Ukraine’s EU rejection harmful to business environment

kiev protests

Ukraine’s regrettable choice of rejecting the EU Association Agreement could prove particularly harmful for the country’s business environment and future economic development.

Ukraine’s back-pedalling is putting a stop to what has been one of the EU’s most important foreign policy initiatives over the past decades: a relentless determination to deepen ties with former Soviet Union Republics and lock them into a transition path based on Western economic and political templates.

On November 21st, Ukrainian President Viktor Yanukovych suspended negotiations for far-reaching political and free trade agreements with the European Union, due to be signed last week at the Vilnius Eastern Partnership Summit. According to Ukraine’s officials, Kiev’s turnaround resulted from national security and economic considerations. EU’s financial aid of 610 million euros was judged insufficient to compensate for the various economic losses resulting from the adaptation to EU standards and a stricter trade regime with Russia. On the other side, trade partnerships with Moscow proved more attractive, including promising deals such as $10 billion credit, cheap gas supply and debt rescheduling.

Ukraine’s financial and economic woes

With negative growth performance, large internal imbalances (a budget deficit around 8 percent and public debt 30 percent) as well as insufficient foreign currency reserves and heavy energy dependency, Ukraine’s economy is on the verge of bankruptcy, surviving almost exclusively on short-term loans. International credit rating agencies have recently downgraded the country’s long-term foreign debt (on par with Cyprus and Greece), pointing the government’s incapacity to secure enough foreign currency funding and to implement deep-reaching structural reforms.

Over the past few months, Russian President Vladimir Putin has engaged in a trade war with Kiev to dissuade the country from signing the EU Association deal. In mid-August, Moscow blocked almost all imports from Ukraine, cut energy deliveries and publicly threatened to drive Ukraine into default. Due to the Russian boycott, exports declined by 1.5 percent while the economy contracted by 1.5 percent, causing thousands of layoffs and more than $15 billion in lost trade.

Facing such hard political and economic pressures, President Yanukovych chose to slip back under the Kremlin’s control. As the Swedish foreign minister admitted, “Politics of brutal pressure evidently works.”

A missed opportunity for greater business attractiveness

Ukraine’s rejection of the EU deal will hamper the implementation of fundamental economic reforms in line with EU requirements and bring about both short-term and long-term detrimental consequences for businesses.

Several hours after the announcement Ukrainian President’s controversial decision, the cost of credit-default swaps to insure Ukrainian debt against non-payment soared. Ukraine’s sovereign ability to borrow to finance heavy external debt repayments and current twin-deficits will prove increasingly difficult. As a result, the country’s gross international reserves are expected to continue to fall, triggering strong devaluation pressures on the hryvnia. Ukraine ultimately “faces a real risk of full-blown economic and financial crisis.”

From a foreign direct investment (FDI) perspective, the EU deal “would have provided a unique opportunity to reverse the recent discouraging trend of decreasing foreign investment”, as the EU’s foreign policy chief Catherine Ashton said. As often occurs in former Soviet Union countries, threats of “raiderstvo” – the phenomenon of illegal and violent capture of corporate assets such as buildings, sites and societies – remain dramatically high in Ukraine. Such threats significantly undermine the country’s economic competitiveness and credibility as a destination for investment

Ukraine’s weak legal and regulatory frameworks (especially in terms of property rights protection and contract security) create incentives for MNCs to quickly repatriate their profits rather than reinvest them, which would expose them to political and economic uncertainty. FDI fails to participate in structural change and technology transfer. Lower value-added and labour intensive stages of production such as assembly are generally offshored here from elsewhere, while high value-added ones (R&D, conception, marketization) remain in the home country’s headquarters.

Indeed, over the past few decades, many former Soviet Union countries such as Ukraine and Romania have become privileged locations for low wage and low-skilled ‘sweatshop’ industries (including textiles, clothing and footwear). This type of ‘hypermobile’ capital does very little in helping firms and states to implement sustainable strategic coordination and generating industrial upgrading.

The long-term benefits from gaining access to the world’s largest single market would have significantly outweighed the negative impact of Russian sanctions, improving Ukraine’s economic standards and global competitiveness. Recent studies indicate that exports would have increased by 45 percent, while the country’s gross domestic product would have risen by 10 percent. In this sense, Mr Yanukovych’s volte-face shows a regrettable lack of long-term economic and political strategy.

A betrayal of public aspirations?

Although Yanukovych recently reaffirmed a pro-European line, saying that “Ukraine has been and will continue to pursue the path to European integration,” the government has so far refused to comply with public pro-EU aspirations. On November 24th, 100,000 people took to the streets of Kiev to force a change of mind in their government. This protest is reportedly the biggest demonstration since the 2004 Orange Revolution. A recent opinion poll conducted in November shows 58 percent of Ukrainians (and even 47 percent of Yanukovych’s party members) supporting a closer economic and political integration with the EU.

On December 1st, public contestation went a step further. Tens of thousands of pro-EU and anti-government demonstrators took to the streets to demand the resignation of the president and the organisation of anticipated elections. While calling for a national strike, they stormed and took control of Kiev’s city council, causing violent police crackdowns.

Ongoing protests reflect the determination of the Ukrainian civil society to put an end to Moscow’s historically heavy hand and tilt in earnest to the West. Political and social developments over the next few days will therefore be crucial in determining Ukraine’s future with the EU (and especially about the holding of a referendum).

Fortunately, another round of negotiation talks between Ukraine and the EU has been scheduled for March 2014. In the meantime, the EU is likely to open bilateral talks with Moscow, featuring an ultimate window of opportunity for Ukraine’s European course as well as a chance for the EU to correct ambiguities and flaws in regard to its neighbourhood policy.

More on Ukraine’s choice between East and West from GRI:

Ukraine balances energy needs and European aspirations

Ukraine Teeters Between the EU and Russia

Ukraine Moves Closer to Europe

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Categories: International, Politics

Author:Louise Meloy

Louise Meloy is a recent MSc Graduate in Political Economy of Europe from the London School of Economics and Political Science. Her MSc Dissertation provided a comparative analysis of the impact of political conditions (government effectiveness, state capacity, rule of law, level of perceived corruption…) on Foreign Direct Investment in Slovakia and Bulgaria, demonstrating the importance of good institutional bases in generating positive spillovers for host countries. She also holds a MSc in European Studies with Distinction from the Université Libre de Bruxelles and previously achieved her BA in Political Science and Sociology at Paris Dauphine University. Her areas of specific interest include the analysis of Political and Economic transitions in Western, Central and Eastern Countries as well as the study of Interest Groups and Economic Policy Making in the EU. Currently, she is working as an Intelligence intern at AKE Group, providing political and security risk research and analysis on European and Former Soviet Union Economies.

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