The pull of the west

By Stefan Wagstyl

Financial Times

Published: February 21 2005

Vaclav Klaus, president of the Czech Republic, made headlines recently when he fulminated against Europe's "creeping unification". But while Mr Klaus is perhaps the best-known politician from the European Union's new, ex- communist states, he is far from representative.Most of Mr Klaus's fellow leaders are far more comfortable about the club they joined last May, with good reason: membership is turning out better for eastern Europe than supporters of accession dared hope.

Citizens of eastern Europe, too, appear in the main to share their leaders' satisfaction. The EU-sponsored Eurobarometer opinion poll shows that, across the EU, overall support for union membership rose 8 percentage points to 56 per cent between April and October last year - the biggest increase since 1995. Not only have the economic benefits started flowing faster than expected, but the political advantages of membership have also become much clearer.

These developments will not end the new members' problems within the union. There are tensions over the ratification process under way for the EU constitution; over the 2007-13 budget; and - a matter of special importance to the ex-communist states - over EU policy towards Russia. But in particular, Ukraine's Orange Revolution has altered the region's political map by highlighting both the EU's role as a promoter of security and Russia's renewed ambition to interfere in its neighbours' affairs.

US President George W. Bush, who is to meet Vladimir Putin, his Russian counterpart, in Bratislava, the Slovakian capital, on Thursday, is likely to hear from his central European hosts that the Ukrainian crisis has shown them that their position in the world is enhanced by closer co-operation within the EU. In Poland, the largest new member state, Jacek Cichocki, director of the Centre for Eastern Studies, a government-funded think-tank, says: "Recent events have shown that our ability to act in the world depends on the depth and strength of our base in the EU."

None of this was foreseen a year ago, when the new members entered the union with considerable misgivings. Even supporters of accession warned voters not to expect too much too soon, as the benefits of accession would come only slowly. By contrast, critics of accession warned of immediate trouble, particularly in agriculture, and the likely loss of national identity in a union dominated by its wealthy paymasters, especially Germany. Buffeted by contradictory arguments, the voters ignored their political leaders: the turnout in the new member states in last June's elections to the European Parliament was just 20 per cent.

But, to the surprise of politicians and voters alike, accession has been accompanied by a surge in economic growth. The ex-communist EU members saw gross domestic product rise 5 per cent last year, up from 3.7 per cent in 2004. The World Bank forecasts an increase of 4.5 per cent in 2005 - more than twice the growth rate of the "old" EU.

Exports rose by about 20 per cent, led by particularly strong increases from Poland and the Czech Republic. In agriculture, where producers feared they might be swamped by west European imports, exports to the west soared.

Towards the end of 2004, farmers also saw the first tranche of EU agricultural aid coming into their pockets - a minimum of €500 ($653) for the smallest producers. The European Commission estimates farmers' incomes rose by 50 per cent in new member states last year, with a 108 per cent rise in the Czech Republic and 73 per cent in Poland - by far the largest increases since the collapse of Communism.

Enlargement stimulated a wave of inward foreign investment, notably of portfolio capital. Stock markets across the region soared, headed by Slovak equities, which jumped 84 per cent.

Meanwhile, events in Ukraine have been a powerful reminder for central Europeans of the EU's fundamental political benefit. The sight of thousands of Ukrainians demonstrating in favour of Viktor Yushchenko's ultimately successful bid to overthrow former president Leonid Kuchma's authoritarian regime prompted many central Europeans to remember their own anti-communist revolts. The sound of Ukrainians clamouring to join the EU has restored many central Europeans' faith in the union.

If Mr Yushchenko's victory is followed by a political transformation, central Europeans will feel more secure, with democracy's frontiers pushed several hundred kilometres east. Petr Kolar, the Czech deputy foreign minister, says: "The space of stability and democracy and, we hope, in future, of prosperity is expanding."

Moreover, the Ukrainian crisis was a lesson in the EU's political clout, as national leaders from the newly expanded club persuaded Mr Kuchma's side to accept defeat. Polish president Aleksander Kwasniewski and Valdas Adamkus, his Lithuanian counterpart, worked with Javier Solana, the EU foreign policy chief, to secure that outcome. But Polish and Lithuanian officials are the first to acknowledge that their presidents' influence was based primarily on their roles not as local national leaders but as representatives of the whole EU.

At the same time, the Ukrainian crisis has prompted many central Europeans to see Moscow as a renewed danger. They view Mr Putin's Russia as an increasingly authoritarian state that wants to reassert some of the influence it lost in the Soviet Union's collapse. As Jan Hartl, head of Stem, a Czech market research agency, says: "If you ask people, 'What's the biggest threat to the country?', they still see Russia as the biggest threat."

Unlike in the past, central Europeans are not worried about military threats but about what they see as the Kremlin's disruptive political and economic tactics. Government officials acknowledge that Moscow has legitimate historic, personal, economic and political ties throughout the region, and especially in Ukraine, which Russia ruled for centuries. But they argue that Russia has often pursued these interests in a disruptive fashion, sometimes employing secret service or former secret service officers in untransparent ways to extend its influence.

