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Ukrainian Investment Perspectives for international business community

The international business community has been watching Ukraine closely as the political environment, which will have a major influence over the country and its investment climate over the next several years, takes shape. As Ukraine finds itself once again at a crossroads, international investors are observing intently for the signs and movements that will trigger their ability to start to invest heavily for the future. The questions many investors are asking include thing such as: is Ukraine really committed to European integration? Will Ukraine push forward and become a member of the World Trade Organization? Will the current leadership of Ukraine ensure that democratic and free elections take place? How will Ukraine utilize their indigenous and imported energy resources? How will Ukraine handle the looming crisis in the agricultural sector?

On a very positive note, statistical results for the year of 2003 confirm that the basic macro economic indices match if not exceed forecast. The preliminary assessment of GDP growth issued at the beginning of 2003 amounted to a cautious 4.1%. The official figure provided by the State Statistics Committee for the first half of 2003 is 5.1% growth as compared to the same quarter of 2002. This correlates with the optimistic scenario for development of the Ukrainian economy.

For over twelve years, the American Chamber of Commerce in Ukraine has been constantly collecting information from our Members, the Ukrainian government as well as the international donor and diplomatic community, which has resulted in what we believe to be a realistic and comprehensive overview of the economic situation in Ukraine regarding foreign direct investment.

Industry

The fastest rates of growth were observed in the manufacturing industry making up almost 75% of the total industrial production in Ukraine – 12.8% (7.6% in 2002), mining industry – 2.4% (0.6% in 2002), production and distribution of electricity, gas and water – 11.5% (-1.1% in 2002). The growth of consumer purchasing power and the import substitution effect resulted in a substantial growth of consumer goods production oriented towards internal markets. Among the growing industries machine building leads the way with 26.6% growth, production of wood and wooden articles 22.2%, cellulose and paper industry and printing production 16.1%. Considerable growth as compared with the same period of 2002 was also observed in chemical and petrochemical industries (13.3%) as well as in metallurgy and metal processing (12.5%). For the first time since Ukrainian independence light industry demonstrated 0.7% growth as compared to January-May 2002. The mining of coal and peat is still declining posting a -5.4% slide along with oil processing losing 2.1%. All Ukrainian regions have posted positive growth figures in industrial development except for the Khmelnitska and Poltavska regions where the decline amounted to 1.5 and 2.0% correspondingly.

Agriculture

Production of agricultural goods in the first half of 2003 in all categories declined by 6% as compared to the same period of 2002. The overall volume of sales of agricultural goods receded by 1% due to shrinking volumes of sales in crops (-18%). The sale of cereal crops in the first half of 2003 diminished by 33.9% as compared to the same period in 2002. Due to this the actual GDP sank by 5.6% in July 2003 as compared to July 2002. Nevertheless, the government anaylsts have expressed no apprehensions as to this fact and still forecast GDP growth of 4,7-6% in 2003.

Budget and Investments

The actual revenues into the State Budget between January and June 2003 against the same period of 2002 grew by 15.5% (the State Budget grew 17.8 % correspondingly). A substantial part of it was made up of revenues from privatization of communal and state property – UAH 1,029.7 million (967.8 million directed to the General Fund), which is three times more than in the first half of 2002.

The largest part of investments into capital stock was allocated to industrial enterprises (43.3%) of which processing industry received the major part of the investments. Food industry and agricultural goods processing presented the biggest attraction to investors (23.2% of the total volume of investments into industrial enterprises) as well as metallurgy and metal processing (9.8%) and machine building (6.4%).

Foreign Trade

Beginning in the middle of the year the situation on the external global market also saw improvement, which translated in a better export numbers. According to the statistic published by the State Committee for Statistics in the beginning of August 2003, the surplus of Ukraine’s foreign trade in commodities January through June was estimated at $444.6 million ($478.5 million in the first half of 2002). The ratio of coverage of imports by exports in the first six months of 2003 was 1.05 (1.06 in the same period of 2002). The overall volume of foreign trade in commodities over the period under review grew by 27.9% from the same period last year to $20.175 billion. Exports totaled $10.310 billion (a 26.9% rise) and imports - $9.865 billion (a 29% rise).

Ukraine traded with 195 countries in the first half of 2003. The overall volume of foreign trade in commodities over the period under review grew by 27.9% from the same period last year to $20.175 billion. Exports totaled $10.310 billion (a 26.9% rise) and imports ­– $9.865 billion (a 29% rise). The largest volume of exports fell on Russia – 17.9% of the total volume, Italy – 5.9%, Germany – 5.7%, China – 4.6%, Poland – 3.8%, Turkey – 3.6%, Hungary – 3.3%, and the USA – 2.4%. The largest import supplies to Ukraine came from Russia – 38.5%, Turkmenistan – 9.3%, Germany – 9.2%, Poland – 3.4%, Italy – 2.7%, the UK, France and Kazakhstan – 2.3% each.

Direct Foreign Investment

Market analysts unanimously consider foreign direct investment as an essential condition for sustained economic growth. In a survey conducted in 2002, Sigma Bleyzer, an Amcham member, estimated the needs of Ukrainian economy to be USD 40 billion in Foreign Direct Investment (FDI) over the next decade if Ukraine is to maintain a significant level of sustainable growth. According to the most recent figures provided by the State Statistics Committee, FDI in the first half of 2002 reached USD 126 per capita which is the highest since 1991 with only USD 78 in 2000 and USD 89 in 2001. Nevertheless, this is still a long way to go from Czech Republic and Hungary, whose FDI per capita in 2000 was USD 2,233 and USD 2,059 respectively.

