Foreign Direct Investments into Ukraine

1

Foreign Direct Investments

into

Ukraine

Daniyil Pasko

Harvard Business School

December 2009

2

Contents:

1. Introduction 3

2. Global FDI trends 4

3. FDI in Eastern Europe 8

4. FDI into Ukraine in historical perspective 10

5. Ukraine’s current investment climate 13

6. FDI by industry 18

7. Conclusion 39

3

Introduction

Foreign direct investment as one of the main vehicles of development and globalization in the

World economy is a complex phenomenon.

Most common definition used in the modern economic theory states that Foreign Direct

Investment (FDI) – “is acquisition of at least ten percent of the ordinary shares or voting power

in a public or private enterprise by nonresident investors. Direct investment involves a lasting

interest in the management of an enterprise and includes reinvestment of profits.”1

It is important to understand that FDI is not just the flow of capital between economies but also

a flow of technologies, management practices and established customer/supplier bases.

Usually FDI has a spillover effect for the host economy when management practices and

technologies are propagated from the initial target company to other companies in the region.

This propagation is achieved through moving labor force, reverse-engineering and intensified

competition.

FDI is crucial for Developing and Transition economies not just because they suffer from the

lack of capital but because they don’t have access to new technologies and their managerial

and business techniques are outdated.

Different countries have achieved different results in their ability to attract FDI. In order to

analyze reasons driving country specific performance it is important to look at the following

issues:

- Dynamics and trends of global FDI flows

- General investment climate in a given country

- Industry specific opportunities provided by current situation in the host economy

This framework is used to analyze Ukraine’s competitive positioning to attract foreign direct

investment.

1 IMF Glossary of Selected Financial Terms http://www.imf.org/external/np/exr/glossary/showTerm.asp#F

Global FDI had been experiencing

increasing investment activity. FDI flows were not evenly distributed between the countries of

different stages of economic development.

Exhibit 1

Source: United Nations, World Investment Re

Production and Development, Figure I.1., p. 4. (Data source: UNCTAD FDI/TNC database

(www.unctad.org/fdistatistics) and UNCTAD Secretariat estimates.)

Most of FDI was realized through cross

flows and Global M&A activity (All in

Exhibit 2 Global FDI flows and cross border M&A deals

Source: United Nations “World Investment Report 2009

Production and Development”, stats.unctad.org/FDI,

4

Global FDI Trends

Global FDI had been experiencing cycles of growth and decline, but there is a strong trend for


different stages of economic development.

World Investment Report 2009: Transnational Corporations, Agricultural

, Figure I.1., p. 4. (Data source: UNCTAD FDI/TNC database

(www.unctad.org/fdistatistics) and UNCTAD Secretariat estimates.)

Most of FDI was realized through cross-border M&A deals which can be seen from graphs of FDI

flows and Global M&A activity (All in US Dollars at current prices in millions).

flows and cross border M&A deals

World Investment Report 2009 Transnational Corporation

”, stats.unctad.org/FDI, accessed December 2009

cycles of growth and decline, but there is a strong trend for


port 2009: Transnational Corporations, Agricultural

, Figure I.1., p. 4. (Data source: UNCTAD FDI/TNC database

als which can be seen from graphs of FDI

Transnational Corporations, Agricultural

Further analysis of M&A data shows that share of Services as a target for FDI had been

increasing.

Exhibit 3 Historical breakdown of cross

and petroleum, Agriculture, Forestry, and Fishing; Secondary industry


Production and Development”, stats.unctad.org/FD

Exhibit 4 Industry breakdown of cross


Production and Development”,stats.unctad.org/FDI,

5


Historical breakdown of cross-border M&A deals (Primary industry - Mining, quarrying

and petroleum, Agriculture, Forestry, and Fishing; Secondary industry – all other)

World Investment Report 2009 Transnational Corporations, Agricultural

stats.unctad.org/FDI, accessed December 2009

wn of cross-border M&A deals in Services




Mining, quarrying

all other)



6

Among Services most Global FDI flows were registered in:

1. Transport, storage and communications is 27% of 2006 Services FDI with a growth

trend;

2. Finance is 25% of 2006 and stable over the period;

3. Business activities- Legal, accounting, market research, and consultancy, architectural,

engineering, and other technical activities, advertising (21% of 2006 Services FDI);

4. Hotels and restaurants 6% of 2006 and growing compared to 90s and early 2000s but

still below the level of the 80s;

5. Electric, Gas, and Water Distribution 4% in 2006 and declining;

Among secondary Industries global FDI was mostly flowing into following:

1. Chemicals and chemical products is 22% of secondary industries FDI and a stable leader;

2. Metal and Metal Products 18% and growing with growing steel prices;

3. Electrical and electronic equipment 14% stable;

4. Food, beverages and tobacco 9% and at all-time low;

5. Printing, Publishing, and Allied Services 9% and close to historic maximums;

6. Machinery 7% stable;

7. Motor vehicles and other transport equipment 6%;

Exhibit 5 Industry breakdown of cross



In primary industries the share of

certain periods agriculture was more than 10% (1994, 1997).

Exhibit 6 Historical breakdown of Primary industr

Source: United Nations “World Investment


7

Industry breakdown of cross-border M&A deals in secondary Industries



In primary industries the share of Mining, quarrying and petroleum had been dominant, but in

certain periods agriculture was more than 10% (1994, 1997).

Historical breakdown of Primary industries FDI


”, stats.unctad.org/FDI, accessed December 2009

ndustries


had been dominant, but in


Comparing the amount of FDI attracted by Ukraine to other countries of the region it is clear

that Ukraine is not considered attractive by foreign investors.

Exhibit 7 FDI as a % of nominal GDP

Source: International Monetary Fund “

http://www.imfstatistics.org.ezp

Ukraine’s ability to attract FDI as a factor of GDP had been significantly lower comparing to

most countries in the region. 1994

result of the legislative amendments in the pre

their business environment and climbed higher in terms of the FDI performance index. Bulgaria

gained the prestigious 7th spot in the world in 2006 from the 92nd place in 1990

Romania climbed to the 21st spot from the 101st. The index is based on the ratio between FDI

and GDP in the past three years, including the indicated year. Bulgaria is among the leaders in

the region in terms of FDI influx. The prestigious position can be attributed to the combination

between the EU membership and the labor market prices, which have remained competitive”

2 “Rainfall of Investments over the Balkans”

8

FDI in Eastern Europe


is not considered attractive by foreign investors.

FDI as a % of nominal GDP in comparable countries

International Monetary Fund “IFS - International Financial Statistics, country tables

http://www.imfstatistics.org.ezp-prod1.hul.harvard.edu/imf/ accessed December 2009


most countries in the region. 1994 – 2000 Poland had been a clear leader of the region. “As a

result of the legislative amendments in the pre-EU accession, Bulgaria and Romania improved


7th spot in the world in 2006 from the 92nd place in 1990



e region in terms of FDI influx. The prestigious position can be attributed to the combination

between the EU membership and the labor market prices, which have remained competitive”

“Rainfall of Investments over the Balkans” Capital Weekly 27 October 2007, Factiva, accessed December 2009


International Financial Statistics, country tables”,

accessed December 2009;


nd had been a clear leader of the region. “As a

EU accession, Bulgaria and Romania improved


7th spot in the world in 2006 from the 92nd place in 1990-1992.



e region in terms of FDI influx. The prestigious position can be attributed to the combination

between the EU membership and the labor market prices, which have remained competitive”2.

activa, accessed December 2009

Exhibit 8 FDI per capita



To be objective it is important to mention tha

contributed to the success of other Eastern European countries. They were faster integrated

into EU economy especially after the dissension about their EU membership was made.

