Report by Leo Litra, Senior Analyst of the NEC, on assessment of Ukraine-EU relations for the quarterly magazine ТRUMAN Index.  The full version of TRUMAN Index No. 4 (8) is available on the TRUMAN Agency website

July – September 2018

Positive + 47

Negative – 4

Overall + 43

Truman Index: 1.95

Summary

Ukraine’s relations with the European Union have been rich and diverse and have brought good results. First of all, during the monitoring period, Kyiv and Brussels held an EU-Ukraine summit, which delivered a strong joint statement, highlighting Ukraine’s European aspirations and de facto recognizing Russia as the aggressor in Ukraine. The summit also underlined areas in which Ukraine underperformed, especially the fight against corruption. Despite much hope on the Ukrainian side, the summit did not elaborate on the Four Unions concept put forward by Ukraine, but focused on the implementation of the Association Agreement.

Even if the summit was the key event in bilateral relations, the most discussed event in EU-Ukraine relations was the new Macro-Financial Assistance Program worth €1 billion. The program was welcomed by Ukraine as most of the conditions are not difficult and the country should be able to meet them. The MFA program is divided in two equal tranches and it is likely that Ukraine will get the first one by the end of the year, since the conditions for the first installment are easy and most have already been implemented. However, some diplomats from EU-member states regret that Ukraine is being “spoiled” and that the EU did not want to set serious conditions.

President Poroshenko’s proposed amendments to Ukraine’s Constitution have been broadly seen as self-promoting. The proposed amendments is that the president acted on the principle, “Let’s fly it up the flagpole and see who salutes” in order to launch a process in which he would be seen as the driver of European integration. If the Verkhovna Rada supports these amendments, the president will gain some capital; if not, he can claim to be a true eurointegrator, while those who opposed the amendments are against European integration.

Finally, the latest round of EU sanctions deserves some special attention. Although all EU sanctions were renewed, some have met opposition. Since at least two countries have announced their intentions not to automatically prolong sanctions without a proper debate, from this moment on, future extensions may not be as assured as before.

Political dialog and sanctions

President Poroshenko’s proposal to amend the country’s Constitution to specifically include Ukraine’s aspirations to membership in the EU and NATO was a major bit of political news. The president submitted a bill containing amendments to Art. 85, 102, 116 and the Preamble. If adopted, the Rada and the Cabinet will be mandated to implement a course towards full membership in the EU and NATO, while the president will have to guarantee that the provisions are implemented.

In order to adopt these amendments, the Rada first has to vote in principle to pass first reading with a simple majority (226 votes), which is scheduled for the current session. If the first vote is successful, the final vote will require 300 votes or a two-thirds majority to pass, which could be a challenge, although one high-ranked Ukrainian official claims that the votes are there. Moreover, the second vote is set to take place in early 2019, just before the presidential elections scheduled for March 31, 2019, meaning in a very politically sensitive environment. The parties that oppose the constitutional amendments are already building their strategies for how to not participate in the vote. The main opposition candidate for the presidency, Yulia Tymoshenko, proposes signing a Memorandum on the irreversibility of a European and Euro-Atlantic course for Ukraine.

The position of various parties towards the amendments is very important, as many see the president’s proposal as a Catch-22: if the amendments are adopted, President Poroshenko will gain PR and be able to portray himself as the eurointegrator #1. If they aren’t adopted, the president and his team will be able to claim that they alone stand for a European future of Ukraine, while the rest are “working for Putin.”

The actual idea has little practical value. If the amendments are adopted, Ukraine will declaratively and legislatively proclaim its aim to join the EU and NATO. In practice, however, if euro-skeptics come to power after the election, these amendments will be ignored, just like many other provisions of the Constitution. On the other hand, if adopted, these amendments will not harm Ukraine in any way, and they could possibly bring some gains. And so, these constitutional amendments are seen as a process-driven rather than results-driven action. This can be seen in the EU’s reaction, which respected Ukraine’s right to amend its Constitution, but reminded the country’s leadership that reforms and full implementation of the Association Agreement are key to Ukraine’s progress in European integration.

