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Ukraine may gain ‘short-term benefits’ by move east

Monday, 25 Nov 2013 | 9:14 AM ET
Danita Delimont | Gallo Images | Getty Images

Ukraine's rejection of a European Union trade deal, under pressure from the Kremlin, was met with dismay by Western powers that feared a halt to the country's democratization process. However, economic analysts said a move towards Russia and away from Europe could benefit Ukraine over the coming months.

(Read more: Ukraine drops plan to go West, turns East)

The former Soviet satellite state had been expected to sign a long-awaited free trade agreement with the EU later this week, after half a decade of preparation. But, the country struck a surprise move last week when it dropped out of the deal and announced its intention to focus instead on its relationship with the Commonwealth of Independent States (CIS) group of former Soviet countries — just hours after Ukrainian President Viktor Yanukovich reaffirmed his commitment to the EU treaty.

European officials were quick to attribute the U-turn to pressure from Russia, which has threatened to disrupt trade if the agreement were signed. And analysts said that in the near-term, the risk of punitive action by Russia outweighed the benefits of the EU deal — especially when coupled with reports of rewards in exchange for toeing the line, including a lowering in the price at which Ukraine imports Russian natural gas, and a much-needed loan.

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Ukraine's economy is in recession and suffers a gaping current account deficit of around 8 percent of GDP (gross domestic product) or $15 billion, and short-term external debt of over 30 percent.

"We understand from press reports that Ukraine's move back into the Russia/CIS orbit has been backed by sizable short-term financial support from Russia, which should help ease its external pressures, including a large current account deficit and significant foreign exchange payments of roughly $10 billion coming due," said Vladimir Pantyushin, an economist at Barclays Capital based in Moscow, in a research note.

Liza Ermolenko, emerging markets economist at independent research firm Capital Economics, said Ukraine would likely gain in the short-term from its move away from Europe.

"In terms of what a move towards Russia and away from the EU would mean for Ukraine's economy, in the short-term it would probably be positive. An EU Association Agreement would boost Ukrainian exports as it would eliminate most import and export tariffs on EU-Ukraine trade (the EU is the destination for 25 percent of Ukraine's exports). However, these benefits wouldn't come overnight," said Ermolenko in a report.

"In the meantime, by signing an agreement with the EU, Ukraine risks a trade war with Russia… With around a quarter of all Ukrainian exports going to Russia, any retaliation on the Kremlin's part would be costly for Ukraine," she added.

(Read more: Russia takes a page out of the US playbook)

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Meanwhile, the EU has called for Ukraine to reconsider the longer-term benefits of closer integration with Europe.

"While being aware of the external pressure that Ukraine is experiencing, we believe that short-term considerations should not override the long-term benefits that this partnership would bring. However the European Union will not force Ukraine, or any other partner, to choose between the European Union or any other regional entity… We therefore strongly disapprove of the Russian position and actions in this respect," said José Manuel Barroso, president of the European Commission and Herman Van Rompuy, president of the European Council, in a joint statement on Monday.

Ukrainians rioted over the weekend in central Kiev in protest over the scrapping of the EU deal. They demanded the release of imprisoned opposition leader Yulia Timoshenko, on whose liberation the EU treaty was contingent.

—By CNBC's Katy Barnato

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