Geographically they are closer to E

barriers.

On the other hand their governments were much more effective in improving investment

climate. Most of them were fast to introduce simple taxation systems with lower taxation rates.

Privatization in most of the compared courtiers was more transparent and fast then in Ukraine.

9



To be objective it is important to mention that there were several important factors which



Geographically they are closer to EU and the export potential to EU is bigger due to lifted trade



ivatization in most of the compared courtiers was more transparent and fast then in Ukraine.

nternational Financial Statistics, country tables”,


t there were several important factors which



U and the export potential to EU is bigger due to lifted trade



ivatization in most of the compared courtiers was more transparent and fast then in Ukraine.

FDI into Ukrainian in historical perspective

Ever since its independence Ukraine was struggling to attract FDI both as a source of needed

capital and as engine for innovation.

Exhibit 9 FDI into Ukraine 1994-2008



Government Comity of Statistics

During 1994-2003 FDI was growing but in dollar terms amount of FDI was not significant

considering the size of the economy and

was slow in implementing reforms. Corruption, unstable currency, cumbersome legal

framework were few among many problems of Ukraine’s investment climate. Ukraine is

viewed as unattractive region by foreig

1997 – “During a trip to Ukraine in October, Morningstar made waves by telling reporters that

severe corruption was blocking reforms and investment and urging the government to take

action. Many businessmen say the situation has not improved,

pulled out of a planned $500 million investment last month, citing ever

by the government”3.

1998 – “Potential investors are interested in Ukraine, but the investment climate is distinctly

unfavorable at present”4.

3 Associated Press “Clinton aide pushes Ukraine on reform, investment

2009 4 Metal Bulletin “It's even worse in Ukraine

10

into Ukrainian in historical perspective


or innovation.

2008


zp-prod1.hul.harvard.edu/imf/ accessed December 2009

ics “Annual statistics report of 2008” p.239

FDI was growing but in dollar terms amount of FDI was not significant

considering the size of the economy and amount of FDI needed for restructuring. Government



viewed as unattractive region by foreign investors:

“During a trip to Ukraine in October, Morningstar made waves by telling reporters that


action. Many businessmen say the situation has not improved, and the U.S. firm Motorola

pulled out of a planned $500 million investment last month, citing ever-changing conditions set

“Potential investors are interested in Ukraine, but the investment climate is distinctly

Clinton aide pushes Ukraine on reform, investment” 24 April 1997, Factiva, accessed December

It's even worse in Ukraine”, October 15 1998, via Factiva accessed December 2009




FDI was growing but in dollar terms amount of FDI was not significant

amount of FDI needed for restructuring. Government



“During a trip to Ukraine in October, Morningstar made waves by telling reporters that


and the U.S. firm Motorola

changing conditions set

“Potential investors are interested in Ukraine, but the investment climate is distinctly

24 April 1997, Factiva, accessed December

via Factiva accessed December 2009

11

1999 - “The World Bank on Thursday called Ukraine one of the most hostile places for foreign

investors throughout the former Soviet Union, and the International Monetary Fund said it may

delay further loans because of Ukraine's lagging reforms”5. "The investment climate in Ukraine

is one of the worst in the region," said head of the World Bank delegation Lily Chu, acting

country director for Ukraine and Belarus during a news conference. Chu said Ukraine presents

investors too many licensing regulations and inspections, and a complicated tax system6.

2000 – “George Munoz, the president of the U.S. Overseas Private Investments Corporation,

told the Bloomberg Business Information Service that Kyiv has failed to create a favorable

climate for foreign investment, ITAR-TASS reported on 25 December.”7

2002 - "The level of future investment in Ukraine depends on improvements in the Ukrainian

investment climate though changes in the taxation system, and the creation of a truly

independent legal system. This includes real steps to fight corruption, which is the biggest

impediment to investment. EBRD believes the primary problems in Ukraine are a non-

transparent taxation system and an imperfect legal system which, thanks to insufficient

financing, is prone to the influence of the authorities and business."8

“In 2000-04 Ukraine showed somewhat greater commitment to economic reform and to

making the business environment more friendly to investors. The governments in place during

that period made some progress on regulatory, administrative and fiscal reform, and took

important steps towards privatization of the agricultural sector. They also accelerated the

privatization of large enterprises”9.

After 2003 Ukraine had experienced big surge in the FDI activity.

Some of this success can be attributed to changes in government policies. “Since 2005 efforts

have been accelerated to level the playing-field and simplify the tax and regulatory

environment. However, government policies have continued to scare away investments

occasionally, and vested business interests will remain politically powerful in the medium term.

This will slow structural reforms and regulatory improvements”10.

5 Associated Press Newswires “World Bank criticizes Ukraine's investment climate” 2 December 1999, Factiva, accessed

December 2009

6 Associated Press Newswires “World Bank criticizes Ukraine's investment climate” 2 December 1999, Factiva accessed

December 2009 7“ OPIC HEAD SAYS UKRAINE'S INVESTMENT CLIMATE NOT OPTIMAL” 30 December 2000, Factiva accessed December 2009

8 Ukrainian news “Finance - EBRD Urges Ukraine To Fight Corruption” 30 September 2002, Factiva accessed December 2009

9 Economist Intelligence Unit - Business Eastern Europe “Looking to the future: Ukraine” 10 September 2007,

Factiva, accessed December 2009 10

“Looking to the future: Ukraine” Economist Intelligence Unit - Business Eastern Europe 10 September 2007, via

Factiva accessed December 2009

12

On the other hand this success can hardly be attributed to implementation or introduction of

fundamental reforms. 70% FDI in 2005 is attributed to privatization of the biggest Ukrainian

steel producer JSC Krivorozhstal. Although clearly a successful deal and a sign of new strategy in

privatization this event does not represent positive shifts in investment environment in general.

Increase in FDI after 2005 can also be attributed to external factors. Global foreign direct

investment inflows grew in 2006 for the third consecutive year to reach US$1.2 trillion. “The

total is a 34% increase from 2005. FDI inflows to developing countries and economies in

transition (the latter comprising South-East Europe and the Commonwealth of Independent

States (CIS)) rose by 10% and 56%, respectively, in 2006, and reached record levels for both

groups of economies.”11

11

States News Services “FOREIGN DIRECT INVESTMENT ROSE BY 34% IN 2006” 1 September 2007, via Factiva

accessed December 2009

Ukraine’s

In order to analyze Ukraine’s competitive position in terms of attracting FDI several factors

should be analyzed:

1. Attractiveness of the country for foreign investors

2. Barriers for FDI

1. Ukraine has several attracti

Market size and growth.