In July 2018, the policy of EU sanctions against Russia was prolonged for another 6 months. The EU extended economic sanctions in the banking, finance and energy sectors until 31 January 2019. The decision was adopted after the leaders of Germany and France informed EU member states about Russia’s failure to implement the Minsk Agreements. Sources in the EU say that discussions regarding the prolongation took two minutes and that Italy and other countries that wanted to debate the issue did not bring it up.

EU sanctions for the illegal annexation of Crimea were joined by Montenegro, Albania, Norway, Georgia, and Ukraine. On July 31, 2018, the EU Council added sanctions against companies involved in the construction of the Kerch Bridge. The list now includes 44 companies and 155 individuals. Apparently, certain countries like the Baltics and the UK wanted to add more entities to the sanction list, but Italy was against and advocated to exclude from the list individuals who were former officials and no longer held any official position. Given that sanctions must be adopted unanimously, Rome blackmailed other countries by saying that it would vote against sanctions if the list included new names. Thus, the “Crimea senator” Olga Timofeeva was not added to the sanction list.

The next extension of economic sanctions, in December 2018, is likely to raise some debate within the EU. Italy and Hungary, both sympathetic to Russia, already announced that they will ask the EU to debate the sanctions rather than prolong them automatically. Growing opposition to sanctions, although marginal, is creating difficulties for their prolongation and makes the EU’s policy less stable. In his speech to the Rada, President Poroshenko also noted this, adding that it reflected Russia’s efforts within the EU. However, one source in the EU stated that sanctions would definitely be prolonged in December, albeit with some discussion taking place. The EU is aware of the upcoming elections in Ukraine and does not want to provide counter-arguments to populist politicians regarding EU support.

Attempts to cancel sanctions can be seen, not only at the political level, but also within the legal framework. Several Russian banks—Sberbank, VTB, Vneshekonombank, Prominvestbank, and Denizbank, a Turkish subsidiary of Sberbank—and GazpromNeft’ and Rosneft’ have gone to court to get sanctions against them dropped. The court dismissed their appeal, which means that the EU  sufficiently substantiated its position while adopting sanctions. The court’s decision reads: “The declared objective of the disputed acts is to raise the price for Russia’s actions, which undermine the territorial integrity, sovereignty and independence of Ukraine, and also to support a peaceful settlement of the crisis.”

Sanctions against Russia have also been disputed, though in a more sophisticated way, in the Council of Europe. There, Russia initiated a review of the Council’s sanction policy in such a way that there would be no real mechanism for imposing sanctions in the future. Russia wants to return to the Council of Europe without implementing anything in the CoE resolution, and leaving the Council no option to implement new sanctions. The CoE decision will be made in October. If this succeeds, it will serve as an argument to lift sanctions in the European Union as well, “because that’s what they did in the Council of Europe and it worked.”

Energy Dialog and Nord Stream II

The energy dialog with the EU has significantly increased since the Nord Stream II pipeline project kicked in. In this respect, the European Commission, backed by Germany, initiated trilateral consultations regarding the transit of Russian gas through Ukraine after 2019, when the current contract ends. Among others, the negotiations of the new transit contract have to consider minimum annual transit volumes, the rate, and possible guaranties, while other details can be agreed upon directly by the companies involved. But over and above the technical aspects of the negotiations, Ukraine expects, first of all, confirmation of its strategic role as a transit country for gas supplies to the EU. The first round of trilateral consultations took place in Berlin on July 17. The parties agreed to draw up a roadmap at the next meetings regarding gas transit. Based on statements by his spokesperson Dmitry Peskov, Putin assured Chancellor Merkel that transit through Ukraine would continue after 2020. Nevertheless, Gazprom officials did not attend the trilateral expert consultations on September 12. As a result, the Ukrainian position as reflected by FM Pavlo Klimkin is that if NSII is built, Russia will definitively stop shipping gas across Ukrainian territory. Kyiv’s view is shared by the US, as NSA boss John Bolton also stated that Russia would not ship gas though Ukraine, even if it promised to do so.

