Tuesday, September 30, 2014

Ukraine, Russia and the EU

President Vladimir Putin is skilled at exploiting the weakness of his opponents. During the Ukraine crisis he has at times appeared to follow the principle that Russia should take as much as it can get away with. Therefore the fragility of the Ukrainian state is troubling. Its problems were evident during the Yalta European Strategy (YES) conference that I attended recently. This annual event, run by Viktor Pinchuk, a liberal oligarch, used to take place in Crimea but has had to move to Kyiv. 

Eight months after then-president Viktor Yanukovych fled Kyiv, the Ukrainian state remains corrupt and unreformed. The politicians are divided over how to handle the Russians. The economy is shrinking and risks running out of energy. Most Ukrainians hope for closer ties to the EU – but in order to placate the Russians, the implementation of the EU-Ukraine trade agreement has been partially postponed. Meanwhile Russian propaganda that the EU provoked the crisis in Ukraine continues to resonate in many European countries.

President Petro Poroshenko and Prime Minister Arseniy Yatsenyuk both impressed the international audience at YES with their eloquence and good English (still unusual for Ukrainian politicians). Poroshenko comes over as a bluff, reassuring figure who is trying to forge compromises, and Yatsenyuk as a bright technocrat with a hard edge. Poroshenko is the optimist among Kyiv’s politicians, believing that the truce which began on September 5th (and is just about holding) and his negotiations with Putin can lead to a peace deal. A key provision of any settlement would be far-reaching autonomy for parts of the Donbass, and the Rada (Ukrainian parliament) has passed a law to allow this. Poroshenko insists that he will not compromise on Ukraine’s territorial integrity, and that Kyiv will remain responsible for the foreign policy and security of the Donbass. But he emphasises that there is no military solution to the conflict. Many Ukrainians want peace at any price and back Poroshenko.

But Yatsenyuk and opposition figures like Yulia Tymoshenko are more pessimistic. They worry that the Donbass is becoming an enclave controlled, de facto, by Russia, just like Transnistria, a slither of Moldova. And they fear that Putin has designs on more of Ukraine. Some think he wants a ‘land bridge’ to connect the Donbass and Crimea; others that he wants to take the entire southern coast, all the way to Transnistria. Yatsenyuk and Tymoshenko do not overtly criticise Poroshenko’s attempts to deal with Putin, but doubt that any peace can hold for long. Yatsenyuk recently allied with militia leaders to form a party that is distinct from that of the president. Freed from prison in February, Tymoshenko is trying to revive her flagging career by adopting a hard line on Russia. A lot of Ukrainians share her concern that Poroshenko will give away too much and think the country needs to prepare for more war. If Poroshenko signed a deal that gave away Ukrainian territory, he would have to contend with a revolutionary Maidan.

The politicians are also divided over membership of NATO, which Poroshenko opposes. Any deal with Putin would presumably include Ukraine’s neutrality. Until recently most Ukrainians did not want to join the alliance. But the Russian invasion has shifted public opinion, which is now 50-70 per cent in favour of joining NATO. Yatsenyuk and Tymoshenko want to join, but most Western governments tell them to drop the idea, fearing that it will deter Moscow from seeking a settlement.

All the prominent politicians hope the West will supply lethal weapons and adopt stronger sanctions against Russia. But they are unlikely to get either unless Russia grabs more territory. One former intelligence chief, Ihor Smeshko, told the YES conference that Ukraine should build its own nuclear weapons – it would only take a year, he said, since the country had the necessary expertise. Though few Ukrainians echo his views on atomic bombs, many share his bitterness over the failure of the US and the UK to enforce the 1994 ‘Budapest memorandum’ (by which Ukraine transferred Soviet nuclear weapons to Russia in return for having its territory guaranteed).

