UKRAINE-EU TIES: Brussels seeks new sticks as EU runs out of carrots to encourage Ukrainian reform process

Brussels continues to support Kyiv’s ambitious integration agenda but frustration is clearly mounting over Ukraine’s inability to deliver on political promises

UKRAINE-EU TIES: Brussels seeks new sticks as EU runs out of carrots to encourage Ukrainian reform process
Ukraine's European integration bid was boosted in mid-2017 by visa-free travel and Association Agreement ratification but Brussels is now running out of incentives to motivate further reforms in Kyiv
Leonid Litra
Monday, 17 July 2017 18:34

Brussels and Kyiv had their ups and downs over April-June 2017. Finally, the visa-free regime with the EU came into effect and European integration became more tangible for ordinary Ukrainians. The EU has also finished the process of ratifying the Association Agreement, which was delayed because of the Dutch referendum in spring 2016. This good news was topped by the EU decision to raise caps on zero-tariff imports and open up new opportunities for Ukrainian business.

However, relations between Ukraine and the European Union showed signs of growing strain in other areas during the second quarter of 2017. The EU is increasingly impatient about delays in a series of reforms that Ukraine has committed to deliver. These reforms are mainly stuck in the Ukrainian parliament and involve such areas as healthcare, customs, and more. Meanwhile, Ukraine’s parliament has also made a number of decisions that breach the terms of the EU Association Agreement. One example is a three-year extension of an increased export tax on scrap metal. Although it is against prior commitments made by Kyiv, the Ukrainian steel industry has been given a new lease on life thanks to such protective measures.


Increasingly Strained Relations

Ukraine was moderately successful in delivering on reforms in Q2 2017. Reforms related to European integration cover a wide range of areas that, in most cases, require parliamentary votes. Ukraine’s parliament has come under heavy criticism from the EU, mainly via the head of the EU Delegation to Ukraine, Hugues Mingarelli. The Union’s main complaint is that parliament is delaying and even blocking a series of reforms to which Ukraine has committed itself. The average timeframe for adopting important laws related to European integration is now 12 months, a delay that is difficult to justify. Moreover, aside from these delays, quite often the bills are drafted or adopted in a manner that does not meet EU standards.

In the opinion of both the EU and many Ukrainians, the problems with parliamentary adoption of EU-compliant reforms come from the fact that many MPs have vested interests and thus are preventing the legislature from fulfilling its commitments to the EU. Bills are frequently prepared by the Cabinet of Ministers and various ministries and are registered in parliament, but then they are neither debated nor adopted because the chairs of the relevant VR committees fail to put the bills on the agenda.

Various sources point fingers at several committee chairs as the guilty parties over these delay tactics including the chair of the tax committee, chair of the healthcare committee, and chair of the industrial policy and entrepreneurship committee. EU dissatisfaction with the results of the parliament’s work is backed by statistics for 2016: of 126 EU documents that were supposed to be implemented in the Ukrainian legislature, only 36 of them were, in fact, implemented in part, while only 23 documents were fully implemented.

The EU’s growing disappointment with the pace of reforms in Ukraine is evident in the comments of the EU Ambassador to Ukraine and other Brussels officials. The EU clearly feels deceived by the Ukrainian side because there was actually no progress at all on a series of reforms that had been jointly agreed. Previously, the EU restricted its criticism largely to private discussions with Ukrainian officials. However, in recent months it has been noticeable that there is no longer any taboo over discussing the wrongdoings of Ukrainian authorities.

As seen from Brussels, growing tension is expected to pressure Ukraine into delivering on at least some of its commitments. In Kyiv, this additional pressure has not been well received and many think that this will only worsen relations between the two sides without leading to any positive results. The avalanche of criticism from the EU has been tolerated as long as it takes place in Kyiv. Once the criticism starts echoing in Brussels, it will be a particularly bad sign for Ukraine, since it could erode unity within the EU over Ukraine.

The timing of this criticism is primarily related to expectations about the delivery of reforms that have not been met, whereas the EU finally delivered on its commitments, specifically the visa-free regime and ratification of the Association Agreement. In the past, the absence of these two results kept Brussels from heavily criticizing Kyiv, as the EU itself was guilty of delaying on its commitments.

In order to avoid more criticism from the EU, Kyiv will likely make an effort to deliver on certain reforms that will have a limited impact on the positions of the current political elite. Ukraine will try to buy some time on more complicated reforms that are related to sensitive issues such as fighting corruption, the moratorium on exports of timber, and so on. As a result, around half of required reforms will be implemented in order to show progress while the dysfunction surrounding politically sensitive areas will remain.


EU Carrots and Sticks

The mismatch in expectations and actions between the EU and Ukraine could result in attempts on the part of Brussels to find additional stimuli. Such instruments could include delaying disbursement of its third EUR 600 million macro-financial tranche. At the beginning of April 2017, Brussels disbursed the second tranche without the necessary conditions in place, as described in the EU-Ukraine Memorandum of Understanding, on the lifting of the moratorium on timber exports. In Brussels, the decision to push for the disbursement of EUR 600 million, despite Ukraine’s failure to meet the agreed conditions, was associated with European Commission Vice President Valdis Dombrovskis.