There continue to be two ways to stop NSII. The first is to amend the EU’s gas directive, which would mean that all pipelines supplying the Union, including foreign ones, are subject to EU law. That is how South Stream was stopped in 2014, as it became commercially unfeasible. Discussions regarding amendments to the EU gas directive are ongoing, but according to deputy Ukrainian FM Lana Zerkal, the final decision will depend on Germany, the Netherlands, Belgium and Austria, which are the countries that will directly benefit from NSII and with whom Ukraine is now working.

According to one high-ranking official in Ukraine, Kyiv does not think the EU will be able to stop NSII as the EU is under strong influence from Germany, so there are no expectations in Ukraine that EU will stop the Russian pipeline The only way to hamper it is through the US sanctions against the companies involved in its construction. Still, US sanctions are also not the best option for Ukraine. Yes, Uniper, a German company, has declared that it would withdraw from the project if Washington imposed sanctions. But US sanctions on German and other European partners also present risks. The EU might retaliate in various ways, which could affect the common sanction policy against Russia, which is also crucial for Ukraine. In the meantime, Russia has taken a new step to cover the risks of the project. Apparently, while meeting the German chancellor in Meseberg on August 18, the Russian president told Angela Merkel that Russia was ready to fully assume funding of NSII in the event of sanctions.

Other possible barriers to the project were a lawsuit brought by environmentalists to Germany’s Constitutional Court and Denmark’s position. In the first case, the Court rejected the suit, which was a popular decision in Germany: opinion polls show that two thirds of Germans support the pipeline. In the case of Denmark, the country did not immediately grant permission for NSII construction to go ahead and the Russian reaction was prompt. Kremlin presented an alternative route that according to Russians does not require additional permits and avoids Denmark’s territorial waters. At this point, Russia has already started work on laying the NSII pipeline in the Gulf of Finland.

In tandem with Kyiv’s efforts to stop NSII, Ukraine has been advancing the cause of integration into the EU energy market. The road to the energy market is not easy and depends on many factors. For instance, for the EU, the key condition for successful reform of the gas market in Ukraine is unbundling. However, Ukraine cannot finish the unbundling process because of its current transit contract. Ukraine can change its contract in 2020, but until then it cannot modify any provisions. One way to sort this problem is to apply EU legislation on external pipelines, which will force Russia to comply with EU law. Meanwhile, Russia went to the WTO to prove that the EU regulation, meaning the Third Energy Package, is discriminatory. The WTO found no basis for claiming that the EU would discriminate against Russian gas suppliers or Russian natural gas in the Third Energy Package.

Ukraine has intensified efforts to integrate into the EU energy market, which should result in the country being granted the same rights and obligations as EU members. The issue was discussed during the EU-Ukraine summit and is part of the Association Agreement as well. If Ukraine integrates into the EU energy market, EU law will directly apply to network codes, the determination of transit and other rates, information exchange, capacity allocation, and balancing.

EU-Ukraine summit and reforms

The most important bilateral event, the EU-Ukraine summit, took place in Brussels. This year’s summit was a special one, as it was the 20^th summit. It was the last scheduled summit before presidential elections in Ukraine. Compared to last year, when the EU and Ukraine did not manage to agree on a joint statement, this year the two sides did adopt a joint statement, agreeing on a shorter but quite ambitious document. Both the joint statement and the summit were good for Ukraine—possibly even better than anticipated.

The EU-Ukraine summit focused on issues like decentralization, fighting corruption, establishing rule of law, developing the economy, and energy. The leaders also discussed the Minsk Agreements, their implementation, and EU support for Ukraine. The joint statement covered a wide range of issues, but among them a few stood out. First of all, Ukraine’s European aspirations were recognized. Secondly, the EU condemned the violation of Ukraine’s territorial integrity and sovereignty and effectively acknowledged that Russia was the aggressor: “…acts of aggression by Russian armed forces…” During the previous summit, it was the wording on Russia’s aggression and Ukraine’s European aspirations that resulted in no joint statement. This year also affirmed Ukraine’ role as a strategic gas transit country.

Significantly, the Netherlands did not oppose the formulation “European aspirations” in the statement, while Hungary insisted on an insertion regarding Ukraine’s new education law that reflected mainly the Hungarian view. This took place on July 4 at the meeting of ambassadors, otherwise Budapest threatened not to endorse the joint statement. Still, it was a good outcome because Hungary failed to do to the EU-Ukraine relations what it had done in NATO-Ukraine relations. However, relations with Hungary could become an issue at the next summit: after a recent scandal with the Hungarian consul issuing Hungarian citizenship in Berehove, Budapest threatened to slow down Ukraine’s integration in the EU even more.