Ukraine has a big internal market of 46 million people and disposable income had been growing

constantly over the last 8 years.

Exhibit 10 Dynamics of disposable income

Source: Aidan Manktelow, The Economist Intelligence Unit

http://secure.alacra.com.ezp-prod1.hul.harvard.edu/cgi

December 2009

Potential for growth had been demonstrated in the past despite poor economic policies of t

government.

Ukraine is well positioned for further growth of its internal market.

13

Ukraine’s current investment climate


Attractiveness of the country for foreign investors

Ukraine has several attractive features as an FDI destination


Dynamics of disposable income

The Economist Intelligence Unit “Country Data Notes

prod1.hul.harvard.edu/cgi-bin/alacraswitchISAPI.dll

Potential for growth had been demonstrated in the past despite poor economic policies of t

Ukraine is well positioned for further growth of its internal market.



Country Data Notes” 2009,

bin/alacraswitchISAPI.dll , accessed

Potential for growth had been demonstrated in the past despite poor economic policies of the

14

Exhibit 10

Source: World Economic Forum, Foundation for Effective Governance “The Ukraine

Competitiveness Report” 2008, http://www.feg.org.ua/ru/cms/projects/economic_concept,

accessed December 2009 (Data source: Economist Intelligence Unit)

Ukraine is located close to two big external markets of EU and CIS. Recently Ukraine became a

member of WTO which will increase its export potential. In future there is possibility to sign a

free trade agreement with EU.

In 2009 Ukraine is ranked 31 in the World on the “Market Size” pillar of Global Competitiveness

Index12 with only Poland and Russia surpassing it in the region.

High quality, cheap labor force and labor market efficiency.

Ukraine is ranked 43rd in Global Competitiveness Index 2008-2009 pillar of education and

training. “In this pillar it is ahead of all the CIS countries and Slovakia, Romania and Bulgaria.

Ukraine is 14th in the world by the number of students enrolled in the higher education. It has a

strong school of math and sciences.”13

Labor market in general is ranked 54th by the pillar of efficiency. “De facto” hiring and firing

procedures are easy. Ukraine’s labor force is the cheapest in the region.

12

World Economic Forum, Foundation For Effective Governance “The Ukraine Competitiveness report 2009”, 2009

p.46. 13

World Economic Forum, Foundation For Effective Governance “The Ukraine Competitiveness report 2009”, 2009

p.38.

Exhibit 11 Labor cost per hour

Source: Aidan Manktelow, The Economist Intelligence Unit

http://secure.alacra.com.ezp-prod1.hul.harvard.edu/cgi

December 2009

Unfortunately on other pillars of competitiveness used by

Ukraine is either behind or on par with peer countries.

Exhibit 12

Forum, Foundation for Effective Gov

http://www.feg.org.ua/ru/cms/projects/economic_concept

15

Aidan Manktelow, The Economist Intelligence Unit “Country Data Notes

prod1.hul.harvard.edu/cgi-bin/alacraswitchISAPI.dll

Unfortunately on other pillars of competitiveness used by Global Competitiveness Index

Ukraine is either behind or on par with peer countries.

Source: World Economic

Foundation for Effective Governance “The Ukraine Competitiveness Report” 2008,

http://www.feg.org.ua/ru/cms/projects/economic_concept, accessed December 2009

Country Data Notes” 2009,

ISAPI.dll , accessed

Global Competitiveness Index

Source: World Economic

ernance “The Ukraine Competitiveness Report” 2008,

, accessed December 2009

16

2. Barriers for FDI

In 2008 - 2009 Ukraine is ranked 143 out of 183 in the Ease of Doing Business Index created by

World Bank14. All of the compared countries in the region are ranked higher than Ukraine

Exhibit 13 Ease of Doing Business Index of comparable countries

Economy

Ease of

Doing

Business

Rank

Starting a

Business

Dealing with

Construction

Permits

Employing

Workers

Registering

Property

Getting

Credit

Protecting

Investors

Paying

Taxes

Trading

Across

Borders

Enforcing

Contracts

Closing a

Business

Slovak Rep. 42 66 56 81 11 15 109 119 113 61 39

Bulgaria 44 50 119 53 56 4 41 95 106 87 78

Romania 55 42 91 113 92 15 41 149 46 55 91

Poland 72 117 164 76 88 15 41 151 42 75 85

Turkey 73 56 133 145 36 71 57 75 67 27 121

Russia 120 106 182 109 45 87 93 103 162 19 92

Ukraine 142 134 181 83 141 30 109 181 139 43 145

Source: The World Bank Group, “Ease of Doing Business Index” , 2009

www.doingbusiness.org accessed December 2009

Taxation

Ukraine has one of the worst taxation systems in the World (ranked 181 out of 183 countries).

Exhibit 14 Assessment of Ukrainian taxation system by the World Bank

Source: The World Bank Group, “Ease of Doing Business Index” , 2009


High labor taxation does not allow Ukraine’s investors to take full advantage of high skilled and

cheap labor force. Foreign companies are usually in disadvantaged position compared to local

companies in the process of navigating cumbersome tax legislation and bureaucratic

procedures needed to fulfill tax obligations. Corruption makes things even harder for foreign

investors.

14

http://www.doingbusiness.org/EconomyRankings/

17

Trade barriers

Problems with trading across borders are preventing Ukraine form realizing its potential in

external market size and logistics.

Exhibit 15 Assessment of ease of trading across borders by the World Bank

Source: The World Bank Group, “Ease of Doing Business Index”, 2009


As with taxation, barriers for trade are not just the direct costs associated with import or export

but the number of necessary documents and procedures and time it take to fulfill them.

Registering and protecting property

Time and number of procedures needed for property registration is much bigger than in other

countries.

Exhibit 16 Assessment of ease of registering property rights in Ukraine by the World Bank

Source: The World Bank Group, “Ease of Doing Business Index”, 2009


Protection of property rights can be an issue considering high level of corruption. In 2008-2009

Ukraine is ranked 146 out of 180 countries by Corruption Perceptions Index (CPI) published by

Transparency International (Most of the other countries in the region are ranked from 49 to 75

except Russia 146)15.

15

Transparency International “Corruption Perceptions Index”, 2009, www.transparency.org accessed December 2009

FDI by industry – achievements, challenges and opportunities

Exhibit 17 Historical structure of FDY by industry

Source: Government Comity of Statist

Several industries were initially well positioned

Due to big share of agriculture in GDP

been the industry which historically attracted a lot of FDI

income level and internal consumption. Population was consuming more and more products

with higher share of value added. Barriers for investments were less prohibitive because most

of the investments went into small a

interfering with unnecessary regulation. Amount of FDI into processing was increasing on

average 25% annually (Exhibit18).

Retail was the industry which was underdeveloped in the Soviet Union thus with

consumption foreign investors were well positioned to enter the market. Foreign investors

were investing on average 35% more money into this industry which was booming with growing

levels of disposable income (Exhibit18).

