The Association Agreement Is Not the Answer to Ukraine’s Problems

October 10, 2013
Anthony T. Salvia
Director, American Institute in Ukraine

Just when you thought the drama over Ukraine’s euro-integration, including the Julia saga, could not get any weirder, along comes Prime Minister Azarov to announce that complying with the Association Agreement’s regulatory demands will cost Ukraine 165 billion euros over 10 years. That is the equivalent of Ukraine’s entire Gross Domestic Product (GDP) for one year!

And this in a country that is the poorest in Europe save for Moldavia, has seen Direct Foreign Investment plummet by 53% in 2013 (year on year), and whose foreign exchange reserves have been declining precipitously for the past two years.

London-based Capital Economics said in a July 2013 note to investors: “The slump in Ukrainian FX reserves serves as a reminder that Ukraine’s fragile external position continues to keep it one step away from a full-blown balance of payments crisis.”

The Financial Times (September 26, 2013) have sounded a similar theme: “Just as the country gets closer to signing an economic and political pact with the EU, investors have got the jitters about its creditworthiness.”

Few emerging market countries carry as much short-term external debt relative to foreign exchange reserves as Ukraine. Over the past year, FX reserves have declined by 7.4 % to $22.7 billion. According to Moody’s, the US-based ratings agency, Ukraine has enough FX reserves to pay for just 2.3 months of imports – the lowest level since 2006.

That is why foreign holders of Ukrainian debt are increasingly hedging their bets on Ukraine’s creditworthiness, recently bidding up Credit Default Swaps (CDS) on the hryvnia to a three-year high.

Thus, Ukraine faces a scenario of possible default (for a variety of reasons we cannot explore here), the assumption of massive levels of indebtedness to comply with the demands of the Association Agreement, and the possible collapse of its traditional export markets in the CIS as Ukraine places itself definitively outside of the Customs Union’s tariff wall. And with winter approaching, it will need to increase its importation of oil and gas.

Having rejected Russia’s offer of sharply reduced energy prices and the elimination of gas import fees (in exchange for joining the Customs Union), and facing the prospect – in the event of default -- of sharply higher borrowing costs in global credit markets, the Azarov government seems strangely insouciant as to where it expects to raise the money to comply with thousands of pages of often daffy European regulations. It certainly will not get the money from Europe, which is bankrupt, and can hardly turn to Moscow after having given the Kremlin the cold shoulder. It would be one thing if Ukraine could count on Europe to serve as a locomotive to pull the country out of its economic doldrums. But Europe itself is in chronic economic distress (British journalist James Delingpole calls the EU a “Soviet-style economic dead zone.”) In any case, it has no interest (unlike the countries of the Eurasian Customs Union) in anything Ukraine produces and has no tradition of buying in the Ukrainian market.

Ukraine’s elite appear willing to run the risk of associate status in the EU on the grounds this will somehow bolster Ukraine’s sovereignty. But surely they are not unaware that the very mission of the European Union is to curtail and eventually eliminate national sovereignty? Surely they know that the centralized, unaccountable Brussels technocracy has visited untold distress on counties from Britain to Bulgaria?

The nation’s elites are being egged on by Ukraine’s Western “partners” who care not a whit for Ukraine and its welfare, but only wish to use it as a pawn against Russia. These “partners” will not lift a finger to help as the cost of Ukraine’s compliance with the Association Agreement mounts. And they will be delighted if relations between Kiev and Moscow descend into acrimony and mutual recrimination – which was the whole point of the exercise from the beginning.

Prime Mnister Azarov’s assertion in an interview with Sovetskaya Belorussiya that Ukraine has the right to join theEurasian Customs Union as a full member even after having signed the Association Agreement with the EU offers Ukraine a tantalizing way out of its dilemma.

Ukraine does not need trade wars, and it is not in Ukraine’s national interest to find itself on the wrong side of a tariff wall with it largest trading partner, one which, unlike Europe, is not in negative growth, but is experiencing comparatively robust growth, and which has a tradition of buying Ukrainian manufactured and agricultural products.

Azarov is correct that Ukraine has every legal right to join the Eurasian Customs Union even as an associate member of the EU. It is granted by Article 39 of the Association Agreement, a fact he says the EU itself confirms.

Good. Then let Ukraine use Article 39 to its advantage. Membership of the Eurasian Custom Union – not just observer status – is the key to putting Ukraine on an even economic keel, giving real substance to Ukraine’s vocation as a bridge between east and west, and shoring up the president’s increasingly shaky political base in eastern and southern Ukraine.