Although Ukraine insisted on discussing the Four Unions that it had proposed during the Eastern Partnership summit in 2017, the EU did not engage with Ukraine on this issue. There was relatively positive feedback from the EU on the energy union and the digital union, but a negative response to association with Schengen and a customs union at the summit. Brussels made it clear it wanted Kyiv to focus on the implementation of the Association Agreement first and on fulfilling many commitments from the past that still languish.

Ukraine’s reforms related to EU integration and advocated by the EU have entered the technical phase and the summer holidays slowed the pace somewhat. Still, there were a few scandals. First of all, the German newspaper Süddeutsche Zeitung published an investigation that concluded that Ukraine’s annual losses due to corruption at Customs are at least $4.8bn. The investigation further claimed that corrupt schemes are managed not only by Customs, but also involve the police, border guards, prosecutors’ offices, and the SBU.

Scandals related to law enforcement agencies continued when the Prosecutor General’s Office was backed by the Pechersk Court in an attempt to gain access to the phones of investigative TV journalist Nataliya Sedletska and Novoye Vremia’s Kristina Berdynskykh. The EU issued a statement of disapproval and asked for this investigation to be curtailed, while an EU diplomat called the investigation “shameful,” saying it was meant to silence Sedletska and other journalists who uncover corruption among high-ranking officials. The European Court for Human Rights reacted promptly, agreeing to apply an exclusive procedure for “urgent temporary measures” by forbidding Ukrainian authorities any access to the mobile operator’s data regarding Sedletska’s phone.

On the positive side, the Cabinet and legislature have renewed their roadmap of 50 “eurointegration” bills, of which 20 will be a priority for the current session of the Rada.

Some positive steps were made regarding the setting up of the automatic verification of e-declarations. A taskforce has been established and a schedule prepared. UNDP contracted a company that meets the technical conditions of the National Agency for the Prevention of Corruption (NAPC) in order to launch automated verification. There is a legal hitch, however: the NAPC does not have automatic access to the necessary registers. A bill that will allow automatic verification has languished in the legislature for more than a year and the launch of automatic verification depends on votes of the MPs who are apparently not in a hurry.

Macro Financial Assistance

Lengthy talks about a new EU Macro-Financial Assistance (MFA) program worth €1 billion finally yielded results in September, when EC Vice-President Valdis Dombrovskis signed the Memorandum on the MFA with officials from Ukraine’s Ministry of Finance and the National Bank. Although the Memorandum concerns the European Commission and the Cabinet, President Poroshenko insisted that the signing ceremony take place in his presence and noted that the new MFA was made possible due to his efforts, as it was he who agreed with the EC president on the new program.

The conditions in the new MFA are the very good for Ukraine and much better than the previous program. The money is being provided as a form of loan for 15 years on the model of EURIBOR +0.2%, which means virtually interest-free. The general conditions require Ukraine to have an agreement with the IMF. The MFA is divided into two tranches, each worth €500mn.

The EU has also reduced its conditions. As one Ukrainian official put it, the EU has set “more realistic” conditions. For instance, the new MFA does not contain requirement to lift the moratorium on the export of unprocessed wood. For now, the EU-Ukraine dispute over unprocessed wood will be settled by a special arbitration panel. The conditions for the tranches vary. First installment is an easy task for Ukraine, while the second contains requirements that are more difficult to implement. Sources in the EU told that this was done on purpose by the EU in order to be able to deliver the first tranche by the end of the year and then the second tranche ideally before presidential elections. However, the latter seems quite unlikely, since there should be at least three months between the tranches.

For the first tranche, the key condition is to put in place all the necessary elements for automatic verification of e-declarations and institute changes in the governance of the state-owned enterprises. Ukraine also has to put at least 200 small state-owned assets for sale through the ProZorro tender system. As of end of September, Ukraine had already met many of the conditions for the first tranche and will probably get it.