The third EU disbursement, which should take place at the latest in October, has a long list of conditions for Ukraine to meet. First of all, it includes the reforms identified in the MoU and the list of issues that was compiled after the memorandum was signed. Currently, among many issues on the table, few are very important, but lifting the moratorium on timber, relaunching the work of the National Agency for Corruption Prevention, and issuing benefits to internally displaced people (IDPs) are among the issues that are regarded as crucial. If the EU does not disburse the third tranche by October, the funds will return to the EU budget and could be earmarked for other needs. Since Ukraine already well behind schedule, Kyiv might find it difficult to deliver on these reforms, even if it would like to do so.

The overall macro-financial assistance of EUR 1.8 billion is the biggest the EU has ever provided to a non-member country. For Ukraine, the third tranche of EUR 600 million is not a critical issue, especially with national currency reserves having reached a stable value. However, any EU decision to withhold the funds would be a bad signal for Ukraine. Economic actors interested in Ukraine would certainly interpret it as a rollback of reforms. This means Ukraine will have to fight for the third tranche for reasons not necessarily related to its direct financial value, but due to the potential reputational damage it could cause.

Nevertheless, if Ukraine does not at least partly deliver on reforms, the country will continue to lose credibility among international supporters, and that could have major consequences in 2018. The EU could even change its broader discourse in relation to Ukraine. Some signs of this possibility have already been observed, with EU officials speaking increasingly about “rapprochement” rather than “integration”, suggesting a weaker appetite for Ukraine engagement in Brussels.

On the positive side, two important laws have been passed by Ukraine’s parliament relating to the electricity market and the Energy Efficiency Fund. The first of these brings into force the standards of the Third Energy Package, which would create a properly functioning electricity market and regulate relations between electricity generation, supply, transportation, and distribution. The second law set up an Energy Efficiency Fund. The passage of this law led to the disbursement of EUR 100 million from the EU to help launch the Fund. The Fund’s aim is the modernization of residential buildings that will save about US USD 3 billion if implemented properly.


Corruption Complaints Unresolved

Fighting corruption remains one of the key reforms demanded by the EU and warrants special mention. Since the Euromaidan Revolution, Ukraine has taken some serious steps to set up the necessary institutions. It must now make these institutions fully operational. One of the main issues on the EU-Ukraine agenda in this area has been independence and functionality of the National Anti-Corruption Bureau of Ukraine (NABU).

Of all issues related to NABU, two are particularly noteworthy. The first one is the NABU audit, which has been on the agenda since the beginning of the year. A negative audit would allow for the removal of current NABU Director Artem Sytnyk and appointment of someone who is “more loyal” to the powers that be. So far, however, a team of NABU auditors has not been put together, although several attempts have been made with no result. The EU has suspected political motives behind the selection process and has requested a transparent procedure. Recently, a number of EU officials such as Commissioner Hahn, the EU Ambassador to Ukraine Hugues Mingarelli, and MEPs Rebecca Harms and Petras Austrevicius have called for depoliticizing the audit selection process and making it transparent.

The second big issue is granting NABU the right to tap phones. This point was agreed earlier, but so far has not been implemented. The political class seems to be afraid of giving such a tool to an institution it does not control, since some politicians are scared of falling foul of NABU. It is likely that the right to tap phones would significantly improve NABU’s chances of collecting conclusive evidence. The EU has called many times for NABU to have this power without result.

Another anti-corruption issue is reforming the Office of the Prosecutor General. The EU Advisory Mission (EUAM) to Ukraine has openly criticized Prosecutor General Yuriy Lutsenko for impeding reforms, as demonstrated by the fact that he disbanded the unit in charge of the reform process. Lutsenko is in a difficult position, given that he is loyal to a president who appears very reluctant to carry out hardcore reforms at the Prosecutor General’s Office, while imitating the reform process and even delivering the occasional element in certain instances.

Unlike Ukrainian officials, the EU considers the Prosecutor General ineffective because the office has produced few results. However, this problem will have to be handled by President Poroshenko himself, since he appointed Lutsenko and convinced Ukraine’s international partners, especially the US and the EU, that PG reforms had not been taking place before precisely because the previous prosecutors were insiders, while Yuriy Lutsenko was an outsider with no special relations to the office. This theoretically gave him a free hand in reforming the institution, but it has yet to produce results.


Freer Trade

The EU and Ukraine have seen progress on temporary trade preferences for Ukraine in recent months. These trade preferences have been introduced for a period of three years and cover a number of additional import quotas at zero tariffs for agricultural products including honey, tomatoes, grape juice, oats, wheat, maize, and barley. The EU has also decided to completely drop import duties on several industrial products such as fertilizers, dyes, pigments and other coloring matters, footwear, copper, aluminum, and television and sound-recording equipment.

