Ukraine sets course for Europe, but rough waters lie ahead

Though Ukraine signed a trade deal with the EU amid much fanfare, the accompanying reforms and regulations are sure to bring much short-term pain for the struggling country.

Last November, Ukraine was thrust into chaos after its then-president, under pressure from Moscow, rejected a European Union trade and association deal.

Now, seven months later, after losing Crimea to Russia and in the midst of a deadly conflict with pro-Moscow separatists in eastern Ukraine, the country’s new, Western-leaning President Petro Poroshenko has put a final signature on the deal.

Proponents say that in the long term, the deal will set Ukraine on a course for much needed economic and institutional reforms. But those potential long-term benefits will extract a more immediate, heavy cost from the former Soviet republic of 46 million people.

The deal is likely to provoke more tensions, both political and economic, with neighboring Russia, which Kiev accuses of trying to destabilize Ukraine in order to steer it away from Europe’s orbit.

“By signing this, Ukraine will make a clear statement that the country is Westernized and not oriented to Russia and the Customs Union,” says Timothy Ash, the head of emerging market research at Standard Bank in London.

Under the agreement, Ukraine and the EU will eliminate nearly all of their import and export tariffs, potentially making it easier for Ukrainian producers to reach deeper into the EU market. This will be significant for Ukraine; already, one quarter of all its exports go to Europe.

The European Commission in a statement said that "the deal is expected to boost Ukraine's income by around 1.2 billion euros [$1.6 billion] per year," behind an increase of 1 billion euros per year in Ukrainian exports to the EU.

The new markets won’t materialize instantly. The agreement includes thousands of regulations and standards that Ukrainian products will have to meet before they can be sold in the EU market – making the trade agreement "much more complicated ... in the short-term," says Jaba Devdariani, EASI-Hurford Next Generation Fellow at the Carnegie Endowment for International Peace.

Many of the necessary reforms and modernization requirements will be costly. Investment will be key to reviving Ukraine’s staggering economy, which even before the political crisis was looking at negative growth and possible default. 

Perhaps most significantly, Ukraine’s agreement with the EU will force it to create institutional reforms to improve the climate for businesses and potential investors. This will include establishing transparent government procurement procedures, and reducing Ukraine’s crippling and omnipresent corruption.  Judicial reform will be tantamount to Ukraine’s ability to ensure potential investors that their assets will be safe.

“The process here is the most important part of the deal,” Mr. Ash of Standard Bank says. “Ukraine has the opportunity and has shown its willingness to get rid of its Soviet past, which they never were able to do before.”

Retaliation from Russia?

But by signing the deal, Ukraine can expect to see retaliation from Russia, a long-time key trading partner.  Russian President Vladimir Putin had pressured Ukraine to become a member of its nascent Eurasia Union, which rejoins former Soviet partners Russia, Belarus, and Kazakhstan.

In fact, Ukraine has already felt Russia's economic wroth amid its crisis: Russia threw up barriers after opposition leaders gained control of Ukraine’s parliament when former President Victor Yanukovych, who rejected the EU deal in November, absconded in late February. And just two days ago, Russia said it was considering more trade barriers on Ukraine.

During the first quarter of 2014, Ukraine’s overall exports decreased by 30 percent, a hugely significant reduction for a country in which 50 percent of its gross domestic product is made up of exports, says Oleg Ustenko, the executive director of The Bleyzer Foundation in Kiev.

Still, any new Russian-imposed barriers to Ukraine’s exports might have little effect today, Mr. Ustenko says. “What they have already been able to impose, they have.  So we are already losing.”

But if Mr. Poroshenko’s commitment to joining his country with Europe is sincere, Ash says, the losses in trade with Russia could translate into new markets opening up for Ukrainian products meeting EU standards.

Ambivalence in Western Europe?

While the hard work of adopting difficult and expensive reforms will be left up to Ukraine’s new government to adopt – and the population to grin and bear – the former Soviet nation will need to attract European investors.

Russia’s annexation of Crimea in March and the unrest that followed in eastern Ukraine gave rise to the most unsettling East-West standoff since the Cold War. Suddenly, Ukraine emerged as a much bigger priority for the EU overall.

Before that time, many Europeans felt ambivalent about the Ukrainian deal, which will be signed Friday along with similar agreements with two other countries that Russia considers to be part of its “sphere of influence,” Georgia and Moldova.

While some EU nations, led by Poland, argued for the bloc to form closer alliances with Ukraine and post-Soviet nations, the bigger countries in Western Europe were skeptical. The prospect of Russia's reaction, as well as EU enlargement fatigue confounded by the European debt crisis, all played a role.

The bloc has disagreed over sanctions for Russia, on which it is heavily dependent for gas. But now the importance of a trade and association deal is largely considered a necessary step to make sure "Ukrainians do not waste another revolution," says Jan Techau, the director of Carnegie Europe in Brussels.

The best way Europe can counter Russia is not via sanctions or NATO, but by building a stable Ukraine, with rule of law and a healthy economy not run exclusively by oligarchs, he says.