Iana Dreyer of borderlex.eu -

Ahead of a regional summit in Belarus this week where the situation in Ukraine was a major focus, German Chancellor Angela Merkel provoked controversy by saying she wouldn’t raise objections if Ukraine decided to join the rival Russian-led Eurasian Economic Union (EEU) instead of the EU. Some commentators in Europe took this as an indication of wavering German support for Ukraine’s cause, but in fact she was only saying the EU would respect any Ukrainian choice if it was "a voluntary decision".

There is no sign of the EU backtracking on its commitments to Ukraine and the yet-to-be ratified free trade and association pact with the EU that the two sides agreed in June. But an understanding on specific implementation matters between Ukraine, Russia and the EU to address Russian concerns over its future exports to Ukraine is possible. A contour for a deal is in the making, but the EU and Ukraine want Russia to accept that there will be no changes to the Association Agreement text.

The "EU Association Agreement vs Eurasian Economic Union" debate lies at the heart of the crisis in Ukraine. Since 2008, the EU had been negotiating closer ties with Ukraine that involve the wide-ranging free trade deal known as the Deep and Comprehensive Free Trade Area (DCFTA). However, Russia wants Ukraine to join its Customs Union, a rival trade bloc with Kazakhstan and Belarus that will deepen into the EEU from 2016, perhaps with other members like Kyrgyzstan and Armenia.   

Moscow has raised many trade-related objections to the DCFTA and threatened to terminate a 2011 free trade deal with Ukraine. In order to avoid a trade war after Moscow banned Ukrainian dairy products and potatoes this spring, Brussels, Kyiv and Moscow have been holding trilateral talks on how to monitor and manage potential negative consequences of the EU trade deal for Russia’s economy.

Russia’s main argument so far has been that with the DCFTA, cheap EU products could enter Russia via Ukraine. That argument does not stand up to scrutiny. Now Russia is asking that the DCFTA delay the phase-out of Ukrainian tariffs. Russia also fears that it will be left out of the domestic Ukrainian market after Ukraine starts introducing EU technical and sanitary standards into its home legislation as is required by the DCFTA.

Ukraine and Russia trade a lot with each other. Russia accounts for a third of Ukrainian imports and a quarter of its exports. Russia’s main exports to Ukraine are energy-related: gas and nuclear equipment. Ukraine accounts for about 5% of Russia’s trade and is its biggest trading partner in the former Soviet Union.

Incompatibility

Now let’s presume Ukraine wanted to take up the EU’s Association Agreement and its DCFTA, while at the same time enjoy free trade with Russia as part of its EEU. Would that be possible?

Members of a customs union apply the same tariffs on imports of goods from the outside world and delegate their tariff negotiating authority to the customs union authority. In contrast, "straight" free trade agreements (FTAs) allow member countries to make arrangements with third countries as they see fit, provided basic World Trade Organization guidelines are respected. If Ukraine joined the EEU, it would need to renounce its free trade deal with the EU. Alternatively, the EU’s free trade deal with Ukraine would need to be transformed into an FTA with the EEU – an unlikely prospect.

Both the Association Agreement and the EEU are not only about border tariffs. The EU-Ukraine trade deal has Ukraine apply a certain number of EU laws that also apply to the EU’s single market. The DCFTA liberalises a certain number of service sectors, opens Ukraine up for investment, and enjoins Ukraine to apply EU competition rules and intellectual property rights, among many other things.

Most importantly, a selected number of Ukrainian industrial product standards need to be changed. The text requires Ukraine explicitly to phase out its Soviet-era so-called GOST standards. Yet it formally only requires Ukraine to adopt 27 EU-specific industrial product directives, says Michael Emerson, senior associate fellow at the Centre for European Policy Studies (CEPS).

The text also requires Ukraine to “approximate its sanitary and phytosanitary and animal welfare legislation to that of the EU”. The list of items to cover in this field is rather comprehensive, however Ukraine is responsible for drafting the implementation strategy.

In return for aligning some of its domestic legislation to the EU’s, the deal opens the door for Ukrainian agricultural and industrial exports produced according to EU norms to be treated exactly like EU products produced in the EU. Put simply: parts of Ukrainian industry would then become part of the EU single market.

Flexibility

Although the Ukraine DCFTA deal does not explicitly prohibit Ukraine from importing goods that do not match EU standards, in practice some Russian exports could lose access to Ukraine’s domestic market. However, nothing can stop Ukrainian industries from setting up or keeping open their production lines to sell to the Russian market according to Russians standards, and Russian inputs could still be used for these supply chains.

The actual impact on Ukrainian-Russian trade on the whole standards issue is hard to establish. Russia has been modernising its technical standards, and about half of them are similar to those applied in the EU. What is more, product standards for military equipment, a mainstay of Russian-Ukraine industrial trade, are not covered by the EU-Ukraine DCFTA.

Finally, there is the question of Ukraine’s domestic non-economic legislation more generally (justice, labour laws, environmental laws, etc). The EEU sees itself as a political union. Whereas its final body of laws is unclear, and currently rudimentary compared to the EU’s heavy rule-book, a chunk of which Ukraine will be asked to apply, presumably EEU law would take precedence over Ukrainian law. For this reason Ukrainian membership in the EEU is problematic if Ukraine also decides to implement EU laws.

This issue throws up the whole question of Russia’s future trade relationship with the EU. Plans for a Common Economic Space between Russia and the EU launched a decade ago have been put on hold. If such talks were to be revived, a great deal of uncertainties over Ukraine could be addressed at the same time, especially those concerning industrial and sanitary standards. But the prospects for such an agreement are currently dim.

There certainly could be a flexible arrangement that would allow Ukraine to maximise its trading relationships with both the EU and the EEU. If Ukraine wants to maintain its Association Agreement with the EU, there is no reason to believe the EU would oppose Ukraine making trade arrangements with Russia. Certainly nothing in the Association Agreement prohibits Ukraine from doing so.

But some arrangements are technically not feasible or a political "no-go" area for the EU and Ukraine. Technically, Ukraine cannot be in a customs union and have a separate free trade deal with the EU. Also Ukraine has signed up to specific laws in the DCFTA which it must comply with. This is not compatible with being a member of the EEU. In current trilateral discussions, there is also no question of changing the letter of the EU agreement, even though Russia appears to be asking for this.

Yet a deal could be in sight. EU Commissioner for Trade Karel De Gucht on his return from the Minsk summit stated that the EU and Ukraine were willing to consider longer phase-in periods for Ukraine to adopt EU standards, and also consider a deal by which certain Russian product standards would be recognised as equivalent to the EU ones implemented by Ukraine. The question is whether Russia will accept this deal. If not, Russia would probably get nothing, but Ukraine might be exposed to further trade retaliation.

Iana Dreyer is Editor of borderlex.eu