In private, some Ukrainian politicians say they would happily give away the Donbass, so that the rest of the country could prosper as a more pro-EU and coherent entity. The rationale is that the people in Donetsk and Luhansk differ from other easterners, such as those in Kharkiv or Dnipropetrovsk, in not wanting to be in Ukraine. But such radical ideas shock other Ukrainians, who say that if you let Putin take one part of the country, he will then ask for another.

The state remains very weak. Entrepreneurs and NGOs are critical of Yatsenyuk’s government for having reformed so little. They believe that he is reluctant to upset oligarchs – some of whom back him – or the public with painful structural reforms. Ukraine’s governance problems remain: an inefficient state, widespread corruption, including in the judiciary, and politicians who are too close to oligarchs. The current Rada contains many former supporters of Yanukovych and cannot be relied on to back reforms – in September it refused to pass anti-corruption measures. A number of senior officials and ministers are widely regarded as incompetent. 

But Yatsenyuk claims that the current IMF programme, the EU’s Deep and Comprehensive Free Trade Agreement (DCFTA) and the government’s own ‘action plan’ are all driving reform. Poroshenko says that after parliamentary elections on October 26th, the priority will be reform of the courts and the security sector. But reform will be very hard to achieve so long as the country remains on a war footing.

Poroshenko’s strongest argument for trying to forge a deal with the Russians is that the economy needs peace. It may shrink by as much as 10 per cent this year. Inflation is close to 20 per cent and the budget deficit nearly 10 per cent. The current account deficit, having contracted after a summer devaluation, is not widening. Many of the exports that normally go to Russia, such as farm goods and steel, are blocked (Russia still takes armaments). The latest figures from the EU, however, suggest that Ukrainian exports to the EU in May-June 2014, after the EU removed barriers to them, rose by 25 per cent, or €587 million, over the same period in 2013. This almost balanced the effect of Russia’s embargo, which resulted in a fall in exports to Russia of €592 million in the same period.

One positive story is agriculture, which provides about a third of total exports; the country is the world’s second biggest exporter of grain. Nevertheless the existing promises of Western help – $17 billion from the IMF, $14 billion from the EU and less than $250 million from the US – are far from sufficient to meet future needs. 

Energy shortages are undermining the economy’s prospects. Russia normally supplies about half of Ukraine’s gas needs but cut off supplies in June. Ukraine produces nearly half of what it consumes but is now running down stocks of stored gas. It had started to import Russian gas indirectly, via Austria, Hungary, Poland and Slovakia, but Gazprom recently reduced deliveries to those countries, which have now ceased re-exports to Ukraine. Hungary stopped the reverse flow, after a meeting between Prime Minister Viktor Orbán and Gazprom CEO Alexey Miller. Many power stations rely on coal from the Donbass but the war has disrupted supplies. Energy subsidies cost the state 7 per cent of GDP, compared to defence spending of just 1.5 per cent. These subsidies explain why Ukraine is among the world’s most inefficient users of energy. The government has started to make modest cuts to energy subsidies, to comply with IMF prescriptions.

Not all the news is gloomy in Kyiv. Civil society is strong and vibrant. Many NGOs act as a check on the corrupt elite, monitoring what it does. The press is free and there is real political competition, even though the parties are built around personalities rather than policies. The Russian invasion has created a feeling of national unity across much of the country, including in many Russian-speaking areas.

The current crisis began last November when Yanukovych – under Russian pressure – abandoned the DCFTA and a related Association Agreement that his government had negotiated with the EU. Popular protests triggered the president’s flight. When Poroshenko was elected he revived these EU agreements. However, after recent talks between Brussels, Moscow and Kyiv, Ukraine announced that it would postpone the implementation of its side of the DCFTA for 15 months – meaning that it will maintain tariffs on imports from the EU. For more than a year Russia has been arguing that the agreement would unleash floods of imports from the EU, damage Ukrainian industry and lead to the dumping of Ukrainian products on Russia’s market. That is unlikely; Russia’s real concern is probably that it does not want its exports to face competition in Ukraine’s market. In any case, Putin has threatened “immediate retaliatory measures” if Ukraine implements any part of the agreement.

