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Dec 31, 2014 | 10:00 GMT

9 mins read

The Tumultuous Birth of the Eurasian Economic Union

The Tumultuous Birth of the Eurasian Economic Union
(MAXIM SHIPENKOV/AFP/Getty Images)
Summary

On Jan. 1, 2015, the Eurasian Economic Union will formally come into effect. The new economic bloc will include Russia, Kazakhstan, Belarus and Armenia, with Kyrgyzstan expected to join in May 2015. At its heart, the Eurasian Economic Union is part of Russia's attempt to create buffer zones in the former Soviet Union in which Russian influence is entrenched and other powers — particularly the West — are kept out. The Eurasian Economic Union was designed to boost Russia's economic ties and influence in the region.

The launch of the bloc was envisioned as the pinnacle of Eurasian economic integration and growth. However, the long-planned economic group will come into being just as its new member countries begin facing the regional effects of Russia's ongoing economic troubles and as Russia's financial constraints threaten to limit its ability to give economic support to countries in its periphery. Although Russia could rebound economically, and the Eurasian Economic Union could ultimately provide tangible benefits to its member states, Russia's ongoing economic problems will have both political and economic repercussions for the bloc's members. 

The Eurasian Economic Union is the outcome of a series of agreements and integration efforts among some of the former Soviet states. Discussions regarding a Customs Union began in 2006, and the Customs Union of Russia, Belarus and Kazakhstan came into effect in 2010. The same three countries launched a Single Economic Space in 2012. The Eurasian Economic Union builds on the foundations of these initiatives, with integration efforts spanning trade, energy, industry and competition and transport regulations. Policymakers in the region have envisioned an economic bloc with the free movement of goods, services and labor. Like the European Union, the Eurasian Economic Union provides a large-scale bureaucratic structure, which includes more than 23 different departments. The Eurasian Economic Union requires unanimity for major decisions, but like the Customs Union the new bloc leaves much room for informal political bargaining and exemptions based on domestic economic and political considerations.

The circumstances of the Eurasian Economic Union's launch are starkly different from those envisioned by the Kremlin when it set out to build an economic union that could expand and solidify Russia's influence in the region. Russia's currency, the ruble, has lost more than 40 percent of its value since the beginning of the year, leading the Central Bank of Russia to spend billions of dollars in an attempt to support the currency's value. Meanwhile, as it tries to limit the effects of the crisis on Russia's consumers and businesses, the Kremlin has introduced plans for a duty on wheat exports, issued orders forcing the country's leading exporters to sell portions of their foreign currency reserves, and allocated funding to help finance Russian firms and banks.

Russia's economic troubles are already creating problems for currencies, inflation levels, remittances and trade patterns in the new economic bloc's member states. Nevertheless, these countries highly value their relationships with Russia and Russia's ability to provide them with investment and funding. Thus, they will take the risk that comes with closer ties to the Russian economy.

Belarus

Belarus has benefited greatly from its participation in economic integration projects with Russia. Between 2009 and 2013, Belarus' exports to Russia more than doubled, and its exports to Kazakhstan nearly tripled (though the volume of exports to Kazakhstan has remained relatively modest). Belarus has selectively implemented Customs Union regulations, employing its right to claim some exemptions and bargaining with Russia for compliance — in some cases in exchange for loans and investment.

However, Belarus, which depends on Russian firms and consumers to purchase about 40 percent of its exports, has absorbed most of the political and economic fallout from Russia's economic problems. Three days after the Russian central bank's Dec. 16 decision to increase its benchmark interest rate from 10.5 percent to 17 percent and the ensuing fall in the price of the ruble, which hit record lows, Belarus ordered firms to sell 50 percent of their foreign currency reserves and declared a 30 percent fee on the purchase of foreign currency, though this was lowered to 20 percent on Dec. 29. In the following days, the country's stock exchange shut down temporarily, and the websites of some online stores and news sites were blocked. As Belarusian residents rushed to use their Belarusian rubles, sales of goods such as refrigerators and washing machines reportedly doubled.

The economic disruptions in Belarus caused by the Russian ruble's fall ultimately affected the country's political system. Belarusian Prime Minister Mikhail Myasnikovich directly connected the increased "panic demand" for foreign currencies to Belarus' membership in the economic union with Russia, saying on Dec. 22 that devaluations or inflationary shocks in one member of an economic bloc spread throughout the union immediately. On Dec. 27, Belarusian President Aleksandr Lukashenko fired Myasnikovich and National Bank head Nadzeya Ermakova, as well as several ministers. This high-level reshuffle is typical of Belarus' Soviet-style administration system, particularly during times of economic hardship. Similar reshuffles are likely in other Eurasian Economic Union member states as economic challenges continue.

Kazakhstan

Kazakhstan has experienced mixed outcomes as a result of its participation in Russia-led economic integration projects. When Kazakhstan joined the Customs Union and adopted the common external tariff in 2010, the country's average tariff rate on imports rose by nearly three percentage points, from 6.7 percent to 9.2 percent, in 2010. Nevertheless, Kazakhstan was able to negotiate exemptions for a range of goods. Moreover, while joining the Customs Union did boost Kazakhstan's trade volumes overall, the country's exports to both Russia and Belarus declined between 2008 and 2013, indicating that increased tariffs on imports and deeper integration with the Russian and Belarusian markets made Kazakhstan's exporters less competitive within the Customs Union.

