Ukraine’s Post 2022 Annexation Trade & Development Prospects

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Ukraine Trade Analysis by Chris Devonshire-Ellis

What will happen if Kiev returns to Russia’s sphere of influence? Will the CIS, EAEU and Belt & Road become the new Ukrainian trade partners and what could happen with EU trade arrangements? Or will Moscow, Brussels, and Washington usher in a new trade war? We answer the tough questions.

With Russian troops now in Ukraine along several corridors and now close to Kiev, it seems possible the entire country will fall into Moscow’s hands and its Government be deposed. Whether that happens speedily or not is the issue, however it is distinctly possible if Russia continues its current aggression.

What will then happen to Ukraine in terms of trade and supply chains if a pro-Russian government is then installed?

De-Militarization

The first objective, and the issue that created this conflict in the first place, is to evaluate the extent of serious US and European supplied weapons in Ukraine and to secure these. Second, the country is awash with small arms and the new Government will also want to see these secured. It was telling last week that the Ukrainian President advised citizens to go shopping for weapons in Kiev’s weapons and ammunition shops – as if this is a normal facility to have in a European capital city.

A public amnesty is likely to be put in place to have the population at large return acquired weapons, while searches will take place for hidden weapons dumps. This will take time, probably with sporadic outbursts of violence.

EU borders will be closed for awhile and border surveillance stepped up to prevent the further smuggling of weapons from Eastern Europe, which has been going on for several years now. The Belarus President Lukashenko, during the attempted Belarus coup warned of the amount of weapons being smuggled into Belarus from the Ukrainian border to support the Belarus uprising in 2020. The EU has also said it will now provide weapons to Ukraine, although this would presumably stop if Russia wins. In any event, a small arms clean up would be introduced.

US / NATO Military Intervention

NATO will not send obvious troops as Ukraine is not a NATO member. It is possible that covert military personnel are already in situ and others could join them, although Moscow will be keeping a keen eye out for that. The UK has already said it will permit mercenary militia into Ukraine to fight against the Russians. Russia meanwhile has been approaching the Wagner Group to do the same. Ukraine could descend into a proxy war fought by employed mercenaries from the West and Russia.

Back in Washington, US military hawks, bruised by their spectacular failings in Afghanistan six months ago will be talking up the need to engage. It won’t happen. As US President Joe Biden said just last week ‘When American and Russian troops start shooting at each other, we have a World War.” The EU would also baulk at military engagement against Russia in a non-EU country. One can expect plenty of fiery rhetoric, but the United States military will remain stood down. Anything more would create WW3. However, a forgotten and potentially dangerous other conflict is also brewing in the Balkans over Serbia. Kosovo has requested immediate membership of the EU, and if that breaks out into war, without Russian assistance to suppress violence the EU could find it difficult to cope.

Ukraine’s Trade Demographics

Ukraine has a population of about 41 million, and a GDP of US$622 billion. Nominal per capita GDP is about US$4,958.

Ukraine’s main exports are raw materials such as iron, steel, mining products, agricultural products and chemicals with a need for added value to be developed in the country. Its main export markets are China, Poland, Russia, Germany, Turkey, India, Italy, Netherlands, Egypt, Belarus, and Hungary  responsible for a combined 57% of all exports. Exports from Ukraine to the United States make up just 2% of the Ukrainian total.

In terms of imports, the main sectors are refined petroleum, automobiles,  packaged medicines, coal, and petroleum gas, mostly from China, Russia, Germany, Poland and Belarus. According to the Observatory of Economic Complexity (OEC) Ukraine is also the world’s largest importer of used clothing, indicative of its low income base.

Resumption Of Trade And With Whom

Potential US / EU sanctions on Ukraine

It is entirely possible that under a pro-Russian government, the United States, followed by the EU, imposes sanctions on all of Ukraine.

EU-Ukraine Trade

Much depends here on any US and EU decision over imposing sanctions on Ukraine trade. According to the EU trade commission, EU-Ukraine bilateral trade stood at €43.3 billion, with the EU exporting about €24.2 billion in 2019. The main EU exports to Ukraine include machinery and transport equipment, chemicals, and manufactured goods. Ukraine will also suffer shortages, as the EU markets comprise about 40% of Ukrainian overall trade. Ukraine exported €19.1 billon to the EU in 2019. The main Ukraine exports are raw materials (iron, steel, mining products, agricultural products), chemical products and machinery. The EU enjoys a trade surplus with Ukraine of about €5 billion, or slightly more than 10% of Ukraine’s total bilateral trade volumes.

