Iana Dreyer of borderlex.eu -

High-level officials from the EU, Ukraine and Russia are holding a trilateral meeting in Brussels on July 11 to address Russia's concerns about how the free trade and association pact that Brussels and Kyiv signed in late June might have on its trade with Ukraine. The preparatory talks held this week were expected to set up procedures to manage potential trade-related problems. Ukraine and the EU want to avoid a trade war with Russia, as such a war would be traumatic for Ukraine, which sends more than half its exports to Russia. And such a trade war is unlikely to happen.

Russia has already signalled it isn't happy with what it will get out of this diplomatic effort. But no such effort can make Moscow happy. The Kremlin didn't want Kyiv to sign the agreement with Brussels in the first place. Rather, it wanted Ukraine to join its Eurasian Customs Union – now the Eurasian Economic Union – of which Kazakhstan and Belarus are also members. Russia conceives the EEU as a rival project to the EU.

The EU trade deal lies at the heart of the current crisis in Ukraine. To Russia, it is a first step to Ukraine not only moving toward the EU, but also potentially the Nato military alliance.

With the deal now signed, Moscow is trying to get whatever it can, such as a possible amendment of the deal or a delay in its implementation. It won't succeed. 

Russia's response

Russia's response to Ukraine signing the EU Association Agreement (AA) and the main pillar of that, the Deep and Comprehensive Free Trade Area (DCFTA), has been multi-pronged. For example, it announced plans to introduce an import-substitution strategy away from Ukraine. In particular, Moscow stressed its desire to untie itself from Ukraine's armaments industry. Russia is a leading importer of Ukrainian weapons, buying about 7% of its neighbour's armaments and military equipment.

Ukraine supplies the Russian army with helicopter motors, rockets and missiles, and/or their components. About half of the components of Russia's ground-based intercontinental ballistic missiles (ICBMs) are Ukrainian. Russia's famous airplane manufacturer Antonov has a plant in Kyiv. Russia has increased its military spending in recent years and relies heavily on Ukrainian imports to upgrade its army. Ukraine also supplies Russia's railways sector.

Russia threatened to cancel the free trade agreement (FTA) it inked with Ukraine in 2011 under the Commonwealth of Independent States (CIS) framework, a deal that the now-ousted president Viktor Yanukovych signed to placate the Kremlin because his country wasn't willing to join the Customs Union. Russia claims the DCFTA with the EU would lead to European goods entering Russia illegally because of the FTA with the CIS. Russia also says the two FTAs aren't compatible.

Concrete retaliatory trade measures so far, however, have been limited. One of the most important was Russia's ban on Ukrainian dairy imports in April for alleged sanitary reasons. This ban is in no way comparable to the full-blown trade blockade against Ukrainian imports orchestrated by Russia last summer as a means to dissuade Kyiv from signing its EU deal, which has come at great political and economic cost to Russia.

Russia's arguments that it risks being flooded by EU goods are spurious. All FTAs have rules-of-origin that are precisely designed to avoid trade deflection, ie. that third-country products enter duty-free via the partner's economy.

Russia has also alleged that the CIS' FTA and the EU's FTA with Ukraine are incompatible. This isn't true, either. Whereas membership of a customs union constrains a member's trade policy and forbids it de facto to sign deals with others, FTAs allow their members to do so. What is more, both the EU DCFTA and the CIS FTA include clauses that explicitly permit members to join another trade deal.

Russia has also said Kyiv's DCFTA is incompatible with its CIS deal because Ukraine's industrial sector will adopt EU technical standards. This is only partly true. Although it can be more expensive for Ukrainian companies to set up separate production lines catering to the technical standards of different export markets, the FTA with the EU doesn't forbid Ukraine from exporting to other countries – including Russia – according to other standards.

Moreover, most EU standards are internationally recognised. Russia itself is progressively adopting such standards, to be able to compete on global markets. It is true that if Russia doesn't adopt those standards, some industrial or agro-industrial exports to Ukraine could dry up over time. This is because Kyiv will have to phase in EU standards for its own domestic market. Yet all this depends on where Russia's own ongoing standard-setting process heads. One must also keep in mind that Russia's top export to Ukraine is natural gas – which has not much to do with this particular discussion. Finally, the two sectors that worry Russia most – armaments and railway equipment – aren't covered by the DCFTA's obligations to adopt EU standards.

Ukraine could have cancelled its CIS membership, as Georgia did after its 2008 war with Russia. The CIS FTA states clearly that the ultimate goal of its members is to establish a customs union. That is a prospect Ukraine can no longer offer Russia. Here, one can understand Russia's unhappiness. Kyiv recently signalled it was considering pulling out of the CIS. But it hasn't come forward yet with a concrete move in that direction. Kyiv doesn't want to antagonize Russia even more than it has, or attract potential trade retaliation or face higher tariffs. Indeed, exiting the CIS means it would have to pay the EEU's higher external tariffs.

Russia faces a dilemma. For technical and financial reasons, it clearly cannot become autarkic for its armaments sourcing (only the US might be able to). Recent moves by Kyiv to block exports of weapons to Russia are starting to bite. If Russia actively started diversifying away from Ukraine, it would have to turn to western technology. Yet Russia could encounter western export restrictions if it continues to support the separatist movement in eastern Ukraine.

The untying of Soviet-era industrial ties is bound to take time and is not an economic necessity, unless they hamper economic modernisation. Yet as Ukraine appears like it will be able to retake control of the separatist Donbass basin, the heartland of Soviet-era industrialisation, the greatest irony in the whole story is that it is precisely the arms industry that can guarantee a Russian-Ukrainian truce – be it only in a trade war.

Iana Dreyer is Editor of borderlex.eu