18

achievements, challenges and opportunities

17 Historical structure of FDY by industry

Government Comity of Statistics “Annual statistics report of 2008” p. 273

initially well positioned for attracting FDI.

Due to big share of agriculture in GDP and big, underserved internal market

been the industry which historically attracted a lot of FDI. It was driven by rise in disposable



of the investments went into small and medium size facilities where government was not


average 25% annually (Exhibit18).

was the industry which was underdeveloped in the Soviet Union thus with



levels of disposable income (Exhibit18).

273

and big, underserved internal market processing had

It was driven by rise in disposable



nd medium size facilities where government was not


was the industry which was underdeveloped in the Soviet Union thus with increase in



Exhibit 18 Yearly growth rates of FDI attracted by biggest industries

Source: Government Comity of Statist

Several industries demonstrated

Financial sector is by far one of the most

“On July 7 2005 Ukrainian parliament made drastic changes to the banking legislation equating

the rights of foreign banks' subsidiaries and local banks. According to the amendments to the

law on banks and banking activities passed by Verkhovna Rada (VR) the subsidiaries of foreign

banks are included in Ukrainian banking system, according to IntelliNews”

“Under the previous legislation the activ

open their branches in throughout Ukraine and provide services to private clients. These banks

were just able to open their representative offices in the country. The new legislation removes

all restrictions on foreign banks' activities”

“Ukraine's banking sector has been transformed in the last 18 months attracting

billion of foreign capital. A wave of foreign banks has

lenders, often in fierce bidding competitions. The prices west European banks are willing to pa

worry some observers, but as Julian Evans reports, the sector is growing so fast that there

16

UNIAN, 12 July 2005, Capital IQ, accessed December 2009

17 ibid

19

owth rates of FDI attracted by biggest industries

Government Comity of Statistics “Annual statistics report of 2008” p. 273

Several industries demonstrated significant achievements in attracting FDI.

is by far one of the most successful in its ability to increase FDI



nd banking activities passed by Verkhovna Rada (VR) the subsidiaries of foreign

banks are included in Ukrainian banking system, according to IntelliNews”16.

“Under the previous legislation the activities of foreign banks were limited. They could not

heir branches in throughout Ukraine and provide services to private clients. These banks


all restrictions on foreign banks' activities”17.

tor has been transformed in the last 18 months attracting

. A wave of foreign banks has bought many of the country's biggest

lenders, often in fierce bidding competitions. The prices west European banks are willing to pa


UNIAN, 12 July 2005, Capital IQ, accessed December 2009

273

flows.



nd banking activities passed by Verkhovna Rada (VR) the subsidiaries of foreign

es of foreign banks were limited. They could not

heir branches in throughout Ukraine and provide services to private clients. These banks


tor has been transformed in the last 18 months attracting almost $4

bought many of the country's biggest

lenders, often in fierce bidding competitions. The prices west European banks are willing to pay


20

should be plenty of room to make money, and the foreign-owned players have the advantage

of a ready source of capital”18.

Exhibit 19 Foreign investments into Ukrainian financial sector 2005-2006

Name of the Bank Acquirer Value (m$) Date

Raiffeisen Ukraine OTP 47 Apr-06

Index Bank Crédit Agricole 257 Mar-06

Ukrsotsbank Banca Intensa 1160 Feb-06

Mirya Bank Vneshtorgbank 70 Jan-06

Bank NRB Sberbank 100 Jan-06

Ukrsibbank BNP Paribas 349 Dec-05

Aval Bank Raiffeisen Int 1000 Oct-05

Aggio SEB 27 NA

KreditBank Bank Polski 30 NA

Source: Evans, Julian, Euroweek “Banking sector attracts investors” by; May2006 Supplement,

p8-10 via Capital IQ, accessed December 2009

Financial sector remained attractive for foreign investors even after several international

players moved in.

24 January 2008 “UniCredit announces that today Bank Austria Creditanstalt AG (‘BA-CA’),

responsible within the UniCredit Group for commercial banking activities in CEE has finalized

the acquisition of 94.2% of the total issued share capital of CJSC Ukrsotsbank (‘USB’) from a

group of investors represented by EastOne, an international investment advisory firm (the

‘Selling Shareholders’).

The purchase price at closing is EUR1,525 million (or ca. US$2,211 million at current exchange

rates), which includes the pro-rata capital increase subscribed by the Selling Shareholders in

June 2007. In addition, the final consideration will include a post-closing adjustment to be

based on USB’s net asset value at closing”19.

After entering the market foreign companies usually continue to invest into the expansion:

"Ukraine is a very important market for UniCredit that is why we decided to expand our

presence here. We see good perspectives of economic growth of your country, which has high

GDP growth, joins the WTO and is going to create single trade zone with the UN, - said

Alessandro Profumo, CEO of UniCredit. UniCredit is going to be a long term investor since

18

Evans Julian, Euroweek “Banking sector attracts investors”; May2006 Supplement, p8-10 via Capital

IQ, accessed December 2009

19 ENP Newswire “UniCredit Group: Bank Austria finalizes the acquisition of a majority stake in Ukrsotsbank”, January 2008, via

Factiva, accessed December 2009

21

Ukraine is a key country representing one of our most promising markets in terms of potential

growth"20.

Steel manufacturing is another example when simple government decision regarding fare

privatization dramatically influenced FDI landscape increasing yearly FDI by 4.5 times and

positioning steel sector for a continued investment.

“In a competitive and nationally televised auction held on October 24th 2005, Mittal won the

tender for a 93% stake in Kryvorizhstal, Ukraine’s leading steel enterprise, with a massive bid of

$4.8bn. The price was six times the $800m paid for the same assets in a mid-2004 tender that

was won by a Ukrainian grouping including Viktor Pinchuk, the son-in-law of the then-president,

Leonid Kuchma, despite the fact that higher offers—including from Mittal—had been tabled. In

the wake of the “Orange Revolution”, however, that privatisation was cancelled by the

authorities via the courts and Kryvorizhstal was prepared for sale once again”21.

Foreign investors continue to move into Ukrainian metals and mining sector.

“Dec 12 2007- Evraz Group is buying a host of mining and metals assets in Ukraine from Privat

group. They are 99.25% of Sukhaya Balka GOK, 95.57% of Dnepropetrovsk Metallurgical Plant

and stakes of over 90% in three coke plants. Evraz will pay for the acquisitions with new shares

and cash. The deals will be closed in the first quarter 2008”22.

Evraz Group deal is rumored to be around 2 bln$.

Most importantly after the acquisition of Kryvorizhstal Mittal continued to invest into Ukrainian

steel sector, modernizing the plant itself and expanding into new ventures:

“Mr Yushchenko also confirmed that Arcelor-Mittal remains interested in developing the Kryvy

Rih iron ore deposit, which requires around US$800m of investment to become operational.

Analysts say that access to the deposit is critical for Arcelor-Mittal to meet growing demand at

its steel-making plants in Ukraine, Romania, Poland and the Czech Republic”23.

