Ukraine Pivots to Russia With Last-Minute Freeze of EU Plan

Ukraine opted to seek stronger ties with Russia, cutting off preparations for a European Union trade agreement a week before its scheduled signing would have capped almost six years of negotiations.

President Viktor Yanukovych’s government will focus on reviving trade with Russia and other former Soviet republics, it said yesterday. The decision is probably final, said Linas Linkevicius, the foreign minister of Lithuania, which holds the EU’s rotating presidency. Postponing the signature of the agreement “is not realistic,” he said by phone.

The EU and Russia, buyers of about a quarter of Ukrainian exports each, are jostling over relations with the country of 45 million people that’s an essential transit route for east-west energy shipments. The second-most populous ex-Soviet country is also crucial to the ambition of Russian President Vladimir Putin to set up a trading area to emulate the Brussels-centered bloc.

“There’s always a possibility to go back to negotiations but it will be more difficult to do so in the future,” Joerg Forbrig, senior program officer for Central and Eastern Europe at the Berlin bureau of the German Marshall Fund of the United States, said by phone yesterday. “The momentum was there and this has been lost now. The political momentum has been lost and it will be hard to recreate this.”

Ukraine’s Creditworthiness

The cost to insure Ukrainian debt against non-payment for five years with credit-default swaps rose 78 basis points, or 0.78 percentage point, to 1,003, the third-highest in the world after Argentina and Venezuela, according to data compiled by Bloomberg. The yield on the Ukrainian dollar bond due 2023 rose 8 basis points to 9.905 percent at 12:24 p.m. in Kiev.

The decision exposed a growing divide in the country over economic and political priorities. In a reflection of mounting tensions, thousands of protesters took to the streets in near-freezing temperatures in Kiev last night over the government’s move, with opposition parties calling on Ukrainians to march in the capital on Nov. 24 to show their support for the EU agreement.

Backing for membership of the 28-nation bloc is at 58 percent, according to a poll of 1,000 people this month by researcher IFAK Institut GmbH & Co. It gave no margin of error.

Revolutionary Anniversary

Opposition leaders including world heavyweight boxing champion Vitaly Klitschko spoke and bands performed songs at the rally in Kiev last night, which was attended by about 2,000 people, private television broadcaster Channel 5 reported. People plan to gather for another rally tonight. Today marks the ninth anniversary of the start of the Orange Revolution, which was led by jailed ex-Premier Yulia Tymoshenko and helped overturn Yanukovych’s presidential victory in 2004.

“The European bloc has been facing a rival in Russia all along this process,” Lilit Gevorgyan, an analyst at IHS Global Insight in London, said by e-mail. “From a geopolitical perspective, any delay of the agreement with Ukraine will be a serious setback for the EU’s diplomacy.”

European governments had urged Ukraine to sign association and free-trade agreements at a Nov. 28-29 summit in the Lithuanian capital of Vilnius. Russia, which supplies 60 percent of Ukraine’s natural gas, threatened trade measures if the deal went ahead, offering membership of its customs union as an alternative.

U.S. Disappointment

The U.S. is “disappointed” in the decision, State Department spokeswoman Jen Psaki told reporters yesterday.

“We believe there was ample time to resolve all remaining obstacles to signing the association agreement in Vilnius with sufficient effort and commitment,” Psaki said.

While Yanukovych reiterated yesterday that his country’s goal is European integration, lawmakers repeatedly failed to pass a bill to allow Tymoshenko to travel abroad for medical treatment, a key EU condition for the trade accord to proceed as the bloc deems her imprisonment a case of selective justice.

The Ukrainian leader “can take leadership and take a decision at any time -- but really, it’s maybe more theoretical,” Linkevicius said in a telephone interview yesterday. “Time is not on our side due to many reasons. To postpone a decision, I’m afraid, could mean no decision at all, no signature at all.”

If EU officials sounded subdued, the Russian reaction was more exuberant. Putin’s spokesman, Dmitry Peskov, told reporters in Moscow that the decision was the demonstration of a “desire to improve and develop economic cooperation.” Putin earlier denied opposing Ukraine’s trade deal, though he said trilateral talks must come before a decision is made, the Interfax news service reported.

Ukraine’s Motives

Ukraine’s motivation for suspending preparations for the EU treaty was “purely economic,” with the government making the “only possible” choice in the situation, Prime Minister Mykola Azarov told lawmakers in Kiev today. A decline in trade with Russia has led to falling industrial production, “pushing Ukraine to the edge of huge social and economic troubles,” he said.