Although Kazakhstan continues to export relatively small volumes to Russia, the fall of the ruble directly affected the Kazakh economy and monetary system. Membership in the Customs Union — and now in the Eurasian Economic Union — as well as Russia's role in the Kazakh banking and finance sectors has made Kazakhstan more vulnerable to Russian economic downturns. In February, the depreciation of Russia's ruble was one of the factors that led Kazakhstan to devalue its currency, the tenge, by 19 percent. In mid-December, the tenge reached record highs against the Russian ruble. As a result, Kazakhs reportedly rushed across the border to Russia to purchase goods. Official statistics are not available, but industry figures estimate that Kazakhstan has spent about $3 billion since the summer to help support its currency in the face of a rapidly falling Russian ruble.

Moreover, in response to the Russian central bank's Dec. 16 interest rate hike, Kazakhstan's central bank temporarily raised its interest rate for commercial banks from 2.75 percent to 3.05 percent. On Dec. 24, the National Bank of Kazakhstan doubled its deposit guarantees. As the ruble fails to reach its earlier strong value, despite some modest gains, some consumers and businesses within Kazakhstan expect a second devaluation of the tenge. Another devaluation could fuel protests at a time when Kazakhstan, currently under the leadership of aging President Nursultan Nazarbayev, could be facing a leadership transition.

Armenia

For Armenia, economic integration with Russia, Belarus and Kazakhstan will bring both risks and rewards. Membership in the Eurasian Economic Union will bring Armenia more trade and investment, as well as financial assistance, from Russia. Moreover, accession to the Russia-led economic bloc will cement Armenia's position in Russia's camp, thus securing greater political and military support for Armenia in its long-standing conflict with Azerbaijan over Nagorno-Karabakh.

However, membership in the Eurasian Economic Union will harm Armenia's economic ties with countries outside the bloc, such as Iran and EU member states. Integrating economically with the union also brings political risks. Some opposition groups — though thus far not the main opposition political parties — have already protested Armenia's accession to the bloc, and as Russia's economic problems continue, questions about the advisability of Armenia's decision could proliferate among different domestic constituencies.

Although Armenia is not formally integrated with the Customs Union, Russia's economic troubles already have had a tangible impact on Armenia's economy. Throughout the year, as the ruble has lost its value, Armenia's currency, the dram, has also depreciated, reaching a 12 percent loss against the dollar since January. Inflation in Armenia has risen, and prices in some stores increased by 30 to 40 percent. Armenia generally receives about $2 billion worth of remittances from Armenians working in Russia. As the ruble's value slid, the value of these remittances nearly halved. Further integration with Russia will increase Armenia's exposure to Russian economic downturns.

Kyrgyzstan

Kyrgyzstan was scheduled to join the Eurasian Economic Union on Jan. 1, 2015, but accession has been postponed until May 2015. Joining the economic bloc will give Kyrgyzstan access to new funds to restructure and develop its economy. Russia and Kazakhstan will provide $200 million and $100 million, respectively, for improving customs posts, and a $1 billion Kyrgyz-Russian Development Fund has been created. These financial efforts to aid Kyrgyzstan are designed to help the country manage the negative aspects of its integration with the Eurasian Economic Union. Moreover, Kyrgyzstan's hope is that, while it will raise external tariffs to match those of the rest of the union's members, its lower value-added tax and income tax rates will attract investment from Russia. As a member of the Eurasian Economic Union, Kyrgyzstan also will be eligible to receive aid from its partners to secure and strengthen its borders.

However, these expected benefits come with a cost for Kyrgyzstan's economy. Higher external tariffs will greatly harm Kyrgyzstan's lucrative re-export trade of Chinese goods to former Soviet states — a situation that could double unemployment in the country. Politically, accession has been met with criticism from opposition politicians, nationalists and civil society leaders, who fear everything from a loss of national sovereignty to the rising inflation associated with tariff hikes.

Kyrgyzstan is a small country that is highly dependent on remittances from Russia. Thus, Russia's ongoing economic problems have significantly affected Kyrgyzstan's economy. Thirty-three percent of Kyrgyzstan's gross domestic product depends on remittances from Russia, and the rapid decline in the value of Russia's ruble reportedly has decreased the value of these remittances by 30 to 40 percent. The country's international reserves decreased by 12 percent in the first 11 months of 2014 as Kyrgyzstan's national bank attempted to support the country's currency. Re-exports to Russia have declined, and the International Monetary Fund projected that the country's growth rate will shrink from 10.5 percent in 2013 to merely 3 percent in 2014. Inflation reportedly will rise to about 10 percent this year. While Kyrgyzstan is unlikely to forgo the benefits of Eurasian Economic Union membership, integration with the economic bloc will tie the country's economic fortunes more firmly with those of Russia.

The future of Russia's economy and the way in which the Kremlin addresses the country's ongoing economic challenges likely will shape the Eurasian Economic Union's trajectory. The Russian government's management of its currency, in particular, will be important as the ruble's volatility affects the economic bloc's new members via lower remittances, decreased demand for exports to Russia, rising inflation and, at times, a depreciation of their own currencies.

For the Eurasian Economic Union's new members, deeper economic ties with Russia herald the prospect of new investments, loans and funding. However, the state of Russia's economy and the vulnerabilities that come with further integration with Russia will be key as these countries' governments and publics assess their new status as members of the Eurasian Economic Union, and as other countries in the former Soviet Union consider the advisability of joining the Russia-led bloc.

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