< Disclaimer> < Return To Issue Article Index >

What Ukraine has (and has not) done to Attract Investment: an Overview of Post-Soviet Business/Political Developments  Ukraine’s track record in attracting foreign capital has not been impressive. In absolute terms, the country has attracted only 4.9 billion USD since independence. Foreign direct investment (FDI) per capita stands at only 78 USD (Graph 1), which is ten times less than its Eastern European neighbor Poland and almost thirty times less than the Czech Republic. For Ukraine to attract foreign direct investment, it will need to provide a more predictable investment climate. Most notably they will need to improve corporate and public governance, provide a stable and predictable legal environment, liberalize and deregulate business activities, and eliminate corruption through greater transparency. Corporate Governance The World Bank’s definition of corporate governance refers to that blend of law, regulation and appropriate private sector voluntary practices which enable the corporation to attract financial and human capital.  This includes greater integrity, transparency, and independence and competence with in the judiciary, where shareholder interests come first. The Citizens Network for Foreign Affairs Inc. (CNFA) - a non-profit, nonpartisan organization dedicated to stimulating international economic growth in emerging markets - listed the lack of good corporate governance as the primary cause of more than 50% of joint venture failures in Ukraine.  Natalie Jaresko, President and CEO of Western NIS Enterprise Fund - a venture capital organization specializing in medium sized enterprises in Ukraine, describes corporate governance in Ukraine as an evolutionary process. She said that five years ago “there was little understanding of the need to improve or enforce cooperate governance. Today, the concept of corporate governance has been introduced and is being discussed by the business community.” She then adds that the practice of corporate governance in recent years will act as a catalyst for a more transparent and diversified corporate culture. “Ukraine has now had several years of experience with sound corporate governance and now has something very tangible that businesspeople can look at and determine whether they have the type of corporate governance that they would like. Instead of having something that is very philosophical, it now becomes real.”

The adoption of sound corporate governance would create rights for minority shareholders. A step in the right direction is the recent adoption of the Joint Stock Fund, which is an attempt to attract portfolio investments (less than a 10% share in company stock). This law contains the basic structure to protect the rights of minority shareholder by ensuring shareholder participation, and delineating between management, board of directors, and shareholders.
.

Taras Shevchenko University.

Stable and Predictable Legal Environment “When a large private corporation thinks about investing in a country, the first question they ask is: ‘if I enter into agreement and a dispute arises, can I expect fair treatment in the unfortunate event that we have to go to litigation?’” says Acting Director of the European Bank for Reconstruction and Development (EBRD) William Franks. According to Ms. Jaersko the answer is no, as she explains that “we have one high profile case where we think that the judicial system did not operate in a free and independent fashion.”  However, there is a relatively quick and easy three step remedy to create an independent rule of law that could be implemented by the President of Ukraine without parliamentary approval. First, Ukraine must increase judges’ salaries so that corruption doesn’t become an issue. Clearly, there is scope for corruption when a poorly paid judge presides over a multimillion dollar case. Second, judges that are found to be corrupt need to be removed. Third, Ukraine needs to develop a system where case-level judges and attorneys outside of Kyiv have access to changes in the law.  Privatization of Utilities The privatization of six power distribution companies (oblenergos) in 2001 generated enormous controversies as they were acquired via unpublicized auctions for a fraction of their market value. Most likely only a handful of oblenergos will be privatized in 2003, and even those are in doubt. Until the debt situations are resolved (which in some cases run into several hundred million dollars), few investors will want to buy them, and certainly not at the prices that the government is seeking. The approval of the Privatization Program for 2003-2008 would help create more systematic and transparent future sales of these utilities.  Privatization will continue but at a weak pace.

The role of the local entrepreneur must be promoted to diversify Ukraine’s investment climate, to increase competition, and to create a more positive feedback for investments. SMEs are normally labor-intensive and therefore create purchasing power in the population through job creation. The development of a wealthier middle class will be an important element in attracting larger amounts of investments. Michael Bleyzer of SigmaBleyzer, a leading investment bank, said that “SMEs have played a key role in the development of other transition economies such as Hungary and Poland. Accordingly, the future growth of the Ukrainian economy will depend on a major expansion of SMEs over the next few years.  This is taking place, but at a low pace.” 

