Can Ukraine's Economy Grow While Shackled to a Comatose Europe?

December 26, 2012
Anthony T. Salvia
Director, American Institute in Ukraine

Prime Minister Azarov has given his new Minister of Economic Development and Trade -- Ihor Prasolov -- the unenviable task of raising Ukraine's year-on-year growth rate to 3-3.5% (from its current level of -1.3%.)

The Prime Minister did not make Mr. Prasolov's task any easier when he announced that signature of the Deep and Comprehensive Free Trade Agreement with the European Union was a priority for his government. He said the government would consider signing on to the Moscow-backed Customs Union at some unspecified later date.

This is problematic.

For one thing, the EU insists the FTA and the CU are mutually exclusive. It recently put one of its myriad of faceless officials before the cameras -- in this instance a certain Elmar Brok -- to make that very point: Ukraine cannot join both organizations. Brussels (or, at any rate, Mr. Brok) is insisting Kiev do what President Yanukovich has been at pains to avoid doing since he assumed office -- choose definitively between Brussels (clearly a placeholder for Washington) and Moscow.

For another, Russia is growing at 3% per annum, compared to the Eurozone's -0.6% rate of growth making the prospect of unimpeded access to a growing market of 140 million people attractive to Ukrainian businessmen.

Russia's sovereign debt as a percentage of GDP is a mere 9%, compared to the EU's 87.3% (and the USA's disastrous 103%). There is a connection between Russia's relatively robust growth and its low rate of indebtedness, just as there is between Europe's negative growth rate and its large debt burden.

In addition, Russian inflation is running at 6.5% while Russian banks are paying 8.25% on savings accounts -- meaning Russians have a fighting chance of coming out ahead, and building up their savings and purchasing power. That is good for Ukrainian businesses eager to export to Russia.

Inflation in the Eurozone, meanwhile, is running at 2.2% -- considerably higher than the prevailing interest rate on savings accounts of a mere 0.75%. The European Central Bank is keeping rates low in order to stimulate the continent's comatose economy (an exercise in futility, it would appear, but hope springs eternal). More to the point, the ECB's efforts to stimulate inflation by holding down interest rates is plundering Europeans on fixed incomes -- the elderly, the poor, students, and pensioners are especially hard hit -- as interest rates lag behind with inflation.

Thus, Europeans are hardly in a position to import Ukrainian goods, even if there were Ukrainian goods they wanted to buy (which is by no means clear).

Viktor Suslov, a former Economics Minister of Ukraine, said in an interview with Segodnya.UA that Europe offers Ukraine no reliable market for its exports.

"Trade relations indicate that the import share from the CIS is about 50%, while from the EU it is only 23%," he said. "We can sell higher-technology products only to the countries of the Customs Union, in particular manufactured goods. We must understand that the EU does not offer a niche for Ukrainian products. We are not competitive."

"We produce aircraft engines and export them to Russia, but the EU does not need them. In the shipbuilding industry, we used to manufacture surface vessels, but we are losing that niche as Russia is now importing such vessels from the EU. All enterprises of the military-industrial complex -- this is a Russia-based market," said Mr Suslov.

"If we join the Customs Union, energy prices will be the same as on the Russian internal market, not the European one," says Suslov.

Thus, Ukraine would get out from under onerous IMF demands that it reduce Naftogaz's vast operating deficit by raising the rates it charges to Ukrainian homes and businesses.

Suslov goes on the observe: "According to data of the Institute of Economics and Forecasting of the National Academy of Sciences of Ukraine chaired by Valeriy Geyets, exports would grow by 10% if Ukraine were to the Customs Union. And if Ukraine establishes an FTA with the EU, our GDP would fall by 1.28% by 2015 and by 9.94% by 2030."

"It is clear that the Customs Union will bring more benefits to Ukraine. This will help the country to develop high-tech industries. And the economic situation will improve as a result of lower gas price. We need to understand our place on the geopolitical map," according to Suslov.

In insisting that Ukraine spurn Russia, the EU's aforementioned Mr. Elmar Brok says Ukraine must give precedence to its long-term interests over short-term benefits. In other words: never mind if no benefits flow from the FTA; thwarting Russia is reward enough.

But most Ukrainians disagree. They prefer tangible benefits to renewed tensions with Russia. Consider some recent polling results:

According to a survey conducted by the Social Monitoring Center in 24 regions of Ukraine on December 5-15, 2012, 46% of Ukrainians support the country's accession to the Customs Union while 35% of respondents think that Ukraine should sign on to the FTA. Nineteen percent were undecided.

Among those who have made up their minds on the issue, 57% support joining the Customs Union; 43% say Ukraine should sign the FTA.

Similarly, Kiev-based Research & Branding conducted a survey entitled -- "Which Corresponds More to the Interests of Ukraine: the EU or the CU?"

It shows that support for the EU has declined from 37% in 2011 to 33% in 2012, whereas support fro the CU has grown from 36% to 39% in 2012.

It is clear that the European Union's insistence on the mutual exclusivity of the FTA and the CU stems not from economics but from geopolitics. That seemed to be the import of Russian Foreign Minister Sergei Lavrov's recent sharp response to Mr. Brok's remarks. He pointed out that the CU and the FTA are fundamentally compatible as both countries are members of the WTO and adhere to its rules and regulations. Prime Minister Azarov has staked out a similar position.

The EU sees it otherwise, at least for now. Brussels's efforts to steer Ukraine away from the Customs Union is clearly influenced by outgoing US Secretary of State Hillary Clinton's recent declaration that the US, as a matter of policy, seeks to thwart Moscow's plans to forge a common Eurasian Economic Space of which the CU is the foundation. Let's hope Senator John Kerry, recently nominated to replace Mrs. Clinton, reverses her position, which has nothing to do with American national interests -- and in many respects contradicts them. But that is a subject for another time.