They fear that the Kremlin - having suffered political defeats in Ukraine, where it backed the losing candidate, and earlier in Georgia, where Moscow failed to prevent the triumph of the pro-western Mikhail Saakashvili - will become more aggressive towards its neighbours. At the Centre for Eastern Studies, Mr Cichocki says: "There's a concern that Russia will get tougher."

As east Europeans see it, Russia already has a considerable recent record of interfering, notably in the Baltic countries. In Lithuania, Russians were implicated in a scandal that led to the impeachment last year of Rolandas Paksas, the then president. Mr Paksas, who denied wrongdoing, was accused in a parliamentary report of having secret links with Russian business, intelligence agents and organised crime.

In Latvia and Estonia, officials have accused the Kremlin of interfering on the pretext of defending the rights of ethnic Russian minorities. Moscow says it has a duty to fight what it sees as anti-Russian discrimination.

In Poland, a parliamentary committee is investigating disclosures attributed by Polish secret services to Vladimir Alganov, a former Russian KGB officer, in a complex scandal surrounding PKN Orlen, the state- controlled oil company. Mr Alganov allegedly claimed that Russian interests had offered to bribe a Polish minister to allow Lukoil, the largest Russian oil group, to buy a stake in PKN Orlen.

For the future, the worry is that Russia will use its economic power, as the source of more than three quarters of eastern Europe's oil and gas supplies, for political ends (see below).

Central European government officials insist that Russia must not be demonised. Nor should every misunderstanding be viewed as a plot. But they argue that some senior Russian officials, if not Mr Putin himself, still see the former Soviet empire as a zone of influence. Jan Truszczynski, the Polish deputy foreign minister, says: "We have to persuade these officials that the traditional system in which there are reserved zones of influence is naturally a zero-sum game. We have to lead them out of that system."

The best defence is closer integration with the EU, including on foreign policy and security issues, central Europeans are concluding. Officials say Nato, as a military alliance with an increasingly global responsibility, may be less useful than the EU in confronting non-military threats in Europe. That could imply less reliance on the US as a security partner and more on EU states - even in Poland, often seen as Washington's strongest central European ally.

Polish officials consider the country received little in return for its support of America in the Iraq war. Warsaw is to bring its peacekeeping unit home from Iraq this year. Marcin Zaborowski, a Polish foreign policy expert, recently published a paper for the EU's Institute for Security Studies, arguing that "Poland's Atlanticism is likely to be toned down in future".

However, central European states will struggle to persuade west European countries to be more cautious in their relations with Moscow. The UK, Germany and France, the EU's three most powerful nations, do not share the east Europeans' memories of the Soviet Union as an occupying force and see Moscow as a generally reliable, if sometimes awkward, partner. Privately, they periodically accuse central Europeans of spreading anti-Russian sentiment.

The central Europeans applauded the EU's tough stance over the Russian breakaway republic of Chechnya in the early years of the Putin presidency. But this common front was undermined by the EU's big three courting Mr Putin on a bilateral basis. Today, the EU is debating how to maintain good relations with Moscow while also developing ties with Ukraine.

The central European states face other challenges in the union, notably over the budget, the EU constitution and economic development. The new members want a larger share of regional aid in 2007-13 while current recipients, headed by Spain, are defending their allocation and the union's paymasters, led by Germany, want spending cuts.

The constitutional treaty is also sparking debate. Publicity generated by "eurosceptics" such as Mr Klaus and Andrzej Lepper, the Polish populist, raises concerns among supporters of the treaty that it might be rejected in the Czech Republic or Poland, which both plan to hold referendums before the treaty can be ratified.

Even local eurosceptics concede, however, that the public - mostly ignorant of the constitution's details - could equate the treaty with continued membership and vote Yes. The next few months could generate a lot of Eurosceptic headlines. But three other new members - Lithuania, Hungary and Slovenia - have ratified the treaty in parliamentary votes, and the other five will almost certainly follow suit.

For most central Europeans the key issue remains the economy and the long drive to raise living standards to western European levels. The region's economies have serious weaknesses. Unemployment averages 14 per cent. Countries remain divided between the beneficiaries of EU integration - led by young, well-educated workers - and those who have lost out, including the old, the sick and the jobless.

Governments are struggling to control welfare spending and budget deficits, notably in Hungary, the Czech Republic and Poland. Hungary last year suffered a foreign exchange crisis when currency traders took fright at mounting fiscal and current account deficits. The upheaval showed the region is still vulnerable to shocks.

Policymakers have radical ideas, such as the low flat-rate taxes pioneered by Slovakia. But the challenge is to maintain public support among people who have already suffered 15 years of economic upheavals.