For the second tranche, things get more difficult. First of all, Ukraine will have to adopt long-delayed reforms to tax and customs administration. This means clear deliverables to ensure tax compliance, tax audit, customs and cross-border cooperation and enforcement, and staff integrity. Also, automatic verification of e-declarations, the factual verification of at least 1,000 high-ranking officials, and the High Anti-Corruption Court all need to be working. The verification of declarations of high-ranking officials is something the EU expects as a priority. Other commitments involve sector reforms, state-owned enterprises, and social policy.

A number of EU diplomats in Kyiv are unhappy that the EU has intentionally put forward conditions that are easy to fulfill. Despite this, the EU has gained an additional instrument to influence Kyiv and put pressure on Ukraine to deliver, even if all the country’s politicians seem to already be in campaign mode.

Trade

Trade might appear to be the least exciting aspect of EU-Ukraine relations, but it is actually full of developments and challenges. Above all, trade is a source of very good news, as it is on the rise. The first half of 2018 saw trade with the EU rise 19.2% over the same period of 2017. It was worth $9.79bn and 42.1% of overall trade. With EU countries, Ukraine exports most to: Poland at $1.64bn, up 30.8%; Italy at $1,47bn, up 24,8%; Germany at $0.93bn, up 28.3%; and Hungary at $0.83bn, up 39.3%. Exports to Russia for the same period were down 5.4% to $1.82bn or slightly more than exports to Poland. Certain experts estimate that by the end of 2018, Poland will take the lead from Russia and will become Ukraine’s main export partner.

The news was not all good, as in some EU countries exports declined. Exports to Latvia were down 15.1% to $0.057bn, Spain was down 11.1% to $0.62bn, and exports to the Netherlands slipped 1.9% to $0.76bn. The imports from EU, on the other hand, topped $10bn or up 12.4% in 2018, while total exports were $23.2bn, up 12.7%, and imports were $25.9bn, up 14.5%. By comparison, outside the EU and Russia, Ukraine exported the most to: Turkey at $1.41bn, up by 12.1%; India at $1.24bn, up 9.1%; and China at $1.0bn, up 5.6%.

In terms of goods, Ukraine’s exports are quite diverse. For 2018 Ukraine has already used 100% of the available EU quotas for honey, malt and wheat gluten, processed tomatoes, grape and apple juice, wheat, corn, and butter. Significant tariff quotas were used by Ukraine to starch (85.0%), processed starch (99.4%), poultry meat (75.0%), eggs and albumin (53.7%), and garlic (61.2%). There were few categories of tariff quotas that have not been used at all: 2,000 t of sugar syrups, 500 t of mushrooms, 250 t of processed oil products, and so on.

In a broader context, the Association Agreement, including the DCFTA, was implemented to 41% in 2017. There are areas in which Ukraine has been doing quite well, with very high implementation rates, but there are other areas with zero progress. The one area that is mentioned most during interviews is transportation: here, Ukraine has not managed to adopt a single one of the bills that have been languishing in the Verkhovna Rada for a long time. Both Ukrainian officials and EU sources point out that transport is highly dominated by several players who manage to block reform and lobby their interests.

Another area that reflects the interests of certain groups is unprocessed timber. In July 2018, MPs made a new attempt to strengthen the moratorium on exports of unprocessed wood by adding a ban on the export of firewood to a bill criminalizing the smuggling of wood. In the end, the bill was vetoed by the president, who said that he supported the criminalization of wood smuggling, but he was against the “lobbyist bills” being pushed by individual MPs. In fact, it was Radical Party leader Oleh Liashko who introduced changes to the bill. As the Rada was unable to overcome the presidential veto, the bill did not pass and the Association Agreement was not breached one more time.

Experts claim that the Association Agreement could be transformed into a tool to fight the smuggling of wood. Art. 294 of the AA, which refers to the trade of forest products, provides for such an option. If the focus is switched from restricting trade to proper forest management, this would help a lot. It would allow Ukraine and the EU to cooperate in Trade and Sustainable Development. In the end, this kind of cooperation allows Ukraine to require EU countries to punish buyers of illegal Ukrainian timber.

Events in Ukraine-EU relations (July – September 2018). Point-based evaluation