Ukraine: Perspectives on Eurasian integration

Ukraine does not yet participate in China’s Silk Road initiative (One Belt, One Road – OBOR) and did not agree to become member of the Russian-led Eurasian Economic Union (EEU), thus, its prospects for membership in either project are unclear. The EEU project is much more familiar and comprehensible to Ukraine, given the country’s common border with Russia and Belarus, which are members, and its Soviet/Commonwealth of Independent States (CIS) experience. However, it is currently pointless to debate EEU membership in Kyiv in light of Russia’s war against Ukraine. On the other hand, the OBOR initiative seems economically and financially important to Ukraine. But there is little understanding of the initiative, and this, combined with a lack of vision, seems to undermine the significance of the New Silk Road for the Ukrainian political and business elite.

 

The New Silk Road

Ukraine sees the OBOR initiative as a possible means towards improving infrastructure in various areas, from roads and energy projects to agriculture technology, such as grain storage and processing facilities and irrigation systems. Although there is limited knowledge in Ukraine about the OBOR initiative, stakeholders in Kyiv would like to attract investment from China. Given the current challenges faced by Ukraine’s economy and the 10 percent drop in GDP that it experienced in 2015, the need for investment is urgent.1 Some funds are available from the European Union, the United States, and Japan, but not enough to cover Ukrainian needs. Moreover, in the absence of Russia – the traditional source for loans – Ukraine is not in a position to be picky, despite the fact that it did not like China’s support for Russia during the annexation of Crimea.

In 2013, during President Viktor Yanukovych’s visit to Beijing, Ukraine declared its intention to join the OBOR initiative. At the time, China was quite often discussed within certain political circles in Ukraine. The focus on China was not necessarily the result of a special interest in the country; rather, it was the effect of Yanukovych’s international isolation. The president’s visit secured Chinese commitments for investments in Ukraine, but these were postponed after the annexation of Crimea. Despite Ukraine’s declared interest in China, there was no serious follow-up.

Today, lack of consistency on the part of Ukraine’s authorities is preventing the development of concrete projects with China. Meetings between Chinese and Ukrainian representatives do not go beyond general statements and concrete projects are rarely discussed: in fact, an intergovernmental commission scheduled for September 2015 has been postponed several times, because the parties are not able to set an agenda involving concrete projects. This means that Ukraine’s relations with China are kept within the traditional framework of bilateral trade, which has experienced significant growth. For instance, Ukraine has become the biggest corn exporter to China, overtaking even the US, the traditional number one exporter – and beyond corn, “since the 2014 Russian annexation of Crimea, Ukraine has increased its agricultural trade with China by 56 percent”.2

Despite increasing levels of trade between the two countries, the OBOR initiative remains generally unknown among the business community, except by a very few players who are directly involved in certain cooperation bodies, such as the Joint Ukrainian-Chinese Business Council. The “anonymity” of OBOR is driven by a lack of research and feasibility studies that could explain the opportunities provided by the initiative to the business community. Moreover, there is almost no information about the OBOR project in the public sphere. With some minor exceptions, all knowledge and communication is concentrated in official channels such as the Chinese Embassy in Kyiv, the Ukrainian Embassy in Beijing, and intergovernmental bodies.

The experience of cooperation between Ukraine and China has not always been positive. In the past, failed projects have included the construction of the “air express” railway between Boryspil International Airport and Kyiv, and a project on affordable (social) housing, which was abandoned. The annexation of Crimea and the war in the Donbas also caused China to lose major projects involving the irrigation of agricultural land and the construction of a combined-cycle power plant. The government had launched a pilot project with China on the reconstruction of mining infrastructure and the introduction of Chinese coal gasification technologies in Lysychansk, in the Donbas area. Today these mines are located in contested areas that the Ukrainian constitutional authoritiies do not have full control over. This means that it is impossible to continue with the implementation of these projects.

Other projects were agreed during Yanukovych’s visit to China: the former president even convinced Beijing to commit to a multi-billion-dollar investment deal aimed mainly at Crimea. As in the Donbas, the annexation of Crimea means that the projects have been put on hold and might be relocated to other areas such as Odessa or Mykolaiv Oblast that are under Ukrainian control, should the parties reaffirm their claims of support.