Ultimately, east Europeans will judge the success or failure of EU membership largely by its impact on their pockets. Not surprisingly, the Eurobarometer poll showed that levels of satisfaction with the EU are generally lower in eastern than in western Europe. East Europeans know their countries have a long way to go. However, levels of dissatisfaction were also lower - indicating that relatively few people are committed opponents of the union. A large number of voters in the middle are waiting to see how membership will turn out for their countries. For eastern Europe's supporters and critics of EU integration there is everything to play for. But the first few months of membership have done more to emphasise the advantages than the disadvantages of the union.

Oil and gas needs give Moscow influence

The Latvian government has a headache selling its remaining shares in Ventspils Nafta, the country’s oil transit company and a key link in exports of Russian crude.

Ventspils Nafta has been operating at one-third of its capacity since Russia abruptly stopped shipping oil through Latvian pipelines two years ago. The company’s terminal in the Baltic port of Ventspils runs on a trickle of crude supplied by train.

Russian officials, who are diverting oil exports to other terminals, say Latvian pipeline shipments will resume when Ventspils Nafta cuts its charges from “uneconomic levels”. But Latvian officials suspect Russia is trying to force the government to sell its remaining 38.6 per cent in Ventspils Nafta to Russian buyers.

There is endless speculation in Riga about whether Russia is acting out of commercial or political motives or both. West Europeans often say Latvian suspicions of Russia are based on exaggerated fears. But east Europeans, sharing a common history of Soviet oppression, understand the Latvians perfectly. Jiri Gavor, a partner in ENA, a Czech energy consultancy says: “You are never quite sure. Russians are different from westerners. Perhaps they do not make decisions entirely on commercial grounds. There is always a feeling that there is a political strategy there as well.”

Russian energy groups, which supply more than 75 per cent of the new European Union members’ oil and gas, compared with the 20 per cent western Europe supplies, insist they have sound commercial reasons for investing in eastern Europe. Gazprom, the gas giant, and Lukoil, the flagship oil company, which have led the way with extensive investments from the Baltic to the Balkans, say that, like other global energy groups, they are adding value by investing downstream.

However, the Kremlin has considerable political influence over their activities. Any hopes Russian energy groups may have entertained in the 1990s of securing greater independence have been dashed under President Vladimir Putin. His officials want the government to dominate the energy industry and the larger companies - irrespective of whether the state has a big equity stake, such as at Gazprom, or no shares, such as at Lukoil. The Kremlin has made clear its determination with the assault on the Yukos oil group.

Gazprom and Lukoil insist they act in the interests of their shareholders. But east European states see in increased Russian state influence a danger that political factors will play an expanding role in decision-making.

East European governments have tried to limit Russian energy investments, usually acting quietly to avoid offence. The Czech Republic discreetly kept Russian bidders out of the privatisation of Unipetrol, its oil refining company, which was later sold to Poland’s PKN Orlen. Poland has so far rebuffed Lukoil’s attempts to buy a stake in PKN Orlen.

Given the choice, western buyers are preferred. For example, in a recent deal Slovakia sold control of Slovenske Elektrarne, its electricity producer, to Italy’s Enel for €840m ($1.1bn), having earlier received approaches from Russia’s UES electricity giant.

Such policies do not always succeed. Lithuania rejected Russian bids for the big Mazeikiu Nafta refinery and chose Williams, a US company. However after arguments over oil supplies, Mazeikiu was later sold on to Yukos anyway.

Slovakia, almost totally reliant on Russian energy, sold 49 per cent of Transpetrol, its oil pipeline, to Yukos in 2002, when Yukos seemed to be breaking free of state influence. But now the Kremlin has seized control of a large chunk of Yukos, raising doubts about the independence of the rest of the group.

However, east European governments recognise that, as long as Russian companies operate transparently, they can bring benefits. East Europe needs capital and it needs to show western Europe that it is not unreasonably anti-Russian.

Some government officials prefer to influence the structure of deals to ensure transparency, rather than block them outright. Hungary recently permitted Gazprom and Germany’s Eon to collaborate in the purchase of the gas distribution assets of Mol, the energy group.

A key asset for some east European states, including Poland, Slovakia and the Czech Republic, are Russian transit pipelines running to western Europe. The transit countries benefit from substantial fees and the knowledge that Moscow cannot cut off their energy supplies without also cutting off far bigger countries, such as Germany. Since Russia depends on energy export revenues, it has always attached as much importance to the maintenance of these supplies as to its clients in eastern and western Europe.

However, a new Baltic Sea pipeline project might undermine this harmony of interests. Russia has proposed a seabed route that would by-pass eastern Europe. The plan has support in Germany and the UK, but arouses fierce opposition in Poland and other transit states.

Janusz Reiter, director of Poland’s Centre for International Relations, a think tank, says: “We cannot treat all Russian investments as suspect. But we have to go case by case, especially in vulnerable sectors such as energy . . .The stronger our states and economies become in future, the easier it will be to absorb Russian capital. For the next 10 or 20 years it will be a problem. Then the problem will cease to exist.”