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Investing in Ukraine: improvements in 2010
Restoring economic and political stability
Due to high demand for steel, Ukraine's primary export, and increase in domestic consumption in pre-crisis years, the Ukrainian economy became one of the fastest growing emerging markets in the region. The average GDP growth in 2000-2008 was more than 7 percent. This led to a substantial spike in foreign investment, in particular in the financial sector where foreign ownership exceeded 35 percent. The music stopped in 2008. Ukraine was one of the countries hardest hit by the global financial crisis, facing a GDP decline of 14 percent in 2009.
In 2010 the economy is experiencing a cautious recovery. In the second quarter the GDP grew at a 6 percent rate. According to the latest monthly analyst poll by Consensus Economics, Ukraine's economy is likely to expand by 4.2 percent in 2010 and 4.4 percent in 2011. Forecasts from the International Monetary Fund are less optimistic, projecting growth of 3.7 percent in 2010 and 4.3 percent next year.
The crisis of 2008 resulted in a nearly 40 percent devaluation of the national currency, the hryvnia, which reduced imports and gave a boost to the Ukrainian exporters. In 2010 the new government was able to halt increases in the import price of natural gas, which Ukraine receives mainly from Russia and which is vitally important for energy-intensive Ukrainian industrial manufacturers. These changes, coupled with more favourable world prices for Ukraine's main export commodities, resulted in the current account surplus of $400 million in the first six months of 2010. During the same period of 2009 current account deficit stood at $479 million.
Despite this recovery, the effects of the crisis offer considerable start-up investment opportunities due to reduced prices of assets, including stocks, attractive commercial rental prices, and lower labour costs (the average monthly salary in 2010 is $267). Also, in early 2010 a new president, Viktor Yanukovych, was elected and his party together with allies formed the new parliamentary majority and government. This ended a period of political volatility and divided government which Ukraine experienced since 2005. Today Ukraine is experiencing something it lacked for the past five years: a unified government capable of passing major economic legislation. The new government announced an ambitious program of deregulation and reform. It remains to be seen how far it goes in fulfilling these promises. However, many of the laws passed by the new government so far have been rather business friendly.
In short, 2010 saw marked improvements in the Ukrainian investment environment, caused by political stability, upward revisions in sovereign debt credit ratings, some deregulation, GDP picking up at the annual 6 percent in the second quarter, and finally monetary stability and a more balanced budget. Unless there is a serious external negative push, all of this is likely to result in improved investment environment and greater interest of foreign investors in the country.
Capital markets: Ukrainians abroad
In Ukraine the domestic stock market is still quite weak, due to a variety of factors. This means that larger capital markets transactions require Ukrainian companies to tap international, not domestic, markets. The most popular destinations for Ukrainian companies seeking substantial investment have been the London Stock Exchange, in particular its Alternative Investment Market, and the Warsaw Stock Exchange.
The access of Ukrainian equity issuers and borrowers to these markets in 2009 was quite limited. However, this situation improved in 2010.
According to various market research outfits, at least ten Ukrainian companies have expressed an interest in an IPO in late 2010 and 2011. June 2010 saw the first-ever IPO by a Ukraine-based IP sector company with EasyDate, a Scottish company with all major operational facilities located in Ukraine, entering the LSE's Alternative Investment Market.
Major agribusiness companies eye debt and equity issuances on international markets with particular interest. In April 2010 a major poultry producer Avangard had an IPO on the London Stock Exchange and a major sunflower oil producer Kernel had a secondary public offering in Warsaw.
Investing in Ukraine: risks and opportunities
Perhaps the most important feature of Ukrainian business environment is the dominance of several politically powerful business groups, mainly centred in the Eastern industrial regions of Donetsk and, to a lesser extent, Dnipropetrovsk. Business regulation is marred by a high degree of bureaucratization and lack of transparency.
As far as the general economic and political environment is concerned, the general barriers to investment in Ukraine are often high levels of political risk (although these diminished dramatically with the new government installed in 2010), excessive regulation, and lack of transparency. There was a time when this level of risk was offset by quite attractive returns on investment which were unheard of in the West. The returns diminished in the current global economic environment but are likely to pick up if the global economy does reasonably well in the coming years.
One of the few Ukrainian sectors which showed positive results even at the height of the global crisis in 2009 was agriculture. Investors recognize that Ukrainian agricultural companies stand to benefit long-term from Ukraine's enormously fertile land and low production costs. These fundamentals may even allow Ukraine to reclaim the title of a "breadbasket of Europe" as the country was often referred to in the early 20th century. Even during the crisis, a number of dynamic businesses invest heavily in this sector. For example, in June 2010 Mriya agroholding attracted a record-breaking $75 million in financing from the International Finance Corporation. Ukrainian agribusiness also actively seeks access to international capital markets.
Since foreign ownership of agricultural land is prohibited and existing law prevents the sale of agricultural land by its present owners until at least 2012, lease arrangements are the only way allowing foreign investors to obtain agricultural land. Sale and limited foreign ownership of non-agricultural land is allowed.
