Ukraine’s trade winds shift to the West

by Matt Miller Mar 24, 2014

Whether by design or forced into action by a hostile neighbor, Ukraine must maneuver trade away from Russia and toward both the West and Asia. While most attention is centered on the country’s natural gas supply, that represents only one part of the geographic calculus. With a change in trade flows, Ukraine could lay the groundwork for dramatic improvements in an economy that has been mired in inefficiency and stuck in recession. Any transformation, however, will require major investments in transportation and infrastructure. That, in turn, will depend on the success of internal reforms. According to Veronika Movchan, an analyst with the Kiev-based Institute for Economic Research and Policy Consulting, Ukraine had before the crisis assumed trade with Russia would remain constant while EU and Asia would grow. “Now, it’s much more urgent to reorient,” she stresses. “We must trade more aggressively with the rest of the world.” In many respects, Ukraine represents the pivot point of the former Soviet Union. If Ukraine, with its huge landmass and 46-million people, can begin to mimic the development of such former Eastern Bloc countries as Poland, the Czech Republic and the Baltic states, it could emerge not only economically more robust, but a stable foundation for the whole region. If not, Ukraine could well be locked in misery for many years to come, resembling a bigger version of a stagnating, state-bloated, corruption-sucking Belarus. Of course, the standoff between Ukraine and Russia remains fraught and unpredictable, as does the response from the West. Obviously, if Russia were to forcibly annex large swaths of Eastern Ukraine, with its heavy industry and mineral deposits, the Ukrainian economy would be in free-fall and the country’s future perilous. Yuzhny and Odessa, the country’s biggest commercial ports, lie dangerously close to Crimea. But assuming Ukraine can survive the Russian bear hug, major trade shifts are likely. That won’t come without some effort. Even before the Russian crisis, Ukraine faced an uphill fight to streamline and substantially improve its economy and the infrastructure that underpins it. The country is burdened by its Soviet legacy. According to one estimate, endemic corruption adds anywhere from 50% to 70% to the price of goods. The bureaucracy has been stifling. Land ownership remains uncertain. Taxes are a jumbled mess. “The country has to reform promptly and with the rule of law,” says Movchan, who believes the new government is eager to do so. External assistance is also vital, especially from the European Union. The EU has the capacity to not only guarantee loans – as discussions are now being aimed – but to jumpstart trade through more open borders, precisely the kind of agreement that then-President Viktor Yanukovych rejected in November. Brussels can provide credit necessary for businesses to expand as well as underwrite roads, railway and airport construction through various EU channels, including the European Bank for Reconstruction and Development. Foreign direct investment in infrastructure is key as well. How easy that will be is another matter. “Right now, the risks are very high,” says Volodymyr Yaremko, a lawyer in the western Ukrainian city of Lviv. For example, he believes it will be very difficult to woo new investment to the Yuzhny/Odessa port area with the Russians so near. For example, Ukraine is planning several new port projects along the Black Sea, with the dredging of Yuzhny now underway. Ülo Adamson is CEO of A/S Trigon Agri, a Central European agribusiness concern based in Talinn, Estonia, with large operations in Ukraine. Adamson believes that neither Ukrainian government money nor EU funding will be necessary for these port terminal projects, if – and it’s a big if – Ukraine can reform, especially its onerous tax system. “Large, international traders will come in and secure these ports,” he says. “They want to be closer to the source.” Some of these trading companies already are exploring the waters. Late last year, for example, US behemoth Cargill bought for an undisclosed amount a 5% stake in Ukrlandfarming, Ukraine’s largest agri-business concern. In a statement, Ukrlandfarming said the two are discussing logistics projects. Trade winds were shifting even before the crisis. Russia in 2012 remained Ukraine’s single biggest trading partner, accounting for 32.4% of imports and 25.7% of Ukrainian exports, according to the World Trade Organization. But the EU has been quickly closing the gap and some estimate it actually overtook Russia last year. Russian gas remains the biggest single import, with a nominal value in 2013 of about $7.2-billion. However, Ukraine has been working to diversify sources and in December signed an agreement to import gas from the EU via Slovakia. That could cut current energy dependency on Russia by as much as 40%. Trade with China has been growing rapidly as well, although it remains only about one-fifth the size of EU-Ukraine totals. Ukrainian exports have been slanted as much toward Russia as imports, another legacy of a Soviet past. By far, the iron ore and related steel and iron products form the country’s biggest export category, totaling somewhere around one-third of all goods shipped abroad. Ukraine’s center of iron deposits and the industry that underpins it is in the eastern part of the country, notably near Dnipropetrovsk and Donetsk, Ukraine’s second largest city. Russia remains the destination of necessity. Transportation costs are high, quality often substandard and production facilities and technology outmoded and inefficient. But demand from even Russia decreased over the past two years. “They were too busy building an Olympics village,” Movchan quips. China is often cited as a potential market for iron ore although Ukraine must modernize its industry to attract Chinese business in even semi-finished goods. While the Ukraine must move production toward more finished goods to substantially boost value of exports, the economy even mid-term appears to be dependent on basic commodities including coal and iron for foreign exchange. Agriculture is especially promising. Yields – now less than half that of the EU and lower than what they were 25 years ago – should easily increase by half with better implements and management. Exports should also see a significant boost once the government eases onerous taxes, quotas and controls. The USDA projects grain exports will double by 2021. Economist Anders Aslund, with the Peterson Institute of International Economics in Washington, calls Ukraine “one of the big breadbaskets of the world.” Last year, Ukraine exported $17.3-billion worth of agricultural goods, a 5.5% drop over 2012, although almost a 75% gain over 2010. Ukraine is the world’s leading producer of sunflower seeds crushed for oil. Grains accounted for $6.4-billion, almost 90% of which was corn and wheat. Egypt, Iran and Saudi Arabia encompassed three of the top four markets. “The key to the future is the Middle East and North Africa,” says Adamson, whose own Ukrainian operation encompasses about 50,000 hectares and is expected to expand. While Ukraine looks to Europe, Asia and the Middle East for improved trade flows, Russia continues to cast a very long shadow. “We can’t change neighbors,” says Movchan philosophically. “But that’s life.” Ukraine Trade Figures