The Ukraine crisis might slow down the pace of Eurasian integration and raise the stakes for greater integration with Asian partners such as China.
Economic problems stemming from Russia’s involvement in Ukraine could prove to be too big a roadblock for the Customs Union to overcome. Photo: Sergey Savostianov / RG
The Eurasian integration project involving Russia, Kazakhstan and Belarus has made great strides over the past five years, with even more ambitious targets to come. Indeed, the goal of creating a “Single Economic Space” has been targeted for 2015, when the full and free movement of goods, capital, services and people will be implemented across the three countries. The important question to ask now is: What impact will Ukraine’s turmoil have on Eurasian integration?
Keep in mind that the Eurasian integration project has always been plagued by an ambivalent stance towards Ukraine, a reality that has come to the fore with the current political turmoil surrounding Russia’s neighbor to the west.
In a worst-case scenario, the new economic scenario resulting from Russia’s annexation of Crimea will stall or even halt the process of Eurasian integration.
The link between integration and Russian economic growth
The first threat to continued integration in Eurasia comes directly from the country that has, for the most part, been the driver of the integration project: Russia.
While Kazakhstan claims to have laid the groundwork for integration as early as 1992, it really has been because of Russian drive and insistence that the Customs Union has gone as far as it has in such a short amount of time.
Of course, this reliance on Russia driving integration means that there is a danger of reform stalling if Russia is distracted. And indeed, this seems to be the case today, as the sputtering economy in Russia has been stagnating for some time and now threatens to grind to a halt under the weight of the Ukraine crisis.
Russian officials are aware of the shortcomings in the Russian economy, as Ksenia Yudayeva of the Central Bank of Russia noted in January of this year. She points out that the country is facing “stagflation” (a mix of no growth and high inflation).
The outlook for the Russian economy has been continually revised downward by both the IMF and the government, with market consensus at the beginning of the year for growth in 2014 at about 2 percent.
Of course, this much-bemoaned economic slowdown in Russia has not been a crash in any sense of the word; there are still many countries in the world that struggle to see even the modest growth rates that Russia has posted as of late, and the economy is still growing (albeit slowly).
However, the worry about the Russian economy is it might be fragile enough to crash given an exogenous shock or internally-generated push.
That push seems to be the current crisis in Ukraine. The economic difficulties that Russia already faced (lack of structural reform, over-dependence on the price of oil) will become exacerbated if the crisis continues, and the markets are aware of this fact.
Citibank has already slashed its growth forecast for Russia in 2014 to 1 percent, while the Central Bank of Russia had a pessimistic view of only 1.8 percent growth before the Crimean crisis.
In reality, the markets were already bearish on Russia, and recent events have increased the fragility of the Russian economy. On Monday, Mar. 3, with fear of instability growing, the Russian stock market lost approximately $60 billion in value in one day, to say nothing of the plummet in the ruble and the corresponding real increase in the cost of imports.
Even beyond this disciplining from the market, there are much more dire economic consequences to consider for the Russian economy. Simply put, Ukraine was a bankrupt country before the political crisis, and in order to sustain even Crimea as part of Russia would require massive transfers from Moscow, in addition to the immense administrative cost that would come with the addition of a new oblast.
This burden on the Russian taxpayer at a time of slowing growth (to say nothing of possible economic reverberations throughout Europe from any possible sanctions from the West) would further stress the Russian economy, possibly past its breaking point.
In such a situation, it is highly unlikely that greater integration would be at the top of the Kremlin’s economic agenda. In fact, history shows that policymakers tend to become even more conservative and protectionist in a crisis (see the advanced economies’ response to the global financial crisis), and without the Russian political will pushing ahead, it is likely that the vast administrative overhaul envisioned by the architects of the Single Economic Space will also grind to a halt.
Infographic by Natalya Mikhailenko. Source: eurasiancommission.org.