The EU has fulfilled its side of the DCFTA by scrapping tariffs on imports from Ukraine. At the YES conference, Yatsenyuk put a positive spin on the postponement, saying that Ukrainian industry needed time to prepare for the chill winds of EU competition, and that reform would not be delayed. Opposition politicians, however, were in despair at this caving in to Russian pressure. They fear that Russia will use meetings of the ‘association council’ that governs EU-Ukraine relations to engineer the amendment of the agreements’ implementing protocols in its favour. 

The EU is keen for Poroshenko to strike a deal with Putin. Therefore, despite having imposed several rounds of sanctions on Russia, it is holding out olive branches – and not only by agreeing to suspend parts of the DCFTA. Štefan Füle, the commissioner for the neighbourhood, told YES that the EU was willing to establish relations with the Russian-led Eurasian Economic Union and to contemplate a free trade agreement with it. The EU is also engaged in trilateral talks with Ukraine and Russia to solve the gas price dispute between Moscow and Kyiv. A deal on gas now seems within reach.

Ever since the crisis in Ukraine began, the Russians have held the EU culpable, claiming that it failed to consult them on the negotiation of the trade agreement with Ukraine. Not only have extremists like Nigel Farage and Marine Le Pen bought this story, but also a number of mainstream politicians and officials, including in Germany. An exchange at the YES conference shot down this canard once and for all. Commission President José Manuel Barroso recounted that for many years, at the six-monthly EU-Russia summits, he had put the DCFTA on the agenda. The Russians never showed any interest in discussing the matter until last year, he said. Then Igor Yurgens, formerly a close adviser of President Dmitry Medvedev, intervened: he said he had sat in on several EU-Russia summits, and confirmed that the EU had tried to raise the DCFTA but that the Russians had not wanted to discuss it. Barroso added that on several occasions Putin had told him he did not mind if Ukraine joined the EU.

Presumably Putin turned against the EU and its agreements with Ukraine when he decided to transform the Customs Union of Russia, Kazakhstan and Belarus into a more ambitious Eurasian Economic Union. Putin thought this project would count for little without Ukraine’s participation – and understood that it could not both adopt the DCFTA and join his Union (which has high external tariffs). 

The Western sanctions on Russia are making an impact, particularly on the ability of its firms to raise capital on international markets. The business climate in Russia is souring, investment by Russians and foreigners is tailing off and economic output is starting to drop. Though Russian leaders dismiss the sanctions as feeble, the prospect of stronger measures may be deterring Putin from further land-grabs in Ukraine. 

The other deterrent may be the prospect of dead Russians. The further that Russian troops move into Ukraine, the more of them will be killed. According to the Russian NGO ‘The Committee of Soldiers’ Mothers’, it is likely that several hundred Russian soldiers have already died, but the Russian media has more-or-less succeeded in hiding that fact from the public. More extensive casualties would be impossible to cover up.

The peace deal that Poroshenko hopes for would allow Ukraine’s economy to recover, give an opportunity for Kyiv’s politicians to modernise the state and enable the country to move closer to the EU. Such benign outcomes, however, may not suit Putin’s purposes, and he may try to prevent them.

The West therefore should do everything it can to strengthen Ukraine, including the provision of more generous financial assistance. NATO should train Ukraine’s armed forces and give them some of the weapons they need to defend their territory. The EU should maintain sanctions until Russia stops interfering in eastern Ukraine, while letting Moscow know that further encroachments will incur further measures. The EU should do more to strengthen Ukraine’s administration and judiciary, enhance energy links to European grids and dispense humanitarian aid where it is needed. And it should give Ukrainians a clear message of hope: the more they reform their country, the more closely it will become integrated with the EU. European governments must not close off the possibility that, in the very long run, Ukraine could become a member. 

Charles Grant is director of the Centre for European Reform.

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