Economic Update
The European Union and Ukraine have officially begun preliminary discussions for the creation of a free trade agreement (FTA) between them. Negotiations began following Ukraine’s admission into the World Trade Organisation (WTO) on February 5, a mandatory prerequisite for FTA talks. Considering their strong bilateral trade, a step forward in their economic relationship would seem to be in the interest of both parties.

The enlarged EU has replaced Russia as Ukraine’s number one trading partner. In 2006, 25% of Ukraine’s exports were absorbed by the EU (mainly basic commodities such as metal, energy, machinery, agricultural products and chemicals) generating 8.7bn euros in revenue, while imports from the EU (mainly machinery, chemicals and transport equipment) made up 42% and amounted to 17.8bn euros. EU-Ukraine bilateral trade surpassed 26bn euros in 2006, and has been growing steadily in recent years. The EU is also the largest foreign investor in Ukraine. Foreign Direct Investment (FDI) flows from the EU-25 amounted to 5.5bn euros in 2006, compared to just above 230m euros in 2003, though most of the investment was channelled into bank acquisitions.

EU Trade Commissioner, Peter Mandelson, told OBG, “What we will be working on over the months to come is an agreement that should bring the Ukrainian and EU economies as closely into line with each other as possible. The EU is not only Ukraine’s largest trading partner but one of the largest and richest markets in the world. Closer economic ties with the EU offer huge benefits for Ukraine. The FTA will be a core part of the New Enhanced Agreement being negotiated between the EU and Ukraine, which will cover all areas of our relationship.”

An enhanced cooperation agreement would require Ukraine to bring its regulatory standards to European levels, which would facilitate investment flows in both directions, and pave the way for Ukraine’s membership of the European Union. Also, improving regulatory standards would strengthen Ukrainian business’s ability to compete on the global market.

The agreement could serve to extend the zero tariff principle to embrace the free movement of all goods, services, capital and labour. However, tariffs are likely to remain in specific areas, notably textile and steel. Essentially the agreement would result in cheaper EU imports for the benefit of Ukrainian businesses and consumers, while increasing Ukraine’s access to the EU single market.

According to a research report produced in cooperation between the Centre for European Policy Studies, the Institut fur Weltwirschaft and the International Centre for Policy Studies in Kiev, when Ukraine can effectively implement and enforce a regulatory environment consistent with that of the EU, “Ukrainian exports to the EU could double, and EU exports to Ukraine could also grow substantially.”

However, to attain this level of prosperity, Ukraine must choose between two scenarios: adopting a simple FTA, the impact of which would be minor, or opting for a deep FTA, which would be more demanding but with more significant rewards. The end result will come down to the administration’s ability to legislate, implement and enforce the necessary policy steps.

“Bringing about change will take political will and ambition in our negotiations, which inevitably will be tough and vigorous. I believe, however, that a balanced and ambitious agreement is within our reach. The more comprehensive and deeper the agreement, the greater will be the economic value. But I think both the EU and Ukraine want an ambitious outcome and they will push for it,” Mandelson told OBG.

Ukraine has not had a great track record in terms of enforcing and creating a stable regulatory environment. Bureaucracy, corruption and political turmoil have impeded the country’s ability to achieve significant reform and there has been much doubt expressed by the local business community concerning the administration’s ability to carry out such an extensive task. However, President Yushchenko should be given credit for achieving WTO accession and with the help of Prime Minister Tymoshenko, who has been a fervent supporter of European integration, it would seem that a deep and comprehensive FTA with Europe could very well be a reality in the not too distant future. With the absence of an agreement on NATO membership last week in Bucharest, an FTA agreement becomes increasingly more vital as an external policy stimulus to bring Ukraine into the European orbit of influence.