It is the European Union of the east. The Ukrainian and Russian parliaments ratified an agreement to create a free-trade Unified Economic Area (UEA) at the end of April tying the two fast growing economies more closely together.

Quite apart from their shared Soviet-legacy, Russia and Ukraine’s fate has become closely intertwined since the early 1990s. Russian companies are big investors into Ukraine’s economy, which surged by 9.3% in 2003 and 11.8% in March this year. Ukrainian companies export one-third of their goods to Russia. The UEA will further boost trade and give investment another fillip by ending controls on cross-border investment.

Latest initiative

The agreement is the latest in a long line of attempts to more closely integrate the economies of eastern Europe, starting with the creation of the Commonwealth of Independent States (CIS) by Boris Yeltsin shortly after the demise of the Soviet Union. But the CIS and its successors, like the Customs Union, have met with little success. This time around, the participating counties are more optimistic.

“Yeltsin started out with a similar idea at the start of independence with the CIS, but relations quickly got bogged down by fighting over gas prices,” says Alexei Moisseev, who heads up Renaissance Capital’s recently launched Ukrainian research desk. “The jury is still out on this latest initiative, but [President Vladimir] Putin is clearly serious about building better economic ties with the former Soviet republics.”

The presidents of the four participating countries – Russia, Ukraine, Belarus and Kazakhstan – signed off the agreement in September, but the UEA had little meaning until ratified by Russia and Ukraine, by far the two largest economies in the group.

Borders lifted

The UEA unites the customs territories of the member countries and allows the free movement of goods, services and capital between them. The participating countries hope the increase in trade will more than compensate for the loss of customs duties: trade turnover between Russia and Ukraine was already up by one-third over the first three months of this year.

“There will be certain expenses in the budget and they won’t be insignificant,” Russia’s Mr Putin said in May at a meeting with Ukrainian Prime Minister Viktor Yanukovych. “However, the effect of expanding cooperation will be sufficiently positive as to cover the budget losses.”

The UEA is just a first step in building a closer economic alliance with Ukraine, clearly modelled on the European Union. The agreement also includes proposals for common external trade agreements, as well as coordinated tax, monetary and exchange rate policies.

Building bridges

However, there is still a lot to do as relations between Kiev and Moscow remain prickly. Russia’s main oil and gas export pipelines to western Europe run through Ukraine and have been the subject of constant bickering between the two countries. Ukraine is also dependent on Russian gas for its energy needs, but has run up huge unpaid bills during the transition period. Under Mr Yeltsin, the Kremlin regularly used the bills to hold Kiev to ransom for political goals.

Mr Putin says that he is working to smooth out the “rough edges” of Russia’s relations with Ukraine. Since he took over as president in 2000, Russian foreign policy has made a sharp turn towards conciliation with its former vassal states, as Mr Putin tries to pull the countries of the former Soviet Union together into an economic bloc that will counter the power of the EU, Russia’s biggest market.

Russia has been working through the issues one by one. In April the state-owned gas giant Gazprom announced it was close to an agreement with the Ukrainian national oil and gas company, Naftohaz Ukrainy on the transfer of $1.4bn worth of Eurobonds as payment for outstanding energy bills.

And the timing of the agreement is perfect as Ukraine apparently throws off the economic misery that has plagued the country for the last decade.

“There is lots of opportunity there,” says Mr Moisseev. “We believe that Ukraine is going to follow the same path of rapid growth as Russia, but is currently only at the same stage of development as Russia in 1999.”

The leaders are due to meet again at a Crimean summit planned for the last 10 days in May that will bring an end of the first stage of building the eastern common market.