Worst friends, best enemies, trading partners: EU and Russia

Jean Claude Juncker, Vladimir Putin

The EU will grow less dependent on Russia for energy security, while Russia will become less reliant on European finance, industry, and infrastructure.

Though the EU and Russia have vacillated between political cooperation and confrontation over the last twenty-five years, economic relations between Europe’s two leading players have remained pragmatic and relatively stable.

Despite continued political tension and mutual economic sanctions, the EU and Russia can be expected to remain important trade partners in the coming years because of their geographic proximity and the complementary nature of their export and import markets: EU-Russian trade is largely based on Russian hydrocarbons (which constitute 85 to 90 percent of all EU imports from Russia) and European vehicles and equipment (which make up more than 65 percent of all Russian imports from the EU).
European demand for natural gas, which trended upward until 2010, had returned to 1995 levels by 2014. Notwithstanding a recent increase in consumption due to a particularly cold 2015, demand in the EU is declining slower than European production of natural gas, so the EU can be expected to continue to import Russian gas in the near term. Russia accounts for 30 to 40 percent of the EU’s total gas imports, and the volume of Russian gas imported to the EU has risen by 17 percent since 2005.
Russian oil will also continue to factor into EU-Russian trade in the coming years. Even though European demand has fallen by 17 percent since 2005 and the EU expects it to continue to decline 0.5 percent per year over the next five years, the EU still depends heavily on imported oil: in 2013, EU countries imported 83 percent of the oil they consumed.
Russia remains the leading supplier of oil to the EU, accounting for about 29 percent of the EU’s total imports. Russia’s reliance on European consumption is even stronger: Russia sells about 75 percent of its oil to EU member states.
With Russian oil output expected to drop by half by 2035, the EU and Russia must prepare for a gradual contraction of this market. Russia must find other goods to export to the EU in order to replace falling oil deliveries, and European oil refineries must prepare to transition from Urals oil to other types of oil.
Although the EU is clearly dependent on Russian energy, Russia is no less dependent on a wide range of European goods and investments. Russia spends more than 50 billion euros importing equipment from the EU per year. Transportation, telecommunications, and data processing equipment accounts for about half of all such imports. Equipment for high-speed trains and commercial airplanes also makes up a significant portion of EU exports to Russia.
For many years, European investment has accounted for more than 80 percent of all foreign investment in Russia. Germans alone own more than 25 billion euros in shares of Russian companies.
European financial markets have also helped bring capital into Russia: Russian companies have raised more than $180 billion through bond sales on European markets, which accounts for more than 35 percent of Russia’s total foreign debt.
Money flows in the other direction, too: since the collapse of the USSR, Russian businessmen and officials have moved at least $1 trillion out of Russia. The former have generally done so legally and the latter—illegally. The lion’s share of this money has ended up in Swiss banks, but German, Austrian, and Cypriot banks also have significant Russian holdings.
Russian media outlets estimate that Russian citizens have bought at least 500,000 houses and apartments in Europe (primarily in Eastern Europe). Though this number might be exaggerated, Russians are clearly major players in European real estate markets.
Although the rhetoric surrounding sanctions has become antagonistic in Moscow and European capitals, and the Russian government is using the sanctions as an excuse for the country’s economic decline, the real effect of the sanctions has been relatively minimal. For example, falling oil prices have inhibited the development of expensive oil projects, so exploratory technologies that Russia can no longer import because of the European sanctions regime have become unnecessary.
Russia responded to European sanctions by prohibiting the importation of a number of agricultural products. This measure was touted as promoting import substitution and punishing the Europeans, but in actuality it produced temporary shortages, a considerable decrease in the quality of foodstuffs, and a spike in prices.
Unable to replace sanctioned goods with domestically produced ones, Russia is now buying many food products from new suppliers. A number of countries, as well as informal groups within Russia, are making money smuggling sanctioned goods into Russia; all they need to do is print and affix new labels on European goods.
Even though sanctions have had some effect on the Russian economy, it could have been much, much worse. The fact that the Ukraine crisis and the anti-EU propaganda coming out of Russia have not caused major changes in trade relations with Europe suggests that European capitals want to keep political relations separate from economic ones.
Still, in the coming years, Russia will import less and less European goods, largely due to the country’s continued economic stagnation. In view of the sharp drop in the influx of foreign currency, Russia will gradually replace higher-quality, expensive European goods with cheaper, lower-quality goods from China and elsewhere. Over time, some Russian regions will revert to producing certain equipment, as they did in Soviet times—the automotive sector, for example, may be revived to a certain extent.
These processes will continue independently of political developments, regardless of whether Ukraine joins the EU or orients itself toward Russia. Trade relations between the EU and Russia will likely remain stable for many years, though the overall volume of bilateral trade will gradually contract. The EU will grow less dependent on Russia for energy security, while Russia will become less reliant on European finance, industry, and infrastructure.

Read more at: http://carnegie.ru/commentary/2016/06/20/worst-friends-best-enemies-trade-between-eu-and-russia/j25s

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