Removal of restrictions on foreign investment
From the legal perspective, the single most important limitation for foreign investors in Ukraine is the fact that Ukrainian national currency is not freely convertible and that Ukraine has a system of currency restrictions. Ukrainian currency cannot be remitted to any account outside of Ukraine without a special license issued to the payer by the central bank of Ukraine. Only foreign currency can be used in settlements between residents and non-residents. Sale of Ukrainian currency and acquisition of freely convertible foreign currency is also subject to strict regulation that provides for an exhaustive list of grounds for these transactions.
These restrictions were further tightened in response to the world financial crisis but 2010 saw substantial improvements in the regulatory environment for foreign direct investment in the country.
In June 2009 the Parliament adopted the Law Amending Certain Laws of Ukraine to Overcome Adverse Consequences of the Financial Crisis, which came into effect in November 2009 (the Anti-Crisis Act). The Anti-Crisis Act provided that monetary investments in Ukraine made by foreign investors had to be: in the Ukrainian currency; through special "investment accounts" opened with a Ukrainian bank; and that all foreign investments in Ukraine had to be registered with the central bank (National Bank of Ukraine). There was also a prohibition on early repayment of foreign currency loans to foreigners by Ukrainian borrowers and amendments to the amendments to foreign currency loan agreements between Ukrainian borrowers and foreign lenders resulting in accelerated loan repayments.
The Law of 27 April 2010 abolished most of these requirements: there are no longer restrictions on modification and early repayment of foreign loans and registration of foreign investment is optional. Foreign investor still have to use special investment accounts opened in Ukraine but they no longer have to convert their investments into Ukrainian currency. In a relatively minor but important change, 2010 also saw the abolishing of the mandatory contribution to the Pension Fund which used to be required for currency conversion operations. However, not all restrictions are gone. For example, Ukrainian law still requires all loans from foreign lenders to be registered with the central bank and caps the maximum permitted interest rate for such loans.
"... the effects of the crisis offer considerable start-up investment opportunities due to reduced prices of assets, including stocks, attractive commercial rental prices, and lower labour costs"
New incentives for public-private partnerships and infrastructure investment
Another recent change which could facilitate investment in infrastructure projects is the new Public- Private Partnership Law of 1 July 2010 (the “PPP Law”). The Law expands the range of sectors where PPP can be employed. Under the new Law these sectors include construction and operation of highways, railroads, airports, bridges, ports, tourism, healthcare, power generation, exploration and extraction of natural resources, and several others.
The PPP Law introduced a number of changes to land legislation which are meant to make it simpler to obtain land rights for PPP projects: (i) the public partner must provide all land allocation project documents and other necessary documents for leasing the land, arrange for approval of the documents by the respective authorities, and, if necessary, obtain a positive report of the state land use expert. The relevant costs are to be reimbursed by the private partner; (ii) the right to lease the state or municipal land for a PPP can be obtained through a simplified procedure: the private partner can secure the lease as part of the PPP tender without an additional land auction, which is normally required for state and municipal land; (iii) the private partner can use land easements held by the public partner if this right is granted to the private partner by the agreement governing the PPP project.
The PPP Law introduces other incentives for private partners in infrastructure projects. For example, in concession arrangements depreciation of assets used in the PPP project will now be deducted from concession payments payable by the private partner. Concession under Ukrainian law is close to the internationally known "buildoperate-and-transfer" PPP arrangement.
Euro 2012 championship incentives and deregulation in real estate and construction
The approaching Euro 2012 football championship which will be organized jointly by Poland and Ukraine spurs some development activity in several major Ukrainian cities. Ukrainian authorities make efforts to attract foreign investment in the infrastructure projects associated with the championship. For instance, the development projects associated with Euro 2012 are free from the mandatory infrastructure development charges. These charges, normally payable to the local authorities, can usually amount to up to 10 percent of the estimated cost of construction.
As in many other countries, the construction industry in Ukraine felt the sting of the 2008-2009 financial crisis particularly acutely, Ukrainian lawmakers sought to mitigate the negative impact of these events and to boost the industry. The law now allows developers to defer the payment of infrastructure development charges. There are also several reform efforts under way to reduce the number of permits required to start construction.
In late July 2010 Ukraine received the first $1.9 billion tranche from the International Monetary Fund as a part of a 29-month stand-by arrangement worth $15.15 billion. The funding is staggered with each successive tranche dependent on compliance with the Fund’s conditions. Among them is continuing budget tightening as the Fund requires Ukraine to slash budget deficit to 3.5 percent of GDP by the end of 2011 and to 2.5 percent by 2012. Renewed cooperation with the IMF already brought upward revisions of the Ukrainian sovereign debt by the major rating agencies.
Among other developments worth watching for investors is the continuing discussion surrounding the draft Tax Code which was adopted by the Parliament in its first draft in June 2010 and which triggered substantial criticism for its unbalanced and too fiscally minded approach to tax administration.
Ukraine is in active talks with the European Union on the proposed so-called "deep" free trade area between Ukraine and the EU. The parties previously announced that talk would be concluded and the association agreement including an FTA would be signed by the end of 2010. However, it is unlikely that this tight timeframe will be met. Depending on how soon the FTA will come into existence and on how the agreed FTA looks in the end, the FTA might also have a substantial impact on investment opportunities in the key sectors of the Ukrainian economy.