This trade corridor increased significantly to its current status from 2016, when the two entities signed a ‘Deep & Comprehensive Free Trade Agreement‘ (DCFTA) following Ukraine’s rejection of the Commonwealth of Independent States (CIS) in 2014 and complete withdrawal in 2016, when the EU deal was signed instead. The loss of trade caused by withdrawing from the CIS was intended to be counterbalanced by trade with the EU.

According to the European Commission, since 2018, Ukrainian exports to the EU actually fell by US$1 billion to €16.5 billion in 2020 while EU exports to Ukraine grew by US$2 billion to €23.1 billion, with the balance in the EU’s not Ukraine’s favour. As Ukraine’s GDP growth during this period has been slow, the implication is that the EU has done rather better from the DCFTA than Ukraine has. Coming from a lower economic base, Ukraine’s GDP and export growth should have been far higher.

The Commonwealth Of Independent States

The CIS comprises Armenia, Azerbaijan, Belarus, Georgia, Kazakhstan, Kyrgyzstan, Moldova, Russia, Tajikistan, Turkmenistan, Ukraine, and Uzbekistan. Today, the CIS has a GDP of about US$5.5 trillion and a nominal per capita GDP of US$7,732. That compares with Ukraine’s current nominal GDP per capita of US$4,958. A return of Ukraine to the CIS bloc would almost certainly occur, the timing depending upon any moves by the EU to impose sanctions and any discontinuation of the EU-Ukraine DCFTA.

According to data from the IMF’s World Economic Outlook, Ukraine’s nominal GDP per capita is lower than both the CIS average and that of neighboring EU States Poland (US$19,056), Slovakia (US$21,528), Hungary (US$18,527), and Romania (US$16,293). Western Russia’s nominal GDP per capita is about US$18,750, while that of neighbouring Belarus to the north is also higher at US$6,133, meaning that Ukraine is a poor relative of all. Proposed EU membership was supposed to raise Ukraine to the same level as other bordering EU member states, however it has been overtaken in growth rates by the trade bloc it left behind – the CIS.

Ukraine’s GDP growth rate since the EU DCFTA was signed in 2016 has also been low. These figures are from the World Bank:

Ukraine GDP Growth       Rate 
2016                                   2.2%
2017                                   2.5%
2018                                   3.4%
2019                                   3.2%
2020                                  -4.0%
2021                                   3.2%

In fact, they mirror the GDP growth of the EU over the same period, and are similar to neighbouring Belarus, suggesting that minimal benefit has been achieved for Ukraine by aligning itself with the EU for the past six years.

We can compare this with the CIS as follows, with data from Statistica:

CIS GDP Growth              Rate 
2016                                   2.8%
2017                                   3.6%
2018                                   4.8%
2019                                   2.2%
2020                                  -3.8%
2021                                   2.5%

The implication is that Ukraine would have had an overall 6% higher GDP growth rate over the past six years had it remained a trade partner with the CIS rather than the EU; and that EU trade with Ukraine has thus far failed to deliver to expectations.

The Eurasian Economic Union

The Eurasian Economic Union (EAEU) is a free trade bloc comprising five of the CIS nations: Armenia, Belarus, Kazakhstan, Kyrgyzstan and Russia. Geographically, it fills a space between Western China and the Eastern EU, offering transit benefits along the various BRI rail and related connections that Ukraine is not currently party too. and which are worth billions of dollars each year in transit fees. The EAEU has been active in recent years and has current Free Trade Agreements in place with Iran, Serbia, Singapore, and Vietnam, and is holding negotiations over FTA with several other ASEAN nations, China, Egypt, India and South Korea among several others.

Intra-EAEU trade grew by 33% in H1 2021 with 2022 looking to duplicate high trade volumes.

Ukraine has never been a member of the EAEU however it would make sense in time for it to be so. The bloc has a GDP of US$5 trillion and a market population of 187 million. At present, it flies somewhat under the radar as a trade bloc in Western minds, however when outstanding FTA are agreed it will become a significant Eastern trade bloc.

Cooperation Between The EU, And CIS / EAEU Members

Ukraine need not necessarily have to chose between these, although this depends upon the political attitude taken by Washington and its influence upon Brussels. If the EU imposes sanctions then Ukraine will look towards the CIS and EAEU as alternatives.

But if they can maintain trade agreements then the Ukrainian people will continue to enjoy access to EU markets and vice-versa. That could be augmented with trade ties to the East with the CIS and EAEU.

There is precedent: Uzbekistan is a member of the CIS and has signed recent trade agreements with the UK and the EU.