Speaking over chants of “Shame!” by opposition lawmakers, who attempted to keep him from speaking, Azarov said a Nov. 20 letter from the International Monetary Fund tipped the balance for Ukraine.

“The last straw that broke the camel’s back was the IMF’s position,” Azarov said. “They offered to provide us with a loan equal to what we have to repay them. At the same time they demanded to double utility prices, freeze salaries, and cut budget spending.”

Third Recession

Ukraine entered its third recession since 2008 in the second quarter as demand for its steel exports shriveled, while reserves have plummeted. Joining Russia’s customs union would shrink its current-account gap by cutting energy costs.

The reasons may have been more complex, according to former Polish President Aleksander Kwasniewski, one of the EU’s main negotiators with Ukraine. While economic difficulties contributed to yesterday’s decision, “unprecedented pressure” from Russia also played a part, he said.

“Russians tapped the whole arsenal of possibilities they have in Ukraine,” he told Poland’s TVN24. “All Ukrainian presidents will want to balance between their big eastern neighbor and the West.”

Yanukovych told his Lithuanian counterpart Dalia Grybauskaite that Russia threatened to suspend imports from industries in eastern Ukraine, potentially causing massive losses and affecting hundreds of thousands people, the Baltic News Service reported, citing Grybauskaite’s adviser, Jovita Neliupsiene.

Darka Chepak, Yanukovych’s spokeswoman, didn’t answer her mobile phone when Bloomberg News called for comment.

‘Brazen Pressure’

Similar accusations were leveled at the EU in Moscow, where Foreign Minister Sergei Lavrov said this week it was the trading bloc that put Ukraine under “brazen pressure” to choose between Russia and the 28-member bloc.

Kwasniewski and his co-negotiator Pat Cox, a former head of the European Parliament, urged EU leaders to reassure Ukrainians that “the door will not be shut,” according to an e-mailed statement yesterday. They also recommended to “maintain active vigilance” over Tymoshenko’s conditions.

Yanukovych, whose 2004 victory in a presidential ballot was overturned amid the Orange Revolution that Tymoshenko helped lead, has accused her of involvement in crimes including a murder, claims she denies. He defeated Tymoshenko to become president in 2010 after serving two stints as premier.

Yanukovych’s Fears

“Yanukovych clearly fears releasing Tymoshenko” before presidential elections in 2015, Luis Costa, an emerging-markets strategist at Citigroup Inc. in London, said by e-mail. “It’s time to partially take profits in Ukrainian bonds for those who bought at the lows a couple of months ago.”

That means the EU’s ambitions to cement Ukraine’s place in its orbit fell victim to the trading bloc’s maneuvering, said Alexei Pushkov, head of the foreign-affairs committee in Russia’s lower house of parliament. Ukraine halting preparations to sign the pact is “logical,” with the Tymoshenko demand representing “a mine the EU laid itself,” he said.

“Setting Tymoshenko free would have given the EU a chance to work against Yanukovych in 2015 elections, and ‘‘for a political leader, this is suicide,’’ he said by phone.

Yanukovych trails Klitschko in polls for the presidency. Opposition parties are organizing a demonstration for Nov. 24 to back stronger EU ties.

Negotiating Ploy?

Regardless of the political backdrop, Ukraine’s actions may be a negotiating ploy to help garner financial aid, according to Liza Ermolenko, an emerging-markets analyst at London-based Capital Economics Ltd.

‘‘There have been some suggestions in the media that policy makers are just trying to raise the stakes,’’ she said by e-mail. ‘‘The key in all this is that until the summit next week there’s not much point trying to guess what Ukraine is going to do.’’

Still, time may be running out. EU Enlargement Commissioner Stefan Fule canceled a planned trip to Kiev yesterday, the DPA news service reported, citing his office.

Yesterday’s decision ‘‘puts a large question mark over the general direction of Ukraine’s foreign policy,” Tatiana Orlova, an economist at Royal Bank of Scotland Group Plc in London, said by e-mail.

To contact the reporters on this story: Daryna Krasnolutska in Kiev at dkrasnolutsk@bloomberg.net; James G. Neuger in Brussels at jneuger@bloomberg.net

To contact the editor responsible for this story: Balazs Penz at bpenz@bloomberg.net

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