According to Ms. Jaresko, the lack of SME’s in Ukraine “is due to is a combination of factors: it’s the regulation; it’s the corruption; and there is the cultural issue from making entrepreneurial activity illegal and criminal in the Soviet period to being something to be proud of and necessary.”
.

The European Bank for Reconstruction and Development (EBRD) is the largest and most diversified investor in Ukraine with a cumulative investment in the country of 1.4 billion USD through 57 projects since independence. Its SME Lending Program has provided over a 184 loans worth around 156 million USD. EBRD is also a co-founder of Ukraine Microfinance Bank, which since January of 2001 has approved 9,281 loans worth 54.2 million USD. Frank Williams, Acting Director of EBRD in Ukraine, said “I think our SME and Microfinance Programs are two of the most successful projects in the financial sector. We have now made three SME transactions the first two were sovereign guarantees. Our Microfinance Project with the Microfinance Bank is making loans of fifty or thirty thousand dollars or even smaller, some one, two or three thousand dollars.  This has been very successful in bringing finance to companies that find it very difficult to achieve finances otherwise.”  Poland: Lessons Learned Clearly the pace of economic reforms in Poland over the last ten years is the most decisive factor explaining the disparity of the amounts of FDI between Poland and Ukraine. Michael Bleyzer states that “Starting in 1991, Poland undertook a comprehensive number of measures to stabilize and liberalize its economy, improve its legal environment and improve corporate governance. The results were felt quickly.  By 1992, Poland started to experience positives rates of GDP growth and began to receive increasing amounts of foreign direct investments. In Ukraine, very few economic reforms were made during the first few years after independence, which led to economic stagnation for many years. Currently, the implementation of comprehensive measures to improve the business environment is still in the initial phases of implementation.”

.
Dmitro Tarabakin, Director of Dragon Capital, has experience working the financial markets in both countries. He agrees that “Poland’s successful economic growth is based on stable economic policy and a high GDP growth.” He adds that “Poland also made a bet on small businesses. They made very straight forward and streamline procedures for registering and running SMEs.” This is evident in the growth rates of capital of Polish companies, where only 7% of companies had over 500,000 USD of capital in 1993, but with the inflow of FDI to the country, that percentage has now reached 40.8. Mr. Tarabakin contrasts this to the reality of SME’s in Ukraine: “Unfortunately medium sized corporations were given a quite hard time here. They don’t have access to political lobbying. The bureaucracy of registering and running business and taxation was not transparent enough for people to easily come in register and do it. So the people willing to invest money were looking at Ukraine verses Poland, and in Poland the policies were much more transparent. Even though investors knew Poland was a bit more expensive, the political risks of investments were much lower than those in Ukraine.”

Politics

The 2004 presidential elections are expected to take a lot of resources out of the country. The high level of risk due to the presidential elections in 1999 was directly related to the drastic drop in FDI. In 1998, foreign direct investors contributed 757 million USD, that number fell to 437 million USD in 1999 (graph 2).  Dmitro Tarabakin believes that the uncertainty of the elections “puts constraints on investment plans, especially for bigger scale businesses who are putting things on hold until they know the candidates. This may slowdown investment.”

A huge hindrance to attracting investment is the over estimation of a negative political climate, which deterred investments that may have come but never did. Ukraine has had eleven years of independence and ten prime ministers; therefore a smooth transition of government is necessary to sustain investment levels. Mr. Tarabakin claims that “Ukraine needs to be the China of Europe, and this is something that has to be sold to the West. It is a lack of political leadership and local businesspeople have not grown to the idea of letting the market expand and having a smaller chunk of it and still be able to make more money.”

Conclusion

Ukraine’s investment potential still remains largely untapped. The improvements in corporate governance, reform of the regulation and law, and GDP growth in recent years has led investors to believe that the country has gotten over the post-Soviet hump and is on its way to greater reforms and prosperity. However, optimism should be guarded as complacency at this stage of reform could throw the country back to its chaotic mid-90s growing pains.  We can see that the large multinationals are here to stay, but the question remains: Will further reforms entice would-be investors, which are comprised of small stakeholders and SMEs, to enter a market that is today nontransparent and unknown? 
.

To read Jason's previous article on real estate in Kiev Click Here. Jason Jones can be contacted at the following: Jason_jones1@hotmail.com

.

< Send a Letter to the Editor > < Subscribe  > < Submit An Article >< Disclaimer>