Armenia is also a member of both the CIS and the EAEU yet still benefits from the EU’s Generalised Scheme of Preferences plus (GSP+) trading initiative. This offers Armenian exports advantageous access to the EU market by allowing complete duty suspension across approximately 66% of all EU tariff lines. More than 96% of EU imports eligible for GSP+ preferences from Armenia entered the EU with zero duties in 2017. The EU is Armenia’s biggest export market, trade with the EU accounts for around 26.7% of Armenia’s total trade.

The EU then has its own political decision to make. Does it continue to trade with Ukraine – as there is precedence for it to do so, even if it should join the CIS or EAEU. On the other hand, should it impose sanctions? These are questions that Brussels will need to address.

Ukraine Reconstruction: The Crimea Precedent

A flawed political process from Kiev that has marginalized the Russian-speaking population of Ukraine has resulted in uneven national development, leading to resentment, economic stagnation, a lack of investment from Kiev, and especially in the Eastern Donbas regions, a similar situation to pro-Russian Crimea pre the 2014 annexation of the Peninsula.

The Crimea situation has meant that funding to redevelop neglected and antiquated infrastructure that existed in Crimea at the time has been undertaken by Moscow, resulting in the construction of Europe’s longest sea bridge and numerous other infrastructure improvements including both hard developments such as road, rail and ports, and soft infrastructure such as telecommunications and related IT connectivity. In fact Crimea became Russia’s fastest growing regional economy by 2019. Russia’s “Federal Target Program for the Development of the Republic of Crimea” released in 2015 estimated a budget expense of US$15.3 billion to 2022 to redevelop the region.

That has manifested itself through a construction and manufacturing boom. According to the Russian Federal State Statistics Service (Rosstat) the Crimean capital city of Sevastopol’s construction sector expanded by 70.9% in Q1 2019, while Crimea’s regionally grew 20.7%. Manufacturing output in Crimea grew by 20.2%. Crimea has also experienced a boom in tourism from Russia.

A similar exercise can be expected in Ukraine, and especially the civil war ravaged regions of the Donbas close to Russia’s borders, which have endured violence and unrest for the past eight years. Moscow will be keen to see these urgently repaired and refugees who fled the fighting return home.

Ukraine – Belt And Road Infrastructure Assistance

This should spark a redevelopment and investment phase into Ukraine, which will manifest itself, in China’s Belt and Road Initiative style, by repairing old infrastructure, creating new builds and upgrades, especially at Ukraine’s seaports, and installing new technological upgrades throughout the country, including Kiev. China is certain to be an interested BRI partner for Ukraine – it signed off agreements to help Ukraine develop road, rail, and other infrastructure developments on June 30 last year. Ukraine is a member of the Belt and Road Initiative, and Chinese investors have been putting in US$2 billion per annum the past three years to help develop supply chains and ease congestions. However, Kiev has proven an unreliable partner, although a Russian-backed Ukrainian administration will resolve this.

Summary

Ukraine under the Eurasian Economic Union and CIS trade and free trade membership would seem to be able to perform better economically than its current trade status with the EU. It would reposition it as an export market able to reach West (if the EU continues to permit this) and East, where more significant GDP and trade growth is expected to be during the course of the next two decades.

Russia will be keen to show off to both Washington, Brussels and Beijing that it is more than capable of looking after what it regards as its sphere of influence. With Russia’s significant financial reserves and oil and gas clout, it is well able to absorb Ukraine, and even more so as reconstruction fits in exactly with Beijing’s BRI remit and its desire to construct supply chain routes to and from Europe. Ukraine thus far has not benefited from this connectivity. Under Moscow, it will.

The main issue of how quickly the Ukrainian economy can recover lies ironically with the EU. Will Brussels eventually accept the new normal and engage, or will it revert, Washington-style, into a Cold War negativity and seek to deny Ukraine any leeway of returning to Moscow’s orbit.

The Ukrainian people deserve to have the door left open, rather than shut. The trade and supply chain issue is now placed firmly on Brussels doorstep as to what happens next. Whether Brussels and the US wish to keep the trade relationship door open to the Ukrainian people under the governance of Russia could become a complex geopolitical and moral issue very soon.

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Russia Briefing is written by Dezan Shira & Associates. The firm has 28 offices throughout Eurasia, including China, Russia, India, and the ASEAN nations, assisting foreign investors into the Eurasian region. Please contact Maria Kotova at russia@dezshira.com for Russian investment advisory or assistance with market intelligence, legal, tax and compliance issues throughout Asia.

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