereby Ukrainian goods will be driven out of Ukraine by European ones and will instead be sent to Russia. Alternatively, the territory of Ukraine will be used by EU companies for simple operations in finishing, assembling, and then re-exporting their products to the Customs Union.”

Other Russian leaders have sounded more dire predictions about the impact of the AA and DCFTA signing on Russian interests. Deputy Prime Minister Dmitri Rogozin has stated that “an [AA] with the EU is a change in the neutral status of Moldova. There is a certain rule that all NATO members know: in order to enter the EU, you are required to join NATO. This rule will not change for Moldova. All countries go through this. Therefore, association with the EU will be the moment when Moldova turns the doorknob of NATO.” This statement, despite it being false, appears to reflect the real concerns of Putin personally and is one of the main drivers of Russian policy.

However, Minister of the Economy Aleksei Ulyukaev has staked out a less alarmist position. According to Ulyukaev, a trade conflict is not inevitable, and Russia can and must try to avoid it: “You always have to look for possibilities. Politics is the art of the possible. Yes, we need to try to combine the logic of Ukraine being in the CIS free trade zone and Ukraine’s possible participation in the European Union’s free trade zone … It is a very complex task … This issues has a legal side—around 400 agreements connecting Ukraine and the CIS, … around 40 of which are vital … We cannot pretend that these agreements don’t exist or that they can be violated, because violation of the agreements is a risk.”

Ulyukayev’s deputy in charge of international economic cooperation Andrei Likhachev, was also quite subdued in his comments. He focused on the possible conflict of regulatory norms in the future:

“Moldova will not be able to combine two regulatory systems: the CIS and the EU. It will be forced to make a certain choice. And if that choice will be in favor of the European system, then the CIS system will cease to be comfortable. … If Moldova signs the agreement with the EU, it may encounter contradictory obligations in customs and transport regulations, sanitary and migration control. Moreover, the most painful issue may turn out to be the differences in the application of sanitary norms and migration policy.”

The vague and non-specific nature of Russian statements suggests that the immediate damage to the Russian economy as a result of Ukraine, Moldova, and Georgia signing DCFTA with the EU is likely to be minimal if any at all. The most credible threat to the Russian economy seems to be from the "domino effect," meaning the displacement of Ukrainian goods by European ones on the Ukrainian market, resulting in a sharp increase in the level of competition in the Russian market. Many Ukrainian goods will likely win in this competition due to their lower costs associated mainly with lower wages in Ukraine. A quantitative assessment of this threat is not feasible at this time, but customs statistics can detect such shifts fairly quickly while Russia within CIS FTA framework has all instruments to protect itself.

Inevitably, there will be discrepancies and contradictions between the regulatory frameworks of the EU and the CIS. Some of them can be solved through negotiations; others are more acute contradictions and will have to be resolved through a variety of trade restrictions. However, there is no evidence to suggest that these contradictions threaten a whole array of Russian-Ukrainian trade, and moreover, that they are insurmountable.

Russia’s Threatened Response

In response to Ukraine, Moldova, and Georgia signing their AAs and DCFTAs with the EU, Russia has threatened to take a series of retaliatory steps. These include:

  1. Cancellation of the agreement on a Free Trade Area within the CIS and raising customs tariffs for these three countries from zero level to the level of “most favored nations” agreed with WTO (7,1 percent). But according to the EACU agreement, Russia needs to coordinate this step with Kazakhstan and Belarus who have initially rejected it;
     
  2. Stricter veterinary and phytosanitary controls that could lead to serious limitations in the movement of foodstuffs, which make up a significant share of the Ukrainian and Moldovan exports to Russia;
     
  3. Cancellation of the simplified procedure for citizens of Ukraine, Moldova, and Georgia entering Russia 5;
     
  4. Restrictions on employment in Russia for citizens of Moldova, Ukraine, and Georgia. According to the Russian Migration Service, there are approximately 24,000 citizens of Georgia, 530,000 citizens of Moldova and 1.38 million citizens of Ukraine of working age in Russia. Given that, on average, citizens of these countries work in Russia 6 months a year, about 1 million Moldovans and 2.5 million Ukrainians would be affected by this measure.
     
  5. Political guidance to Russian business to reduce or stop investing in Ukraine, Moldova, and Georgia.

The View from Europe

While Europe is interested in stronger ties with Ukraine, Georgia and Moldova, it is definitely not in favor of escalating tensions with Russia as a result of AA/DCFTA signing. Moreover, the official position of European politicians and bureaucrats is conflict-averse and can be expressed in the following items:

  1. Both the DCFTA and CIS FTA are free trade zones agreements and they should not create any tension in trade relations;
     
  2. The DCFTA does not require any of three countries to cut their economic links to Russia or to leave CIS FTA. Moreover Europe is interested in further development of those links as they are mutually beneficial;
     
  3. The DCFTA in its current form  does not allow any of three countries to join Russia-sponsored EACU 6 because in such a case EU should start FTA negotiations with the entire CU, while the EU is not ready for that;
     
  4. Europe wants to avoid any tensions with Russia and is ready to postpone the de facto validation of the DCFTA until technical discussions with Russia can take place.

In Conclusion

This overview of the likely consequences of Ukraine’s, Moldova’s, and Georgia’s signing of the AA/DCFTA suggests that there are few if any reasons for Russia to worry about an immediate negative impact on trade and economic interests. In the future, some such concerns may emerge, but they can be easily identified and quantified based on existing customs data and international practice. Moreover, even if such concerns do emerge they can be dealt with on the basis of political good will. The Russian government’s position on potential trade disputes with Ukraine, Moldova and Georgia is more likely to reflect concerns about the loss of geopolitical influence rather than trade and economic relations. Hopefully, even a partial settlement of the conflict in Eastern Ukraine will lead to a less charged atmosphere surrounding the issue of former Soviet satellites’ ties with the European Union. Comments by some Russian officials already suggest that over time, this could lead to a more measured and pragmatic conversation about trade relations with Russia, which will remains a very important partner for its neighbors for a long time.

Sergei Aleksashenko, the former deputy chairman of the Russian Central Bank, is a visiting fellow at Georgetown University.

Notes

1 Before the Vilnius summit had Ukraine started talks on joining the EACU as an observer. However, it was mostly interested in obtaining lower gas prices which Russia promised for full members of the CU.

2 For example Ukraine will need to increase its import tariffs as EACU-agreed level which is less open that that agreed by Ukraine and WTO. If this happens Ukraine would need to pay compensations to other WTO members negatively affected by such changes.

3 Article 37 of DCFTA.

4 Annex 6 to the Agreement on the Free Trade Zone from October 18, 2011. "If one of the parties involved in the agreement specified in Paragraph 1 of Article 18 leads to an increase in imports in such quantities that damage or threaten to cause injury to an industry of the Customs Union, the states—members of the Customs Union, without prejudice to the application of Articles 8 and 9 of this Agreement, following appropriate consultations, reserve the right to impose duties on imports of the products of such first Party in the amount of MFN rates."

5 Today, citizens of Ukraine can come to Russia on an internal passport instead of an international one. Additionally, citizens of Ukraine may stay up to three months in Russia without registration. Citizens of other countries must register within one month.

6 Armenia was going to be the fourth country to sign a AA/DCFTA but opted to join EACU in October 2013.

By:
  • Sergei Aleksashenko