Some investment from China is still taking place through credit lines opened by state banks, but these are unknown to the public and do not have a visible impact. This might be because all of these projects are state-driven, and private business is poorly connected.

The legal issues between the two countries make things even more complex. In February 2014, China took Ukraine to the London Court of International Arbitration claiming damages amounting to $3 billion because, it said, Ukraine had broken the rules on which credit was offered. In 2013, Ukraine received $1.5 billion for the supply of grain which it did not deliver, and Ukraine pledged to purchase Chinese goods with another $1.5 billion, which it did not do. After the lawsuit, Ukraine and China entered into negotiations, and the results have not yet been made public.

Officials and think-tankers see potential political risks in joining the Chinese project. Would Ukraine have to be more loyal to Chinese ideas if it were to join the project and receive funds from China? On the one hand, China could offer political incentives that would be appealing for Ukraine: Beijing could provide support at the United Nations Security Council on the issue of Crimea and on opposition to Russian aggression. However, it would be unlikely to do so, since the Kremlin’s relations with Beijing are significantly more developed than Ukraine’s, and more important to China. Moreover, China widely accepts Russian supremacy in the CIS region. The joint statement of the Russian and Chinese presidents during their 2010 meeting says: “The Chinese side reaffirmed its support for Russia’s efforts to protect its fundamental interests, and promote regional peace and stability in the Caucasus region and in the CIS.”3

Despite the primacy of Russia in the CIS, one country, Kazakhstan, has a very well-developed relationship with China. Kazakhstan plays an important role in Ukraine’s relationship with China. It is seen in Kyiv as a gateway to China, given the special relations between Astana and Beijing, and Astana functions as a sort of interpreter between Kyiv and Beijing, given that it understands both countries well. Meanwhile, for Kazakhstan, Ukraine could become the gateway to the EU, in light of the advanced and special relationship between Kyiv and Brussels. President Petro Poroshenko’s recent visit to Kazakhstan and his discussion there on the OBOR initiative illustrates Astana’s central role. Some think that if China contributed the same level of investment in Ukraine as it has in Kazakhstan, Russia’s aggressive behaviour in Ukraine would have been less likely.4

The EU could also help Ukraine to benefit from its relationship with China. To increase efficiencies in Ukraine, China is prepared to combine its efforts with the EU, in particular in rebuilding Ukrainian infrastructure and assisting with the process of reforms, as stated in the remarks of European Council President Donald Tusk after the EU–China Summit in June 2015.5 And Ukraine’s trust in Brussels is relatively high. Therefore, including Ukraine in the EU–China dialogue could lead to Ukraine being better integrated in the trade routes and projects between the EU and China. A good comparison is the trilateral negotiations on gas supply between the EU, Russia, and Ukraine, where the EU has helped Ukraine to make arrangements for further gas supply.

In some cases, the EU has indirectly helped Ukraine to get more out of cooperation with China. For example, the Chinese market for Ukrainian milk products was opened as a result of Ukraine harmonising its food legislation with the EU’s requirements.6Another reason why Kyiv is becoming more interesting to China is Ukraine’s Association Agreement with the EU and the Deep and Comprehensive Free Trade Area (DCFTA). Unlike the EEU, the OBOR initiative does not require exclusive membership – on the contrary, overlapping economic projects that complement each other seem to be very welcome.

Some of the missed opportunities for cooperation with China to date are down to Ukraine’s poor road and maritime infrastructure, which require serious investment. Many routes connecting China and the EU transit through Belarus. However, Ukraine has many more EU neighbours than Belarus does, and represents the shortest route connecting the EU with China. If Ukraine’s infrastructure were better, it would be a preferred transit country. Ukrainian officials are fully aware of their infrastructure problem. During President Poroshenko’s visit to Kazakhstan, the broadening of transport infrastructure for transporting cargo from Asia to Europe across Kazakhstan and Ukraine was one of the issues explicitly mentioned.7

Goods in transit from China to Ukraine have traditionally passed through Kazakhstan and Russia. However, in 2015, Russia banned the transit of Ukrainian goods through its territory, which forced Kyiv to begin thinking about alternatives. Help in finding a solution came from Turkey, which has been subject to Russian sanctions since 28 November 2015. On that day, China, Kazakhstan, Georgia, Azerbaijan, and Turkey signed an agreement on the creation of a consortium for transporting goods from China to Europe without transiting Russia. The agreement created the Trans-Caspian transport route.

