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Geographic distribution of exports

As discussed extensively in previous chapters, the trends in geographic reorientation of Ukrainian exports since the start of transition have not been consistent. The initial shock created by the collapse of the USSR was associated with a sharp decline of trade among FSU republics and an increase in the role of the rest of the world and, for Ukraine, the EU in particular (see Figure 3 on p.45). The role of the EU has been on the rise and by 1999 the EU-15, along with the twelve EU candidate countries, was the top destination region for Ukrainian exports. In 2005, however, the trend reversed and CIS regained its position as a dominant market for Ukrainian products. Since then the share of the EU has not recovered, while that of the CIS has been continuously rising. Among the rest of the world some of the most important trade partners are China, Turkey and the United States (see section 3.2.3 on p.

52 for a more detailed discussion). While the primary focus of this chapter is to explore the role of regional trade agreements in determining Ukraine’s exports, the effect of China and Turkey as significant partners is also controlled for.

Commodity composition and high resource-dependence

The commodity composition of Ukrainian exports is dominated by resource-intensive products, in particular iron and steel. As Figure 7 on p. 51 shows, the share of base metals and

articles thereof consistently comprises 35-40 percent of total world exports. The commodity structure of exports is not analysed in this chapter, as this is done in detail in Chapter 3, but given the domination of the steel industry, it is important to distinguish between total and non-steel exports in this analysis, in order to avoid generalising the results where they may be distorted by one commodity. The study therefore compares the effects of external and internal regional trade agreements for total and for non-steel exports.

1998 financial crisis, exchange rate and external sector

In 1998 both Russia and Ukraine were hit by financial crises, which had an impact on the subsequent evolution of their external sectors, and economies in general.

The negative investor sentiment in the aftermath of the 1997 Asian financial crisis resulted in massive capital outflows from Russia and Ukraine, which had been pursuing unsustainable government debt levels (mainly in high-return short-term treasury bills). In order to restructure and repay where possible this debt Ukrainian government had to borrow heavily from the National Bank (NBU). At the same time the NBU was selling foreign exchange on the market to support hryvnia. This was unfeasible for the foreign exchange reserves and in September 1998 the NBU stopped its interventions and allowed hryvnia to float. Russian rouble, however, depreciated even further (see Figure 19 below – while depreciating against the US dollar and the euro, hryvnia appreciated relative to the Russian rouble). This relative appreciation of the Ukrainian currency against the Russian rouble, combined with the negative economic growth and the fall in aggregate demand for imports in Russia, triggered a partial redirection of Ukrainian exports towards countries offering better terms of trade. Thus, exports to the EU-27 and to Asia and the Middle East continued to grow.

Although being a strong shock for the economy, in the medium-term the depreciation of the hryvnia improved Ukraine’s external competitiveness and spurred exports. Given the need to diversify exports, which were highly concentrated on the CIS market and Russia in particular, the shock was also beneficial for the geographic export structure. At the same time, since 2002 the National Bank of Ukraine has been following a policy of de facto fixed exchange rate, which, as theories promoting stable exchange rates would predict, may have had a positive effect on the growth of exports.

Figure 19. Real effective exchange rates of Ukrainian hryvnia (CPI-based), 1996=100

Note: downward trend means appreciation of the REER, and increasing – depreciation.

Source: World Bank (2004) Exports and GDP

Since one of the main explanatory variables in gravity-type models is GDP, the growth rate of real exports is compared below to the growth of real GDP (in constant 2000 US dollars).

Some correlation between exports and GDP can be observed, and although in recent years growth has been mainly due to the increased consumption and investment, growth in 2002-2006 was also boosted by the terms of trade improvement, due to higher global steel prices and improved competitiveness due to real exchange rate depreciation (OECD, 2007). ⁷⁵

75 However, as will be explained below, in our model we do not explore the causality between exports and Ukrainian economic growth and vice versa, primarily because in one-country setting the variance is mostly explained by the demand-side growth, i.e. growth of partner countries’ GDP.

Figure 20. Growth rates of real exports and GDP, % change year-on-year

Source: WB World Development Indicators for GDP data, IMF DOTS for exports

The period under analysis

The analysis in this chapter was undertaken in 2005/2006, when the latest available cross-country data was up to 2004. The fact that the data-set was manually created by the author makes it too time-consuming to update the analysis to include later years during the course of writing up this thesis. This will be done, however, should publication of this study be considered.

Global steel market developments as a factor in Ukrainian export performance

Before passing on to the discussion of the model and the results it is worth outlining briefly the developments on the global steel market, as the distinction between steel and non-steel exports is an important part of this analysis.

Figure 21 roughly outlines the main events from 1996 to 2004. The kick-off point to much of the recent steel prices dynamics was the 1997 Asian financial crisis – it decreased the demand for steel in the affected countries⁷⁶ and consequently the world steel prices. Ukrainian exports of steel in value terms were respectively declining between 1997 and 1999.

76 Thailand, Indonesia, South Korea were the countries where initial securities defaults started, Hong Kong, Malaysia, Laos, Philippines followed. China, Taiwan and Singapore were relatively unaffected.

-16.5

Total real exports, mln USD Ukraine's GDP, constant 2000 mln USD

Besides, in 1998-1999 Ukraine had to cope with a financial crisis of its own. The reaction of the markets to the price drop was to divert a lot of steel exports to the US and Europe. US reacted promptly by opening safeguard investigations in 2001 on 33 products and imposed high additional duties on 14 products in 2002, which was against WTO rules and was subject to criticism by the international community (Bendini, 2007). Therefore Ukrainian steel exports declined again slightly in 2001 (not significantly, due to relatively low share of the US). Besides, in 2001 the EU, fearing being flooded with products that could no longer be exported to the US, also took safeguard measures, which did not, however, concern Ukraine, as with Ukraine, Russia and Kazakhstan the special regimes apply, with quotas being negotiated annually (European Commission, 2002).

Since 2001-2002 the world steel market, and particularly price movements became defined by the Chinese economy – while its steel consumption had been growing by 2.6 percent per year in the period 1995-2002, since 2002 it has been growing by some 25 percent per year. To compare, in the rest of the world since 2001 the average annual growth of steel consumption has been 2.1 percent per year.

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Figure 21. Global steel market developments and Ukrainian exports of steel to the World Source: Steel prices:www.cruspi.com , Ukraine’s steel exports – UN Comtrade Database, author’s research_G^lob

al SPI UA steel X to World 0

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1997: Asian financial crisis: D for steel in Asia falling, as do world steel prices 1998-2001: a lot of steel exports diverted to US and EU

2001: US introducing quotas to cap imports of steel – Steel P falling China’s steel consumption is skyrocketing – world steel P going up

2002: EU follows the US in responding to high steel imports: launches AD investigations, not affecting UA 2003: EU cutting down UA’s quota in response to UA increas. scrap X duty

Figure 22shows the acceleration of China’s steel imports since 2002 (OECD, 2004). Partially because of this, when in 2003 the European Union cut down Ukraine’s quotas on certain steel products by 30 percent to 184,500 tonnes per annum, it did not affect Ukraine’s aggregate steel exports. The steel exports to China doubled in 2003, but other markets, in particular South East Asia and Middle East, were dynamically gaining importance for Ukraine as well (See Annex 7).

Figure 22. Chinese Steel Trade

Source: OECD (2004)

Below follows the description of the theoretical foundation of the analysis, which aims to disentangle the effects on exports of regional trade groupings of immediate concern to Ukraine – the CIS, with its network of bilateral free trade agreements, and the EU, as a big neighbouring bloc granting duty-free access to the insiders, and potentially causing a trade diversion effect to the outsiders.