Customs Union: the next greattrading blocPavel MelnikovGrayling RussiaSummaryJuly 1, 2011 Russia, Kazakhstan and Belaruswill embark on a customs union that touchesthe borders of both Europe and China. Goodswill move freely from country to country and theeconomies of the three countries will be subjectto uniﬁed basic regulation.This is the start. Kyrgyzstan, Tajikistan andUzbekistan may join the Union soon.If it sounds familiar, so it should for it was in1958 that six countries formed the EuropeanEconomic Community, later rebranded as theEuropean Union, now with 27 member statesthat, between them, make up a quarter of theworld’s GDP.Is this the future of the Russo customs union?Time will tell but it is reasonable to suggest thatRussia’s long term game plan is to create atrading bloc that can compete with Europe,America (meaning NAFTA of course), andChina/Japan. Whether that game plan comes tofruition depends on many things, includingcontinuing reform, investment in infrastructure, areduction in social security contributions, andless corruption. It also, to a considerable extent,depends on the stability of Russian government.The ultimate prize is Ukraine. Which way will shejump? It will take many years but we expectUkraine will probably become part of the Russocustoms union, which we would expect tooperate more along the lines of NAFTA than theEU. Indeed, it was recently announced thatUkraine is trying to negotiate a free-tradeagreement with the Union. We expect Russia tobecome more aggressive on disputes over gassupplies, as leverage to force Ukraine into theUnion.Long term the political and economic impact ofthe nascent Customs Union has the potential tobe very signiﬁcant.In the shorter term, there are tradeopportunities, but also some meaningful risks.Indeed we expect the next 1-2 years to presentmajor challenges to foreign investors, mostly inRussia.Constant regulatory monitoring will be vital aschange may come fast and unexpectedly, and itwill be vital to maintain or build strongrelationships with local regulators and people ofinﬂuence.OpportunitiesFree movement of goods. Goods produced inKazakhstan, Belarus and Russia are supposedto move freely within the Union. Generally thiswill happen, but there will be somecomplications, including some stipulated by theUnion’s regulations.Certiﬁcate of origin of goods will eventually beeliminated. Again, we urge caution, becausethis has not come into effect yet..Customs duties and taxes are paid in fourmonths (instead of 15 days). Alterations tocustoms declarations can be made before andafter the manufacturing of goods. This, webelieve, could be very helpful for trade.International ﬁrms contemplating localizing inRussia might consider other options, namelyKazakhstan or Belarus. Theoretically, this ispossible. Belarus, for example, has a very lowcost of labor. Realistically, however, it makes nosense to manufacture for Russia in Belarus oranywhere else now. Investment in Russia is atleast as much political as it is economic.Companies, especially large operations, needfederal and provincial goodwill if they are toavoid business disruption. In 10, 15 or maybe20 years the situation might look different. Todayits value is more theory, but it can be used as anargument when negotiating terms of investmentwith the Russian authorities.