Why policy differences matter for Eurasian integration
While Russia’s economic troubles can derail integration, perhaps more directly problematic for the Eurasian project is the divergence of policies over the past three months in many different spheres, including foreign policy and economics. Even prior to Ukraine, the issue of Eurasian integration was already proving to be a theory that was difficult to implement in practice. The greatest example of this has been the lack of coordination in monetary policies between the two biggest members of the Union, Russia and Kazakhstan.
Russia has pursued, up until the end of February, a fairly sudden, but managed, depreciation of the ruble (it lost approximately 5 percent against the dollar from January 1 to the end of February), as the Russian Central Bank shifted its exchange rate bands outward, guaranteeing that weakness was not just tolerated, but desirable.
This policy move (and its speed) has translated into difficulties for its Customs Union partners as Kazakhstan relies on Russia for 40 percent of its imports. In retaliation, and worried about its own economy, the National Bank of Kazakhstan implemented a 23 percent devaluation of the tenge in late February, widening its own exchange rate targets.
The lack of coordination in timing these policies shows, as has already been seen in the Eurozone, the difficulties in pursuing open economic spaces in the context of modern central banking. If the European Union, with stringent rules and a unified central bank, is having a hard time of it, how can the uncoordinated policies of the Eurasian Economic Space hope to manage it?
These frictions were already present well before any problems were brewing in Kiev in regards to a number of integration issues (including the underlying legal bases for integration), but Ukraine has only served to highlight that there are real policy differences among Kazakhstan and Russia across a broad range of economic topics.
It is unlikely that continued turmoil in Ukraine will help to bring the two countries closer together in economic policy, thus making broader integration more difficult.
Russia’s loss is China’s gain?
As has been argued before, the Eurasian Union project never needed Ukraine to be successful. It was always viable as a complement to the European Union, as long as it could press for greater liberalization and provide economies with the impetus to continue needed structural reforms.
Indeed, the real issue with the Customs Union project was not whether or not Ukraine joined, it was what the Union itself was supposed to be. As Dr. Kataryna Wolczuk of the University of Birmingham has written in a recent book, the actual progress in legislative harmonization by the EurAsEC-3 has been quite impressive, going faster and further than perhaps even the member countries envisioned.
However, the end goal was always elusive: Was the goal deeper integration, in the sense of a large number of issues being comprehensively harmonized, or was it broader integration, in the sense of bringing in as many countries as possible?
This question has still not been answered explicitly, but the events of last year appear to be that the goal of Russia was broader integration first, deeper integration later. However, this strategy appears to have failed rather quickly, with only tiny Armenia joining and Ukraine falling apart. At the same time, this has closed off the second strategy of deeper integration, given the economic repercussions of the failure of rapid enlargement. Due to political ramifications, it may be more difficult to pursue deeper integration any time soon.
This state of affairs means a plausible scenario where the beneficiary of this turmoil may not be the EU or the Customs Union (and certainly not Ukraine) but, rather, China.
Increased volatility in the European part of Eurasia may lead to countries that would have been candidates for Eurasian integration to look elsewhere. And China has already publicly committed itself to a “Silk Road Economic Belt” as a way to integrate with Central Asia and expand economic cooperation in the region.
Countries such as Kazakhstan already rely on Chinese immigration and Kyrgyzstan and Uzbekistan have large trading relationships with China, and that trade is on the rise. In the presence of increased friction between Russia and Kazakhstan (coupled with Russia’s economy slowing down), it might be in the best interest of the Central Asian republics to explore alternative arrangements.
China’s government is aware of this fact, differentiating its own initiatives from the EU and EurAsEC by noting that they avoid “inflexible systematic arrangements.” This is also as a way to distinguish the Silk Road efforts from the Shanghai Cooperation Organization (SCO), which encompasses many of the same countries but began its life as a security and politically-minded organization.
This may be the real legacy of the Ukraine crisis. Economic problems stemming from Russia’s involvement in Ukraine could prove to be too big a roadblock for the Customs Union to overcome. Rather than making Eurasian integration easier, Ukraine would instead make it harder, diverting energy towards greater Asian integration.