After Georgia sent the first train on the New Silk Road in January 2016, Ukraine made its first practical step. In a test run, Kyiv sent a freight train to China using the route from Ukraine through Georgia, Azerbaijan, and Kazakhstan, reaching the border with China in Dostyk, on Kazakhstan’s border with China’s Xinjiang province. It took 16 days for the freight train to reach the Chinese border, instead of the anticipated 11 days. The route is not simple because trains must travel across the Black Sea and Caspian Sea on ferries (at Illichivsk-Batumi and Alat-Aktau Port), something which requires extra logistical effort. In comparison, goods from (East) China reach Hamburg through Russia within 14 days, bypassing Kazakhstan and costing significantly less.8 Transportation through Russia costs half of Ukraine’s test freight train: about $3,900 for one container, compared to the $5,559 officially reported by Ukraine, or $7,950, which experts assess as the real “all-in” cost. On account of the cost efficiencies that routes through Russia offer, the Ukrainian train was stationed in Dostyk for one month, and returned to Ukraine empty.

Politically, the experiment was successful, but from an economic point of view, the route is not yet competitive, since Chinese logistics companies can still transport goods more cheaply and efficiently through Russia. Ukraine’s route by-passing Russia also goes to the north-west of China, which is not a major region for imports and economic activity. If Ukraine cannot encourage greater use of the route and reduce the time of transit and the cost, it is likely that it will remain little more than a public relations exercise. Ukraine needs to join the Trans-Caspian agreement in order to benefit from a single tariff, which would reduce the price and time of transit.

If the project is to be made fully operational and sustainable, it needs to attract the participation of countries from the region. Ukrainian officials say there is interest from Poland, Hungary, Slovakia, and others. Experts also say that other countries such as the Baltic states, Finland, and Austria could be interested.

Creating better transit routes could allow Ukraine to use the New Silk Road to build security of supply and diversify, especially in energy, by using the road to transport oil and liquefied gas from Azerbaijan. Ukraine is also hoping that oil- and gas-rich Turkmenistan will also join the project.

However, Ukraine still needs to become an attractive destination for the transit routes and for other EU member states. What Ukraine is doing now serves the interests of Ukrainian exporters, but does not make it an attractive transit location. China would likely consider Romania and Bulgaria a better option for sending goods to the EU, given that the shipment would be going directly into the EU. Also, non-transparent practices and customs procedures in Ukraine discourage transit through the country. This is not to mention the acute infrastructure problems Ukraine faces. If Ukraine can make itself attractive to China it could stand to benefit significantly from the OBOR initiative, which has a $40 billion fund allocated for infrastructure improvements. Discussions on funding infrastructure projects are already taking place within the Ukraine–China Commission.

 

The EEU

Unlike OBOR, the EEU’s chances of succeeding in Ukraine are almost non-existent. In Ukraine, the Russian-led project is considered a purely political one, created to ensure the incorporation of Ukraine. Most experts believe that joining the EEU would be the same as losing independence.9 Moreover, political support for the EEU right now (and most likely for the next seven to ten years) would be considered political suicide. No serious political party supports the EEU. Even the Russian loyalist party Opposition Bloc does not speak out for the idea, while public support for the EEU has dropped from around 37 percent in 2013 to 15 percent in 2016.10

Before the war, Russian-owned and Russian-loyal media tried to influence public opinion in favour of the EEU (then called the Customs Union), but this strategy is no longer applied. Certain serious media and political figures, broadly perceived as Russia’s voice in Ukraine, such as Viktor Medvedchuk, are now focused on criticising the EU integration process and the “horrors” that await Ukraine after the implementation of the DCFTA with the EU.11 The plan is to create a negative public opinion about the EU and only later to promote integration into the EEU. Medvedchuk has also been criticising and mocking the Ukrainian test freight train to China, which is a sign of Russia’s distaste for the project.