“Ukrainian steel smelter ArcelorMittal Kryviy Rih will invest $398 mln (255.5 mln euro) in

organic development by the end of 2008, Volodymyr Sheremet, head of the plant's production

20

RIA Oreadna “Ukrsotsbank Wants to Attract USD150 bln from Bank Austria Creditanstal” 12 February 2008, via

Factiva, December 2009 21

Economist Intelligence Unit - Business Eastern Europe “Mittal Europa”, October 2005 via Factiva, December

2009 22

Russia & CIS Business and Financial Newswire “Evraz buying a number of mining, metals assets in Ukraine from

Privat (Part 3)”, December 2007, via Factiva, December 2009 23

“Ukraine industry: Arcelor-Mittal to invest up to US$10bn in its local steel operations” June 2007 via Factiva,

December 2009

22

department, told journalists on August 4, 2008. The steel smelter channeled $145 mln (93 mln

euro) in development in the first half of 2008, he added.

By 2012, Arcelor Mittal Kryviy Rih plans to build a new sinter plant and a rolling mill. The plant

intends to put into operation blast furnace No 8 in August 2008 after a 630 mln Ukrainian

hryvnia ($134.9 mln/86.6 mln euro) overhaul, which will produce 5,000 tons of steel daily.

The steel smelter will also launch in September the upgrade of blast furnace No 6, which will

resume operation in 2009 with a capacity of 4,000 tons a day”24.

Certain industries have hidden opportunities to attract more FDI.

Agriculture, processing and agricultural infrastructure.

Ukraine has 9th largest reserves of arable land in the world.

Exhibit 19 Reserves of arable land

Source: World Resources Institute, NationMaster,

http://www.nationmaster.com/red/graph/agr_ara_and_per_cro-agriculture-arable-and-

permanent-cropland&b_printable=1, accessed December 2009

On the other hand due to inefficient farming and lack of investments yields on most widely

produced crops are low comparing to other countries.

24

“Ukraine Arcelor Mittal To Invest $400 Mln in Development by End-2008” Ukrainian News Digest, August 2008,

via Factiva, December 2009

Exhibit 20 Crop yields (Metric tons per hectare, 2003/2004

Source: Production Estimates and Crop Assessmen

http://www.nationmaster.com/red/graph/agr_ara_and_per_cro

permanent-cropland&b_printable=1

There is potential for increasing yield which will lead to growth in

inputs and infrastructure (Elevators, tractors, pesticides etc.)

Agriculture itself is an industry that at

GDP agriculture attracts less than 2% Ukraine’s FDI.

On the one hand share of Global FDI dedicated to agriculture is fairly low.

world FDI inflows in agriculture exceeded $3 billion per

1% of total world FDI inflows25.

On the other hand some countries have been very successful in attracting FDI into the

agriculture sector. Malaysia was able to attract 373 $ of FDI per hectare of arable land. For

Papua New Guinea this number is 316 $. But even if these outliers are excluded Ukraine still

lags behind most other countries.

See Exhibit 20 FDI per hectare of arable land

Source: United Nations, World Investment Report 2009: Transnational Corporations, A

Production and Development, Figure

25

United Nations “World Investment Report

December 2009

23

Metric tons per hectare, 2003/2004)

Source: Production Estimates and Crop Assessment Division, FAS, USDA via NationMaster

http://www.nationmaster.com/red/graph/agr_ara_and_per_cro-agriculture-arable

cropland&b_printable=1, accessed December 2009

There is potential for increasing yield which will lead to growth in demand for

(Elevators, tractors, pesticides etc.).

is an industry that attracts minimal amount of FDI. Being more than 10% of

GDP agriculture attracts less than 2% Ukraine’s FDI.

one hand share of Global FDI dedicated to agriculture is fairly low.

world FDI inflows in agriculture exceeded $3 billion per annum. This still constituted less than



this number is 316 $. But even if these outliers are excluded Ukraine still

lags behind most other countries.

See Exhibit 20 FDI per hectare of arable land

World Investment Report 2009: Transnational Corporations, A

, Figure III.9., p.117. and authors calculations

World Investment Report”, p. 111, 2009, via http://www.unctad.org/en/docs/wir2009_en.pdf

t Division, FAS, USDA via NationMaster

arable-and-

demand for all agricultural

tracts minimal amount of FDI. Being more than 10% of

one hand share of Global FDI dedicated to agriculture is fairly low. By 2005– 2007,

annum. This still constituted less than



this number is 316 $. But even if these outliers are excluded Ukraine still

World Investment Report 2009: Transnational Corporations, Agricultural

http://www.unctad.org/en/docs/wir2009_en.pdf

24

Exhibit 21

Source: United Nations, World Investment Report 2009: Transnational Corporations, Agricultural

Production and Development, Figure III.9., p.117. (Data source: UNCTAD, based on annex table

A.III.3. (www.unctad.org/fdistatistics) and UNCTAD Secretariat estimates.)

There is a direct correlation between amounts of FDI attracted by a country and its average

yields per hectare, although it is hard to talk about causality. Countries who succeeded in

attracting FDI into agriculture are implementing several policies:

“China has adopted a selective support policy on foreign investment in agriculture. FDI for the

production of some agricultural products and TNC involvement in related activities are

encouraged. According to the Catalogue for the Industrial Guidance of Foreign Direct

25

Investment, for instance, foreign investment in the production of products such as rubber, sisal

and coffee is encouraged (e.g. through tax incentives)”26.

“Papua New Guinea, under the rural development incentive, encourages agricultural

production of any kind by inter alia granting a 10-year exemption from corporate income taxes

for businesses engaged in agricultural production that are established in specified rural

development areas. Also, accelerated depreciation rates are offered for new plants (other than

residential property with a cost exceeding kina 100,000 – approximately $37,250) with a life

span exceeding five years that are used in Papua New Guinea’s agricultural production”27.

“Viet Nam had set a target of mobilizing approximately $8.2 billion from 2006 to 2010 for

investments in agricultural development”28.

“Nigeria offers, inter alia, (i) unrestricted capital allowance for agribusinesses, and up to 50%

for agrorelated plants and equipment, (ii) guarantees of up to 75% of all loans granted by

commercial banks for agricultural production and processing under the Agricultural Credit

Guarantee Scheme Fund (ACGSF), and (iii) 60% repayment of interest provided by the Interest

Drawback Program Fund paid by those who borrow from banks under the ACGS for the purpose

of cassava production and processing, provided such borrowers repay their loans on schedule.

Also, processing of agricultural produce has been declared a pioneer industry which entitles the

companies involved to 100% tax exemption for a period of five years”29.

Besides general barriers for FDI there are several agriculture specific problems in Ukraine that

prevent FDI from growth:

- Government intervention in price setting (sugar and bread prices)

- Export quotas (for grains and cereals)

- Moratorium on land sale and purchase and undeveloped system of property rights

protection.

Although in many countries there are restrictions on land ownership for foreign investors,

moratorium on land sale in Ukraine is a problem for increasing sizes of the farms. Foreign

investors would be willing to invest even if the land would be leased but in order to achieve

economies of scale they need access to larger farms.

