Russia: the 'Maleficent' to Ukraine's Sleeping Beauty?

Sounding a bit like the bad fairy at Sleeping Beauty's christening, Russian leaders are dampening the festive mood over Ukraine's signing of a trade agreement with the European Union today to warn darkly that it will lead to "serious consequences."

Those consequences could be painful for Ukraine, at least in the short term, experts say.

Until now Ukraine has enjoyed free trade with Russia, an arrangement Russian leaders say could be terminated once it starts integrating with Europe's free-trade zone and adapting its market to European regulations and standards.

Signing the EU deal is Ukraine's sovereign right, President Vladimir Putin's spokesman Dmitry Peskov told journalists Friday. But "the Russian side will take measures if the implementation of these agreements will have negative consequences on the Russian markets."

Russia is Ukraine's single biggest trading partner, and Russia is the destination for about a quarter of its exports. Some of Ukraine's produce might find alternative markets under the expanded duty-free access offered by the new association deal. But much of Ukraine's heavy industry, especially the mainly eastern-Ukrainian factories producing heavy machinery, rolling stock, and military hardware, may be hard hit if Russia raises tariff walls.

Alexei Vedev, an economist with the liberal Gaidar Institute in Moscow, says it will be extremely hard for Ukraine to retool and reorient most of these industries to compete in European markets. Even Ukraine's agricultural goods, which are of high quality and have always found ready customers in Russia, may not fare well in the crowded and fiercely competitive markets of Europe.

"It seems to me Ukraine is winning a lot of theoretical advantages by moving to integrate with the EU, but it will be extremely difficult to realize them," he says. Due to all the political acrimony between Moscow and Kiev, it seems all but certain that Russia will retaliate by canceling all of Ukraine's free trade arrangements with Russia, he adds.

"This is not about Russia being spiteful, it's just economic imperatives," says Alexander Domrin, a professor at Moscow's Higher School of Economics. "We will have to protect our own market."

Goods from the EU are subject to Russian customs duties, and Ukraine can't be allowed to become a conduit for duty-free European imports into Russia, he says. In practice, Russia might just start to regard all Ukrainian produce as European, and slap tariffs on it.

"You cannot be in two different free-trade areas simultaneously," Mr. Domrin says. "They are separate, have different rules and standards, and it will generate problems – even if there weren't any political tensions."

Kiev has tried to remain optimistic about future relations with Russia. Earlier this week Ukrainian Foreign Minister Pavlo Klimkin told journalists that he expects Ukraine's association agreement with the EU would have a positive impact on economic ties with Russia. He added that Kiev has agreed to "consult" with Moscow over Russia-related aspects of the accord's implementation.

Ukraine, which is dependent on Russia for over half its energy supplies, is already locked in a desperate struggle with the Russian gas giant Gazprom over the price of Russian gas.

Russia has cancelled the politically motivated discounts it offered to former Ukrainian President Viktor Yanukovych, and now insists that Ukraine must pay the European average price of around $385 per thousand cubic meters of Russian gas.

Ukraine has already been forced to raise the domestic price of gas by 50 percent, and more increases are expected. But that has tough implications for several Soviet-era Ukrainian industries, including steel and chemicals, which have been able to remain competitive largely thanks to heavily-subsidized energy inputs.

The most heavily affected industries are located in Ukraine's restive east, where polls show that trust in the Kiev government is already low. Any harsh economic pain could lead to fresh political unrest, regardless of whether the current insurrection in the far-eastern regions of Donetsk and Luhansk is pacified in coming weeks.

The economic fallout from months of civil strife in eastern Ukraine may be hard to calculate, but there is little doubt that it is dire. The United Nations High Commission for Refugees issued a report Friday that estimates almost 200,000 people in eastern Ukraine have been driven from their homes by the turmoil over recent months. According to the report, about 54,000 have been displaced within Ukraine, while a further 110,000 have fled to Russia.

A ceasefire ordered by Ukrainian President Petro Poroshenko a week ago is slated to expire at the end of Friday. Both Mr. Putin and Mr. Poroshenko have called for that truce to be extended.

"Ukraine should embark on the path of peace, dialogue and accord. The priority is to conduct substantial talks between the authorities in Kiev and the south-east," the official ITAR-Tass agency quoted Putin as saying Friday.