We do know of one large multinational that isclosing down all of its Russian operations andwill ship from its factory in Kazakhstan.Technically there is nothing to prevent this. Atthis time, however, we judge it to be acourageous decision.If the cupboard seems a little bare, that’sbecause it is. This is the start of a very longprocess that will take decades to conclude but,for those companies with strong regulatoryoversight and connections, opportunities doexist and can be leveraged.RisksThere are national and supranational bodies formanaging and addressing customs-relatedissue and it is not yet clear where the real powerwill lie. This complicated management structuremakes the possibility of corruption-relatedinterference quite possible.Some countries -- Belarus is most likely -- mayincrease protectionism under the guise of hastilyproduced technical regulation intended to easethe Customs Union. Some FMCG companieshave already discovered, for example, thatpackage sizes are redeﬁned to suit localproducers and fence off foreign competition.There is also some evidence to suggest thatfood & beverage manufacturers in Russia --both local and international -- may face somechallenging new additive regulations, againdressed as a Customs Union issue.The question of WTO membership has not beensettled and have the potential to disrupt Unionharmonization.WTO accession talks with Russia have been onagain, off again for 17 years. There is somereason to think that there is now a chance forreal progress. As our ofﬁce in Washington D.C.,Dutko-Grayling, reports, President Obama seemto have made a personal commitment to do so.However, there are some difﬁcult bi-lateralissues concerning industrial assembly regimes,intellectual property, agricultural subsidies andveterinary and sanitary control. .Ultimately, Russia accession to the WTOrequires a vote by the US Congress, whichwould have to amend the Jackson-Vanikamendment to make it possible for the US tosupport Russias membership.Recent comments made by Dmitry Medvedevand Economics Development Minister ElviraNabiulllina suggest that Russia has assumed a“now or never approach”, claiming that it hasalready done many things and is not ready tomake every possible trade-off to access WTO.There are differences in regulating advertising inthe countries. This need not be a problem. Ittook the EU years to get around to regulatingadvertising. We doubt much will change heresoon, though it remains a possibility.Common antimonopoly legislation might bringsome unpleasant surprises such as an instantmonopolistic position for some companies.Again, we would rate this as low risk. There arefar easier ways to disrupt business.Intellectual property rights are not developedeven in the framework of countries separately,let alone in the Customs Union. This remains amajor problem. In time, the Customs Unionmight force the countries to address the issue.An accelerated pace of adopting newlegislation, in order to comply with therequirements of the Customs Union, will almostcertainly result in many omissions anddiscrepancies -- in other words, bad legislation.The uniﬁed Customs Code, itself, has hundredsof referrals to national codes because ofunresolved issues between the three countries.We present some other cases in Appendix 1Different indirect taxation rates may causeadditional difﬁculties and create grey areas suchas transit through Kazakhstan. With the entry ofthe Customs Code into force, member statesare not expected to change indirect taxationrates, which are likely to be left at 12%, 18%and 20% for Kazakhstan, Russia and Belaruscorrespondingly.This is unlikely to change in the near term. Whilethe EU has a minimum VAT rate, member statesare free to set higher levels, and do.
Adopting technical regulations in the interests ofall the parties concerned is difﬁcult given thatRussia would have to adopt numerous Kazakregulations that are not necessarily in theeconomic interests of Russia.Realistically, however, we expect most of themomentum to come from Russia.Such prospects as the free movement of laborand capital should be ﬁnalized by July 2012,while a common currency is more of a long-term question. By way of a comparison, theEuro was introduced when overall tradeturnover within the union reached 64%. Today,the trade turnover of Russia with both Belarusand Kazakhstan represents less than 8% oftrade with other countries.Politically we suspect that Russia would like theruble to be adopted by all members of theUnion. How soon this might happen isimpossible to quantify, but not in the next fewyears.RecommendationsIt is difﬁcult to navigate in this complex changingenvironment. However, there are a number ofsimple things that we stick to in consultationswith our international clients.It makes sense to proactively explore allpotential opportunities of the Customs Union.However, one should consider implementing aform of 360’ analysis, evaluating and prioritizingexternal risks vs. opportunities to fullycomprehend how the Customs Union caninﬂuence your business.Informally and regularly engage with nationalstakeholders to discern any early threat ofprotectionist technical regulation and othermeasures limiting access to the market and theability to operate day-to-day.We do believe it makes sense for FDIs tonegotiate better conditions on site selectionwithin the territory of the union, taking intoaccount opportunities for further expansion.It is clear, however, that any such negotiationswould require substantial skill in terms ofnavigating through political and “soft”arguments of local government ofﬁcials.Implications for the nationaleconomiesKazakhstan. Participation in theCustoms Union (CU) has it beneﬁtsfor Kazakhstan since it has limitedaccess to the high seas and itsexport relies on its neighbors,especially when oil and gas areconcerned.Moreover, Kazakhstani key exportpartners are already China (16.3%),the EU (about 50%). Import partnersare nearly the same Russia (28.5%),China (26.7%), the EU (27%).Belarus. Belarus is currently in themidst of ﬁnancial crisis and heavilyrelies on Russia in export (33.6%)and import (56.42%). To say nothingabout the oil duties removed inDecember 2010, when Belarus,Russia and Kazakhstan formed aCommon Economic Space. The CUis a one way ticket for PresidentLukashenko giving him someadditional political and economicleverage to keep himself inPresidential post as long aspossible.Russia. The CU cannot substantiallychange the structure of Russianexport-import operations, since theEU (more than 55%) and China(5.7%) are also Russian key exportpartners. The same is true forRussia’s imports: the EU (46%) andChina (14%).