26

“World Investment Report”, United Nations p. 170, 2009, http://www.unctad.org/en/docs/wir2009_en.pdf

accessed December 2009 27

Ibid. 28

Ibid. 29

Ibid.

Tourism is the second largest and the most dynamic (in terms of growth) industry which is

exported by Ukrainian economy (See exhibit 22). Most of its success is attributed to

simplification or cancellation of visa procedures after the orang

“Foreign Minister Borys Tarasyuk has previously said the experiment was successful and the

number of EU tourists to Ukraine has more than doubled since May 1 when the cancellation

took effect”30.

Exhibit 22 Export of Services, Ukraine



In 2008 being 32% of exported services and 6% of total exports it attracted only 1.4% of total

FDI inflows31. The industry is experiencing a rapid growth and expected to attract more FDI in

the future. In foreign countries number of tourists has been in

years.

In Ukraine this process has just begun which means that it is positioned for a long

There is a trend for faster growth in numbers of tour

30

Reuters News “Ukraine scraps visas for Canadian, EU citizens” 28 July 2005, via Factiva, accessed December 200931

International Monetary Fund “IFS - International Financial Statistics, country tables”

prod1.hul.harvard.edu/imf/ accessed December 2009

26

is the second largest and the most dynamic (in terms of growth) industry which is


simplification or cancellation of visa procedures after the orange revolution in 2004.

Foreign Minister Borys Tarasyuk has previously said the experiment was successful and the


kraine




. The industry is experiencing a rapid growth and expected to attract more FDI in

the future. In foreign countries number of tourists has been increasing a lot for the past 20

In Ukraine this process has just begun which means that it is positioned for a long

There is a trend for faster growth in numbers of tourists to developing countries than to

as for Canadian, EU citizens” 28 July 2005, via Factiva, accessed December 2009

International Financial Statistics, country tables”, http://www.imfstatistics.org.ezp


is the second largest and the most dynamic (in terms of growth) industry which is


e revolution in 2004.

Foreign Minister Borys Tarasyuk has previously said the experiment was successful and the





. The industry is experiencing a rapid growth and expected to attract more FDI in

creasing a lot for the past 20

In Ukraine this process has just begun which means that it is positioned for a long-term growth.

ists to developing countries than to

as for Canadian, EU citizens” 28 July 2005, via Factiva, accessed December 2009 fstatistics.org.ezp-

27

developed ones. “In 1990 only 18% of international tourism receipts were earned by developing

economies as tourist destinations; by 2005 this share had risen to 30%, as these countries

continue to attract visitors at a faster pace than their developed peers (an average of 10.2% to

7.1% increase during 2000-2005). The UNWTO forecasts that by 2020 there will be 1.6 billion

tourists (twice the numbers in 2006) and, at the current rates of growth, a majority of these will

be going to developing market destinations”32.

“Ukraine already has a relatively high number of foreign visitors. However, each tourist spends

on average only USD 200 per visit, several times less than in other European countries and half

the level in Russia”33.

Exhibit23

Avetik Chalabyan, Vitaly Klintsov, Georges Massoud, McKinsey and Co “Reviving Ukraine’s

economic growth”, October 2009, p. 7

“Globally FDI in Tourism accounts for no more than 1 or 2 percent of total outward FDI stocks

from the largest source countries. However accounts data on tourism-related FDI are likely to

underestimate the true extent of Trans-National Corporation’s activities, where managerial

contracts rather than equity ownership is increasingly important. Moreover, the indications are

that tourism-related FDI and TNC activities are likely to increase significantly in the medium

32

UNITED NATIONS “FDI in Tourism: The Development Dimension” 2007 p.121, www.unctad.org, accessed December 2009 33 Avetik Chalabyan, Vitaly Klintsov, Georges Massoud, McKinsey and Co “Reviving Ukraine’s economic growth”, October 2009, p. 7

28

term, in virtually all developing regions”34. This hypothesis is based upon the UNCTAD survey of

international hotel investors presented in Exhibit24:

UNITED NATIONS “FDI in Tourism: The Development Dimension” 2007, Figure II.4. p 21.

www.unctad.org, accessed December 2009

The project focused mainly on hotels because, contrary to perceptions, there is relatively little

FDI in other activities such as tour operations or airlines35.

Same research also studies factors which influence the decision about the region for future

expansion. Findings are presented in Exhibit 25 Based on the data on current number of foreign

tourists Ukraine is very well positioned in terms of main criteria for decision about the region of

expansion – “Demand from the developed country tourists”.

34 UNITED NATIONS “FDI in Tourism: The Development Dimension” 2007, www.unctad.org, accessed December 2009 35 Ibid.

29

Exhibit25

UNITED NATIONS “FDI in Tourism: The Development Dimension” 2007, Figure II.5. p 34.


All of this data suggests that Ukraine is positioned for a high growth in FDI into tourism

industry.

Infrastructure projects are the biggest in terms of global FDI flows. “Infrastructure consists of a

group of industries, including electricity, gas, telecommunications, water and sewage, airports,

roads, railways and seaports (the last four collectively referred to as transport

infrastructure)”36. Combined those industries attracted 31% of all Services FDI flows and 19% of

total global FDI flows in 200637. Unfortunately, Ukraine was not able to participate in

infrastructure FDI flows to the needed extent. In its FDI balance infrastructure industries

combined add up to just 5% of total attracted FDI38.

Further analysis suggests though that most of infrastructure FDI flows were attracted by

developed economies rather than developing.

36

UNITED NATIONS “World Investment Report 2008: Transnational Corporations and the Infrastructure Challenge” 2007 p.87, www.unctad.org,


United Nations “World Investment Report”, stats.unctad.org/FDI, accessed December 2009 38

Government Comity of Statistics “Annual statistics report” of 2008, p. 276

30

Exhibit 26

UNITED NATIONS “World Investment Report 2008: Transnational Corporations and the Infrastructure Challenge” 2007, www.unctad.org,


On the other hand some developing countries have clearly been more successful than others.

“In electricity, for example, Brazil alone attracted 54% of the total foreign commitments in Latin

America and the Caribbean during 1996-2006. In the same period China accounted for almost

one quarter of the Asia in total, and Morocco was the largest recipient in Africa, with almost

50% of that region’s commitments”39.

This can be explained by the fact that government policies are much more important factor in

infrastructure projects than other factors like profitability, market size or synergies. Globally

governments gradually shifted from complete control over the infrastructure assets towards

liberalization of infrastructure-asset related markets. “The process of changing the role of the

State and increasing private sector participation involved a series of reforms, such as enterprise

restructuring, market liberalization and regulatory changes. Today, the private sector is a

significant participant in many infrastructure industries globally, in countries of all political

hues, and its role is likely to increase further because of the huge investment, technology, skills

and management needs in developed and developing countries alike”40. “TNC involvement is an

39

UNITED NATIONS “World Investment Report 2008: Transnational Corporations and the Infrastructure Challenge” 2007 p.105,

www.unctad.org, accessed December 2009 40

UNITED NATIONS “World Investment Report 2008: Transnational Corporations and the Infrastructure Challenge” 2007 p.94, via


31

important source of infrastructure financing for developing countries. For instance, according to

the World Bank PPI Database, the share of foreign investors in total investment commitments

in developing economies in infrastructure industries was 29% over the period 1996–2006”41.

