Why The Economies Of Ukraine and Russia Are Nearly Inseparable
20 March, 2015

Ukrainian-Russian Business Ties, Explained.

A Russian gas pipeline in Ukraine (Photo: Bloomberg)


What You Need to Know:

✓ Russia and Ukraine’s territorial proximity and integrated Soviet-era economy means that both countries’ economies are largely intertwined;

✓ Even if Ukraine’s moves towards Europe are largely successful, Ukrainian and Russian business ties will almost certainly remain strong;

✓ Despite a ‘hybrid war’ between Russia and Ukraine and international sanctions against Moscow, these economic links are still vital for both countries, and particularly for Ukraine;

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Why Economies Of Ukraine and Russia Are Almost Inseparable

In Short

Despite a contemporary war and break down of bilateral relations between Ukraine and Russia, Russian-Ukrainian economic ties remain an important aspect of relations between both former Soviet republics. While bordering states often share close trade and business relations as a result of geographical proximity, Ukraine and Russia’s joint imperial and Soviet economies compound what would naturally result in close economic links. Ukraine remains Russia’s largest trading partner in the former Soviet space, while Russia is still Ukraine’s important economic partner. With a shared economy under the Soviet system, many Russian industries continue to rely on Ukrainian imports and assistance, and vice versa. While some Ukrainians saw the Maidan revolution as a way to free their country from the grasp of Russian influence, especially in the energy sector, economic links in Russia will most likely continue to be an important cornerstone of the country’s economic well-being.

A segment of Russia-Ukraine border. (Photo: Ukraine’s State Border Guard Service)

Quick Breakdown Of Russia-Ukraine Economic Ties

Given Russia and Ukraine’s 1500 kilometer long and largely unsecured border, economic links between both states are bound to be an important crux of both countries’ foreign trade and business relations. Seeing as both countries co-existed in a single state as part of a unified economic whole as recently as twenty-five years ago, Russian-Ukrainian economic ties are compounded by co-dependent supply chains in specific industries and close personal business relationships that have largely survived and prospered through more than two decades of political separation. Even without considering Ukraine’s role as a key transit country for Russian natural gas to the European Union, both states share an important interdependent trade relationship. Until the current Ukrainian crisis, there has been little effort from Kyiv to diversify the economy and reduce dependence on Russia.

In 2013, 5% of Russia’s imports consisted of Ukrainian products. Among former Soviet states, this makes Ukraine Russia’s most important trading partner. In addition, 24% of Ukrainian exports went to Russia in the same year.

Given the disparate sizes of the Ukrainian and Russian economies, Ukraine is much more dependent on trade with Russia than vice versa. 

A map of Russian natural gas pipelines traversing Ukraine.

Energy Ties

Since independence, Ukraine has been particularly reliant on Russian energy imports. As one of the most energy intensive and inefficient energy markets in the world, Ukraine until recently fulfilled more than 50 percent of its energy demand in the form of Russian gas imports. Ukraine’s energy reliance has given Russia disproportionate political pressure over Kyiv. In the past decade, the Russian government has used gas pricing and gas shut offs to exert pressure on the Ukrainian government, most recently in the fall of 2014.

Ukraine’s dependence on Russian energy is compounded by energy subsidies that breed mismanagement and misuse. Ukraine is one of the most energy inefficient economies in the world. Like Ukraine, Russia’s economy is also overly energy intensive, but given the size of Russia’s economy and domestic energy sources, Moscow is in a better position to manage this dilemma.

Defense Industry Ties

Perhaps one of the most complicated and important links between Russia and Ukraine involve cooperation in the military sector. Under the Soviet Union, Ukrainian industry served a vital role in the USSR’s military industry, with industrial cities in the Ukrainian east serving as important suppliers of vital military equipment such as intercontinental missiles, components for Soviet aircraft, and particular weapons systems. When the Soviet Union collapsed, these ties in the defense industry remained. Russia still relies on Ukrainian imports for key components of various military systems, including engines for Russian transport helicopters.

In the midst of war, Ukrainian military exports to Russia have been compromised. With Ukraine worried that exports to Russia might be used to undermine Ukrainian sovereignty, President Poroshenko signed a decree back in June of 2014 stopping cooperation in the military industry, and effectively preventing Russia from importing vital equipment. The Russian government estimates that it will need to spend nearly $1 billion USD to offset losses from the severing of defense industry cooperation with Ukraine.

Ukraine’s defense industry relationship with Russia is also important for the Ukrainian economy as well, and the new political dimension to this field of joint ties is also undermining key Ukrainian exporters.

Economic Ties Continue Through the War

Considering that Ukraine and Russia are in an unofficial state of war, it’s probably unsurprising that trade and other links, including personal business ties, have taken a big hit. Trade between Ukraine and Russia first started to sink when Russia banned the import of targeted Ukrainian goods in the summer of 2013, a move that the Russian government said was apolitical but many saw as an attempt to dissuade Ukraine from moving closer to a free trade agreement with the European Union. Since the overthrow of former President Yanukovych and the current conflict between Russia and Ukraine, both Russia and Ukraine have hit each other with trade sanctions of their own, including Ukraine’s ban on military exports to Russia.

Following the annexation of Crimea, Russia removed gas subsidies formerly guaranteed to Ukraine, shutting off deliveries when Ukraine refused to pay the higher prices. While a deal to resume gas deliveries was eventually brokered with the help of the European Union in late October, Ukraine has announced its intention to completely wean itself off Russian natural gas imports. In the early days of 2015, top figures in the Ukrainian government, including Prime Minister Arseniy Yatsenyuk, have announced Ukraine’s intentions to eventually meet all of its energy needs without Russian imports. In addition, Kyiv plans to meet 60% of its energy import needs from Europe in 2015, with the remaining 40% coming from Russia. This is a significant difference from 2013, when all of Ukraine’s imports and 58% of Ukraine’s total energy needs were covered by Russian imports.

Projecting the Future

Regardless of which direction the Russia-Ukraine bilateral relationship turns, and the need for Ukraine to orient its economy westward, a healthy Ukraine will naturally have business links with Russia as a result of the long joint border, interpersonal ties, and past economic integration. Even now, despite the war in the Donbas between Russia and Ukraine, the Russian Federation is still Ukraine’s single-biggest trade partner. Trade with Russia totaled 19% of Ukrainian exports and 25% of its imports, a far bigger share for the Ukrainian economy than any single country. This is despite a sharp decrease in bilateral trade in 2014.
With a free trade agreement between the European Union and Ukraine, it’s only natural that Europe will increasingly play a larger role in Ukraine’s external trade and overall economic well-being. Parts of the Ukrainian market lost by Russia will inevitably be filled by Europe. A substantial Ukrainian turn to Europe is likely according to many observers. As an example, Motor Sich, the Ukrainian aircraft engine manufacturer, is already in the process of altering its exports to other markets by signing contracts with Austrian and South African manufacturers.

Even despite the re-orientation of the Ukrainian economy, it’s difficult to imagine that Russia will not remain an important cornerstone of the country’s international trade. The Russian-Ukrainian military conflict, mutual sanctions, a re-orientation of Ukraine westward, and a breakdown in personal business relationships will take a toll. But, like the former Soviet and Soviet-allied countries of eastern and central Europe before it, bilateral trade might very well recover in the long-term.