Economic Interdependence

Turning away from the association with Russia will cost Ukraine a fortune in the short term, while the long-term prospects remain uncertain. Economic connections to Russia ran too deep to be ignored. At the start-up of independence, about three-fourth of Ukraine’s economy had been fully integrated in the highly centralized economic complex of the former Soviet Union. Sister republics took 84% of Ukraine’s exports and provided 72% of its imports. The bulk of this trade was conducted with the Russian Federation. Not only did Ukraine remain completely dependent on Russia’s oil and gas supplies but also on the export side as well, 90% of all high value-added goods produced in Ukraine were sold to Russia. By the turn of the century, more than one-third of Ukraine’s total trade was still tied to the Russian market (Molchanov 2002, pp. 235-236).

When President Yanukovych started negotiations on association with the EU, the Russian Federation took 30% of Ukraine’s exports of goods, versus 27% for the whole of Europe. In the same year, 2011, more than 35% of Ukraine’s imports of goods came from Russia, while the share of the whole of Europe, EU-27 and EFTA combined, and was 2% less (State Statistics Service of Ukraine 2012, pp. 22, 29).

In 2000 Russia supplied 75% of Ukraine’s gas and 80% of domestically consumed oil. Moreover, Ukraine has 15 nuclear reactors, which have relied predominantly on nuclear fuel assemblies imported from Russia. The country’s energy import dependency, although down from 45.8% of total consumption in 2004, remained at a rather high 39% level (Balmaceda 2007, p. 10; IEA 2012, p. 21). Russian gas imports share for 2015 totalled 37%.

Russia has been the largest buyer of Ukraine’s machinery exports. Until recently, it absorbed about two-third of Ukraine’s heavy machine-building exports and half of all of its machinery exports. Yet, Russia has also been dependent on cooperation with enterprises of Ukraine’s military-industrial complex, which supplied and serviced Russia’s strategic missile forces, provided combat helicopter engines for the air force and produced gas turbine engines for the navy. Implementing full import substitution for these inputs will take at least three years.

The West is Ukraine’s largest creditor and, collectively, the largest investor, while Russia has been the primary supplier of energy, the largest market for high value-added exports and the fourth-largest investor officially (Finance.UA 2014). Unofficially, it is probably the largest, as Russian business groups have significant interests in Ukraine’s industries, infrastructure, real estate, communications, and the like.

In the past, Ukraine’s chronic excesses of imports over exports forced Russia to supply trade credit, sell energy at discount prices, and accept I owe you as payment. The combined value of energy subsidies, credit subsidies, and transit fee subsidies for 1992-2008 could be as high as $25.9 billion, with a more conservative estimate of $12.6 billion (Krasnov and Brada 1997). In the 2000s, gas subsidies alone amounted to $16.91 billion (Suzdaltsev 2011). If annualized, that was enough to cover near 2% of Ukraine’s GDP year after year. On a country-by-country basis, Russia remained Ukraine’s largest market in 2014 (WITS 2015). Bearing in mind that the economic linkages between the two countries go very deep and are sometimes impossible to replace, Russia is central to any projection of Ukraine’s development.

This dependence is mutual. The World Bank’s estimate put Ukraine as Russia’s fourth largest import partner for 2010-2014 - after China,

Germany, and the USA. Ukraine owns a vast pipeline network that Russia uses for its oil and gas deliveries to Europe. No less than 10-12% of the EU total gas supply is pumped through this network. Russia’s armed forces have been dependent on Ukraine’s defence contractors, which supplied helicopter motors, cargo planes, and gas turbine engines for battleships; built tank aiming systems, boosters, and navigation equipment for strategic missiles; provided air-to-air missiles and other parts for fighter planes. Implementing full import substitution for these inputs will take three to five years, and will cost Russia billions of dollars.

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