Within infrastructure investments to developing countries energy and telecommunications

dominated the scene in the nineties but recently the emphasis shifted to transport.

Exhibit 27

UNITED

NATIONS “World Investment Report 2008: Transnational Corporations and the Infrastructure

Challenge” Figure III.5. 2007, www.unctad.org, accessed December 2009

Within sub-segments of infrastructure there is different FDI attracting potential.

In transport Ukrainian government was not effective in attracting FDI. Most assets are still

government owned or dominated by government monopolies. Railway being the most

important means of transportation is dominated by government monopoly. Construction and

maintenance of roads is also conducted by a state owned company. Ports and airports are in

government property. Privatization plans are unclear because of the constant political turmoil.

41

UNITED NATIONS 2007 “World Investment Report 2008: Transnational Corporations and the Infrastructure Challenge” p.100, via

www.unctad.org, December 2009

32

Public – Private Partnerships and concessions proven to be effective in other countries have not

been successful in Ukraine due to poor legislation.

Several small infrastructural investments were made by commodity TNC:

“Glencore Grain put into operation a grain terminal at the Illichivsk port. Simultaneous storage

capacities of the CJSC Illichivsk Grain Terminal are 116 thousand grain. Many transnational companies

(like Toepfer International) and large domestic holdings (in particular, Nibulon) possess their own grain

transfer systems. Kernel Company, one of the largest exporters of sunflower oil in Ukraine, purchased a

transfer terminal Transbulk in Illichivsk sea port for USD 100 million in June 2008”42.

These investments are hardly an achievement of the reform in the government policy but rather the

need by TNC to solve bottlenecks in their main operations.

“Globally In the transport infrastructure of developing and transition economies over 1996-

2006 period foreign participation was largely in the form of concessions: these alone accounted

for 86% of the number of projects. Privatizations, the second most important form, accounted

for less than one-tenth of the total. The dominance of concessions in transport worldwide has

resulted in a proliferation of individual operators. This is particularly evident in ports, where the

majority of international players have expanded by winning new concessions, and only more

recently, through M&As”43.

Energy sector is potentially very attractive for foreign investors.

In natural gas sector import substitution is possible since Ukraine imports more than half

consumed natural gas. In 2008 Ukraine produced 19.985 billion cubic meters of natural gas,

which is just 40% of consumption in 2009 (53 bcm)44.

Internal reserves allow increasing domestic production. By government statistics total proven

reserves of natural gas in Ukraine amount to 1098.4 billion cubic meters. They are spread

around three main basins:

42

Ukrainian National News Agency “Transnational companies in Ukraine invest in construction, purchase of facilities for grain

transfer – experts” 22 July 2008, via Factiva, December 2009

43 UNITED NATIONS “World Investment Report 2008: Transnational Corporations and the Infrastructure Challenge” 2007 p.106,

via www.unctad.org, accessed December 2009 44

Intrefax “Ukraine boosts gas production by 1.3% in 10 months”, 14.11.2009 www.inerfax.com.ua, accessed December

2009

33

Exhibit 28

BCM %

West - Carpathian basin 118.2 11%

East - Dnipro-Donetsk basin 921.9 84%

South - Black Sea/Azov Sea basin 58.3 5%

Total 1098.4 100%

Source: Ukrainian Government Geological company “Geo.Inform”

Drilling activities currently are approximately 200 000 – 220 000 meters per year. “In the

national program Oil and Gas of Ukraine to 2010 and the Energy Strategy to 2030, the Ukrainian

government notes that it expects to increase exploration drilling activities 2.5 times to 415 000

meters per year by 2030. This would add 670 bcm to the gas reserves by 2030 in the pessimistic

scenario, or 1 023 bcm in the optimistic scenario. Exploration drilling is a very expensive and

risky activity. To achieve the targets of the program, it would be necessary to invest some $ 12

billion, an amount that cannot be secured from Ukrainian sources.”45

So far Ukraine had not been able to attract sufficient non government investments into

exploration and extraction due to several factors:

- Lack of transparency. Government had been not fully transparent in publishing data

about the gas reserves. Moreover the data which is published can hardly be considered

reliable due to differences in valuation methods and absence of independent audits.

- Unattractive legal regulation of exploration and production. In current law on

Production Sharing Agreements the limit to 40% of foreign participation is implemented.

This significantly reduces attractiveness of PSA for foreign investors. Besides that

Ukrainian legislation demands acquisition of two different licenses: 5 year exploration

license for each individual site; and 20 year production license. In practice this means

that the company which made a discovery during exploration is not guaranteed access

to the site making it a very risky investment. In the past there were several disputes

around this issue resulting in lost time and money.

- Legal disputes around previously rendered licenses scare away potential investors. .

Production licenses of a UK based company Regal Petroleum had been disputed in

courts in 2005, 2006. “The contract with an affiliate of Vanco International Ltd. - a

subsidiary of Houston’s Vanco Energy Company – was “revoked and terminated” on 21

May 2008”46.

45

OECD “Ukraine Energy policy overview 2006”, www.iea.org, accessed December 2009 46

Tammy Lynch “Exploring Ukraine’s Vanco dispute” By 28.07.2008, www.unian.net , accessed December 2009

34

- Barriers for gas sales at competitive prices.

Considering huge demand for natural gas in Ukraine, well developed gas transportation

infrastructure and availability of domestic reserves this sector should be very attractive for

foreign investors if government changes its policy.

Electricity sector can become attractive after privatization. “Despite of the fact that currently

Ukraine is a net exporter of electricity the sector will require significant investment in the

future:

- 95% of power units have worked out their useful life; the residual life of thermal power

plants is 5-7 years.

- The level of technological losses constitutes 14.4% of the electricity produced, which is

2-2.5 times higher than in developed countries. In order to decrease the losses, it is

necessary to invest in modernization of transmission and distribution networks.

- Despite constant increase of electricity production and consumption since 2000, Ukraine

may soon face a technical problem of electricity supply to final consumers, especially in

large cities. The growing demand for electricity cannot be satisfied using the old

transmission and distribution networks”47.

Privatization of the sector can open way for foreign investors. “Ukraine privatization agency

plans to auction blocking stakes in five regional power companies as part of a plan to generate

more than $1bn from property sales in 2009. Companies to go on the block include

Prykarpatoblenergo, Lyivenergy, Chernihovblenergo and Sumyoblenergo. Privatization of the

electricity sector, until now delayed by political infighting, may now be prompted by the

financial crisis engulfing the economy”48.