In a de facto state of war with Russia, Ukrainian businesses cannot influence Kyiv’s policy towards the EEU. Ukraine has already started to implement the Association Agreement with the EU and, as of 1 January 2016, it has been implementing its economic component, the DCFTA. Certainly, some businesses in Ukraine have different ideas about the EEU (for which, read Russia). But the oligarchs’ business interests are not generally taken into account in setting policy, with some minor exceptions. Business that was traditionally tied to the Russian market and business created from Russian investments are suffering because of the Russian ban and the sanctions imposed by the Ukrainian authorities. According to the State Statistics Service of Ukraine, in the first seven months of 2015, Ukraine’s exports to Russia dropped by 58.7 percent and imports from Russia fell by 61.5 percent compared to the same period in the previous year.12 Also, exports from Ukraine to Russia made up 12.7 percent of Ukraine’s total exports in 2015, while in January–February of 2016, Ukraine’s exports to Russia were 7.9 percent of total exports.13

The EEU’s inability to dictate policy has brought some benefits to Ukraine. Russia wanted the EEU to impose trade bans against Ukraine, but the effort failed, because Belarus and Kazakhstan did not support the trade bans. This showed that Russia cannot always use the EEU in its own interest. Moreover, the fact that Ukraine’s relations with Belarus and Kazakhstan have not suffered from their membership in the EEU shows that the EEU is nothing more than a project for harnessing political power.

Political incentives for Ukraine to join the EEU could include the potential return of Crimea and the potential of Kyiv to gain control once more of the regions in eastern Ukraine, along with stopping the war in the Donbas. Russia could also offer cheaper energy resources and loans. However, none of these incentives are realistic. Russia will not give back Crimea or the territories in eastern Ukraine. Ukraine has paid too high a price for its European choice for Russia to roll over on any of these issues. Even before the conflict in the East began, Ukraine was not willing to join the Russian-led project because it thought that it would undermine the independence of Ukraine, and would be unlikely to result in substantial economic development.14

As Ukraine is not going to join the EEU in the foreseeable future, and the disputes with Russia over the DCFTA continue, the EU needs to ensure that it participates in the dialogue between Russia and Ukraine. The trilateral consultations that were held on the occasion of the implementation of the DCFTA were negatively perceived in Ukraine, but in fact proved to be useful. The main result for Ukraine was not to resolve the trade disputes between Ukraine and Russia (which would have been impossible, since the reasons are political), but to demonstrate that Russia’s opposition to the DCFTA is not based on economic arguments.

Ukraine’s position is unlikely to change in the medium term, despite the difficulties that Kyiv is experiencing on its integration path with the EU. The negative result in the Netherlands’ referendum on the Association Agreement is seen in Ukraine as a domestic problem of the EU, intended by its opponents to weaken the EU rather than having much to do with Ukraine. This was explained quite well in Ukraine and therefore there is, as yet, no real sense of disappointment about the EU that might lead it to somehow look differently at the Russian-led EEU.

At the crossroads of the EU, the EEU, and the New Silk Road, Ukraine has an opportunity to diversify its trade and consolidate relations with the EU, China, and potentially in the medium term, with Russia. However, Kyiv finds it difficult to manage these processes. Ukraine wants to be integrated with the EU, but the EU is not willing to grant this yet, and Kyiv is not ready. Ukraine could integrate into the EEU but it is not willing to do so. However, Ukraine could, and is willing, to benefit from OBOR, it just doesn’t understand how to.

 

Recommendations for the EU

1. The EU is an important player in relations between Ukraine and China, and including Kyiv in the dialogue between Brussels and Beijing, as happened during the EU–China summit, might lead to better integration of Ukraine in the trade routes and projects between the EU and China.
2. The deepening relations between Kyiv and Brussels have a spill-over effect on Ukraine’s trade with China, such as, for instance, Ukrainian milk being accepted in the Chinese market as a result of harmonisation of food legislation with EU requirements. This process should be extended to other goods, with the support of the EU.
3. Ways to use the DCFTA to boost trade between China and the EU by involving Ukraine should be explored. But for this, Ukraine needs to make sure that its infrastructure has the capacity to make this possible.
4. Joining the EEU is seen as a step towards losing independence and, in the current context, the promotion of the idea would be political suicide, not only because of Russian aggression in Ukraine but also because it is not seen as a project that could bring substantial economic development. However, Kyiv has to consider trade and economic issues if the opportunity does become viable at some point. In this context, the involvement of the EU is crucial, as was evidenced by the trilateral talks on gas supplies and on the implementation of the DCFTA.