Additional import quotas at zero tariffs are an important step on the part of the EU aimed at correcting imbalances in its Deep and Comprehensive Free Trade Area (DCFTA) with Ukraine. Ukraine has been rightly complaining that the DCFTA put a lot of pressure on the country’s economy while offering very difficult conditions for competing with EU companies. The quotas initially proposed by the European Commission were better for Ukraine than the ones actually voted by the European Parliament. The initial quotas were agreed with the EU, but then the Ukrainian parliament decided to increase export tax on scrap metal, which caused the EU legislature to change its mind. For some countries, Ukraine’s mistake offered a good pretext to skate away from the initial offer. Countries like France were reportedly against it, and such a position was outlined by the previous French administration. Surprisingly, the biggest opposition actually came from Poland, a country that has traditionally acted as Ukraine’s advocate, and from Hungary. Some officials reported that Romania had also voiced concern. Many EU countries are uneasy about the country’s agricultural potential since, according to government statistics, Ukraine was one of the top three suppliers of agricultural products to the EU in 2016. The potential for Ukraine’s farm sector is indeed huge.

Today, 281 Ukrainian companies have the right to export to the EU market, 101 of which are food-related. In Q1 2017, exports of Ukrainian goods rose 24.5% compared to Q1 2016. In 2016, total exports to the EU amounted to 40% of all exports, making the EU the number one destination for Ukrainian products. What’s more, some of the most underperforming domestic industries finally started to make inroads into the EU market in 2017. The prime example is Motor-Sich, which signed a contract to supply a German company with 100 helicopter engines. If Ukrainian companies can adapt to the EU market, this could be the beginning of a very productive relationship, as the full-bore DCFTA only comes into effect in about 7 years.

Despite such positive trends in trade, no major investments are expected from EU partners. For example, in 2016 only 1% of the annual privatization plan was actually carried out, which is equivalent to UAH 190 million of a projected UAH 17 billion windfall. Privatization was postponed to 2017, but it is very unlikely that it will actually take place at all this year, partly because of Ukraine’s low business ratings with S&P, Fitch and the World Bank’s Doing Business Index. These negative assessments keep foreign investors away from the country.


Beyond Visa-Free Travel

The EU finally delivered on the Association Agreement (AA) in mid-2016, ratification of which was long delayed by the Dutch referendum a year ago. It is expected that the AA will fully enter into force by 1 September 2017. The process of ratification took a long time, but the decisive moment actually took place on 15 December 2016, when the EU Council made a decision intended to appease Dutch voters and guarantee that the AA does not offer Ukraine membership in the EU or involve military commitments to defend Ukraine.

Ukraine has proposed a new format of “enhanced” association for “advanced” countries in the Eastern Partnership: namely Ukraine, Moldova and Georgia. The proposal was received with skepticism in the EU. Commissioner Hahn noted that there was no consensus on Ukrainian Foreign Minister Pavlo Klimkin’s proposal within the EU. The EU insists on the implementation of Ukraine’s current commitments. Only then will it consider discussing “enhanced” association. From Ukraine’s perspective, Klimkin’s proposal makes sense as the two key carrots offered by the EU have been eaten and Ukraine needs motivation to continue its efforts.

The visa-free regime, the main tangible nationwide component of EU integration, finally entered into force on 11 June. Ukrainians warmly welcomed the event but that did not prevent ongoing animosities between Brussels and Kyiv. Controversy arose when President Poroshenko stated that visa-free travel to the EU was not available to people from the occupied territories—a statement the EU strongly refuted and saw as an attempt to establish a new dividing line. Ukrainian sources were quick to point out that the statement was based on a fear that holders of Ukrainian passports residing in Occupied East Ukraine might travel to the EU and stage provocations that could hurt Ukraine’s reputation.

Ukraine was not disappointed about the vote to extend EU sanctions against Russia, which are now in force until 31 January 2018. In mid-June, Ukrainian officials were discreetly expressing concern over reports that Italy might attempt to block the extension. However, it appears that the briefing given by Angela Merkel and Emmanuel Macron on the implementation of Minsk at a summit of heads of state in Brussels was enough to convince EU members to extend the sanctions. Originally President Poroshenko wanted the extension to last for a year, not six months. But that was not possible because EU members believe that a half-year provides more incentive.

Over the coming year, the EU’s Ukraine focus looks likely to remain firmly on reform efforts, with particular attention towards healthcare, pensions, land ownership and privatization along with the overarching efforts to make sure anti-corruption institutions function properly. For Ukraine, the biggest challenge will be maintaining what little reformist momentum the country has managed to generate, now that the two biggest EU carrots – the Association Agreement and visa-free travel – have been achieved. New motivational tools may be required to produce new results.


This article is based on a more detailed report produced by the Institute of World Policy in cooperation with the Truman Agency

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