FDI Dynamics

The largest volume of FDI took place in 1998, when foreign investors contributed USD 757 million. In 1999, investment dropped by almost 50%. This drastic decline in FDI occurred because of the 1998 economic crisis and an increase in perceived political risk due to the Ukrainian Presidential election in 1999. Until 1999, the average rate of investment approached the average rate for the CIS and Russia. Today Ukraine significantly lags behind Russia. Despite the fact that JP Morgan considered Ukraine one of the most attractive countries for foreign investors (57.1% return on bonds in 2001), net FDI declined by 10.5%. In 2002 foreign direct investments into Ukraine reached USD 780 million, a definite step forward due to adoption of several important taxation laws allowing further investment into construction, banking and transport.

The forms of investment also have changed over the years. While in 1999, 47.5% of all FDI constituted monetary investments, their share increased by 10.3% in 2000 and by 8.7% in 2001, reaching 66.5% of all foreign investments. The share of investment in the form of property, plant and equipment varies slightly, although this form of investment comprises (on average) 30% of FDI. Investments in securities steadily declined during the last three years from 14.9% in 1999 to 0.9% in 2001. Unfortunately, no annual figures on investment form changes in 2002 are available yet.

Recently Standard&Poor;’s reconsidered Ukraine’s Eurobond rating to ‘stable’ (market-weight) from the "negative" (under-weight) which is expected to attract even more investment into Ukraine. This achievement is mostly due to positive changes in legislation conforming with international requirements as well as government promotion of Zones for Free Economic Trade and Priority Areas. Thus the first half of 2003 was marked with USD 581.8 million in FDI injected into the Ukrainian economy, according to the State Statistics Committee. At the same time non-residents withdrew USD 123.2 million from Ukraine in the first six months of 2003, thus the withdrawal rate of 21,2 %. As was reported, the direct foreign investments made in Ukraine in the first quarter of 2003 rose by 18.3 % (USD 252.8 million) from the same period last year. The Economics Ministry projected this year's direct foreign investment growth in the 2003 national budget at USD 750 million.

Main Obstacles for FDI Flow

FDI is a universal and key source of long-term development for the economy. According to separate surveys done by international organizations and Sigma Bleyzer identified the following difficulties impeding foreign investment:

  • Instability and excessiveness of government regulations.
  • Ambiguity of the legal system.
  • Uncertainty in the economic environment.
  • Corruption.
  • High tax burden.
  • Problems in establishing clear ownership conditions.
  • Depressed disposable income level.
  • Difficulty negotiating with government authorities.
  • Lack of physical infrastructure.
  • Volatility of the political environment.

These factors have led to government intervention and to conflicts with the private sector. The absence of a system for investment insurance, as well as the monopolization of the economy and restrictions for land transactions, also affects the level of foreign investment. A study conducted by the International Private Capital Task Force (IPCTF) developed a range of recommendations for attracting foreign capital to Ukraine, including the creation of a favorable investment climate, improvement of Ukraine's image in world financial markets, and development of a system that could attract foreign entrepreneurs and renew foreign investors' confidence in Ukraine. The Task Force specified the following key "policy actions":

  • Liberalization and deregulation of business activities.
  • Stability and predictability of legal environment.
  • Corporate and public governance.
  • Liberalization of foreign trade and international capital movements.
  • Financial sector development.
  • Corruption level.
  • Political risk.
  • Country promotion and image.
  • Targeted investment incentives.

If action were to be carried out in all these areas, Ukraine could expect FDI to increase to over USD 3.5 billion per year within 10 to 15 years. Furthermore, the first three "policy actions" were identified as those that most significantly affect the investment environment. Improvements in these areas alone could propel FDI to USD 2.5 billion per year by 2005.

It is anticipated that the rate of investment withdrawal will decrease in the second half of 2003 provided Ukrainian legislators pursue new positive amendments to taxation and privatization legislation. The long-awaited Tax Code is being adopted on a step-by-step basis which is anticipated to facilitate the adoption of politically sensitive issues. Many of the proposed changes to the taxation legislation are designed to help bring businesses from the “shadow” and establish a larger more predictable tax base. The latest achievement for tax legislators and their supporters was the reduction of personal income taxes starting from January 1, 2004 already approved by the Parliament. Still, this measure could become effective only provided the accompanying cuts in social funds taxes that employers have to pay. Moreover, the much-needed reduction of VAT from 20% as well as its proper implementation regarding refunds to exporters is still a hot issue stifling additional FDI into Ukraine.

Another important issue is privatization, a major challenge to foreign businessmen seeking investment opportunities of in Ukraine. The government is pushing a new long-term National Privatization Program for 2003-2008 that is hoped will stimulate investment. The Program is to create a nation-wide inventory of public property, establish registers of enterprises of all forms of ownership, and design mechanisms for effective tenders and allocation of returns. Namely, the architects of the reform envisage that unlike the past, 25% of the privatization revenues will be allocated for restoration of capital assets of property to be privatized. All the activities of the Program are aimed at reaching balance between preserving strategic assets and offering attractive high-quality opportunities to prospective investors.