About GraylingGrayling provides public, government and investorrelations services to clients, including major foreigninvestors, active in Russia, Belarus, Kazakhstan. Wehave ofﬁces in 70 locations in 40 countries acrossEurope, the US, the Middle East and Asia Paciﬁc. Weare the second largest independent PR ﬁrm in theworld. Grayling is part of Huntsworth plc. Furtherinformation can be found at www.grayling.comSpecial NoteThis note is issued only on behalf of Grayling andstatements herein should not, in any way, beimputed to be statements from, endorsed by, orotherwise supported by, individual client ﬁrms, unlessso stated in the text. Grayling accepts no liability forany errors or omissions in this publication or for anylosses or damaged incurred by anyone who actssolely on reliance of the information contained herein,outside of any duty of care Grayling owes itscontracted clients. This note may be freely quotedsubject to crediting its source.
Appendix 1: Unresolved Regulatory IssuesWithin the Customs UnionCountry of origin of the products‒ At present when a vehicle crosses theBelarus-Russian or Kazakhstan-Russiaborder the customs authority mayrequest (under point 1 of the CustomsUnion Committee decision dated17.08.2010 №335) commercial andcommodity/goods transport documents,which verify the country of origin of theproducts.‒ The customs authorities determinewhether the products originate from thecustoms union member countries orfrom third party countries on the basis ofthe provided package of documents.‒ Some companies complain that thestatus veriﬁcation procedure takes toolong and part of the consignment (up to20%) is often being placed at thetemporary storage warehouses.‒ In this situation the procedure is beingintentionally complicated, which resultsin unnecessary delays and queues at theborder crossings.‒ The issue will be resolved only after theestablishment of the common economicspace, which is supposed to happenafter July 2012.Preliminary customs declaration‒ According to the part 1 of article 193 ofthe customs union Customs Code thecustoms entry report on foreign goodscan be submitted before their import tothe customs territory of the customsunion.‒ As the Code does not imply any otheroptions for submitting the customsdeclaration the Russian customsauthorities often refuse to register thepreliminary customs declaration if thegoods have already crossed thecustoms border of the customs union.‒ It remains unclear how the internalcustoms authority control the moment ofthe factual crossing since the JointImport Control System is still in the earlystages of design.‒ It is worth noting that the article 193 ofthe Code does not forbid submissions ofpreliminary customs declarations nordoes the Russian Administrative Code.Obtaining permissive documentation‒ At present the companies face a lot ofdifﬁculties when attempting to obtainpermissive documentation (e.g.registration certiﬁcates and compliancecertiﬁcates) under new Joint forms,approved by the Customs UnionCommittee.‒ There are also additional issuesregarding the necessity of obtainingcertiﬁcates for different types of goodsdue to the silence position of some ofthe authorities including the Ministry ofIndustry and Trade.Issues with the investments to the chartercapital‒ The Customs Code of CU contains anew provision, which was supposed toresolve the issue of determining thestatus of conditionally released goodswithin the customs union (e.g. importedas investments to the charter capital).‒ In accordance with the article 211 of theCode any tax and customs dutiesbreaks for speciﬁc types of importedgoods with disposal limitations areannulled after ﬁve years from the date ofmanufacture.
‒ Under part 4 of article 200 of the Codethese types of goods are consideredconditionally released before therequirement for tax and customs dutiesis removed, such goods will obtain thestatus of ordinary customs union goodsafter ﬁve years.‒ However this is true only for thosegoods, which have been imported to thecharter capital after 01.07.2010 (underarticle 366 of the Code). Thereforeowners those goods, which have beenimported to the charter capital before01.07.2010, will have to pay fullcustoms duties in the case of alienationof these goods.