Electricity is one of the most active service industries in terms of FDI flows into developing

countries:

47 Anna Tsarenko “Overview of Electricity Market in Ukraine”, 2007 p. 18 48 Petroleum Economist “News in brief Eastern Europe and CIS” 1 April 2009, via Factiva, December 2009

35

Exhibit29

UNITED NATIONS 2007 “World Investment Report 2008: Transnational Corporations and the

Infrastructure Challenge, www.unctad.org, accessed, December 2009

Russia can be a very successful example of FDI inflow into the electricity sector after market

liberalization. “In 2008, the reorganization of the power generation industry was completed,

and the unbundling of RAO UES was carried out. The reform involved the lifting of the

company’s quasi-monopoly and the divestment of stakes in 72 vertically integrated affiliates,

each of which has a regional monopoly on electricity generation and distribution. Through a

subsequent process of consolidation, these entities were transformed into six wholesale

generation companies (WGCs) and 14 territorial generation companies (TGCs). This

restructuring and sales of assets have provided opportunities for foreign investors to enter the

industry. A number of the stakes in WGCs and TGCs have already been acquired by various

European TNCs such as Fortum (Finland), Enel (Italy), E.ON (Germany), CEZ (Czech Republic),

RWE (Germany) and EDF (France). In 2008, Fortum (Finland) purchased a controlling stake in

TGC-10 and RWE (Germany) bought a majority share in TGC-12, while EDF (France) has entered

into a partnership with the Russian bidder TransNeftServis-S to acquire OGC-1, one of RAO UES’

most valuable assets”49.

49

United Nations “World Investment Report 2008: Transnational Corporations and the Infrastructure Challenge”, p. 76, 2009,

http://www.unctad.org/en/docs/wir2009_en.pdf accessed December 2009

36

In Telecom there had been significant achievements in the mobile telephony where both

biggest operators Kyievstar and UMC have the participation of foreign investors Telenor

(Norway) and MTS (Russia).

The biggest opportunity for the future is the privatization of government fixed line telephone

monopoly Ukrtelecom. Government had been postponing privatization of this company several

times due to internal conflicts. While the government is hesitating with privatization of

Ukrtelecom the company financials are deteriorating.

Chemicals and chemical products is 22% of secondary industries global FDI. “In Ukraine In 2007,

chemical sector shared 6.4% in the structure of industrial production (6 place), 2.7% - in the

structure of GDP”50.

“Until 1990, Ukraine was producing 16% of the total of mineral fertilizers in the former Soviet

Union, 24% plant-protection chemicals, 18% sulfuric acid, 25% soda ash, 16% caustic soda, and

13% chemical fiber”51.

“The structure of the chemical sector includes two groups of enterprises – chemical and

petrochemical ones. Within the structure of the industry, predominant are asset- and energy-

intensive basic chemistry enterprises. This sector is represented by production of mineral

fertilizers, non-organic acids and soda. Nitric fertilizers are manufactured in Donbas

(Severodonetsk, Horlivka) and Prydniprovia (Dniprodzerzhinsk). Rivne and Cherkasy enterprises

use natural gas in their production. Phosphate fertilizers are manufactured in sugar-beet

producing areas (Sumy, Vinnytsia) and in Odesa and Kostyantyniv (Donetsk oblast). Production

of sulfuric acid is concentrated in the regions where it is consumed and in the centers of

phosphate fertilizers production. Basic chemistry is concentrated in the Crimea and comprises

production of bromine, magnesium and iodine. State-owned enterprises are less than one-fifth

of the total number of chemical industry enterprises manufacturing about one-third of the

products.”52

Theoretically industry in general should be attractive for foreign investors due to developed

infrastructure and skilled labor force. On the other hand most of the physical assets were built

in the soviet era and are physically and technologically deteriorated. Most of the current

industry players are using energy inefficient technologies which are dependent on supply of

cheap gas and electricity. Gas and electricity prices are projected to grow in the near future

moving most of the current producers into zones of negative profitability.

50

“Chemical industry in Ukraine”, by www.export.by. http://www.export.by/en/?act=s_docs&mode=view&id=7191&doc=64


Ukraine Gateway “Chemical and petrochemical industry”, http://www.ukraine-

gateway.org.ua/gateway/gateway.nsf/webcontent/05020300, accessed December 2009 52

Ibid

37

For foreign investors who have experience and technological capabilities in increasing energy

efficiency this situation can create opportunities. Current owners might be willing to sell

money-losing assets at significantly lower valuations.

Other opportunity is the privatization of “Jsc Odessa Port Plant” a major urea and ammonia maker

in Ukraine. The privatization tender was scheduled to occur in 2009 and the company’s value was

estimated to be around 1bn $. Tender in fact took place on 29 September 2009 but later on its results

were cancelled by court. On the one hand “The Ukrainian prime minister reportedly accused bidders of

conniving to purchase Odessa Port Plant at a bargain price”53. On the other hand President Yushchenko

accused Tymoshenko of conducting a prearranged tender. In any case the company is still available for

privatization and may be attractive for foreign investors if the tender is conducted in a transparent

manner.

In Manufacturing there is potential for FDI increase. “In many sub-sectors, such as car

manufacturing, metals and mining machinery, power machinery, instruments, and agricultural

machinery, local production accounts for less than half the domestic market. Therefore, there is

the potential for (at least partial) import substitution by increasing domestic production. For

example, if the total Ukrainian car market growth returns, then in five to ten years the country

will reach the scale necessary to attract large foreign manufacturers to set up integrated

production plants locally, with a view to possible future car export to neighboring countries.

Another possible manufacturing success story is agricultural machinery: Ukraine uses four

times fewer tractors per hectare of cultivated land than Turkey and six times fewer than France.

To reach the level of Turkey would mean a total market of 60,000 to 80,000 units per year,

more than the size of an average European plant”54.

In global FDI flows in Machinery, Motor vehicles and other transport equipment are enjoying

13% share in secondary industries and 4% of all FDI (by 2007 data)55. Ukrainian statistics are not

separating this subsector but based on up to date publicly known investments the potential has

not been reached.

On the other hand there had been some achievements.

“Skoda Auto (SA) (Mlada Boleslav, Czech Republic), automobile company, started to assemble cars in

Solomonov, the Ukraine, in 2001. On the basis of licensed fees, SA started to co-operate with Eurocar

(Ukraine). Eurocar built an assembly plant on an area of 2.7 ha during a nine-month period”56.

53

NITMET “Odessa plant sales in confusion” 18 November 2009, via Factiva, accessed December 2009 54

Avetik Chalabyan, Vitaly Klintsov, Georges Massoud “Reviving Ukraine’s economic growth” McKinsey and Co, October 2009,

p. 4 55

United Nations ““World Investment Report 2008: Transnational Corporations and the Infrastructure Challenge””, via

stats.unctad.org/FDI, accessed December 2009 56

Access Czech Republic Business Bulletin “Attack on the Ukraine” 23 October 2003, via Factiva, accessed December 2009

38

“Ukraine’s second largest car producer, the Lutsk Motor Plant (LuAZ), and one of China’s largest

carmakers, Dongfeng Motor Corporation, signed a contract on June, 30 to jointly develop a new

freight and cargo truck manufacturing plant in Cherkasy Region.

In a recent press release, LuAZ announced that the new facility will produce freight and cargo

trucks with a capacity of 2-10 tons, and is expected to be operational by the end of 2007. The

plant will have the capacity to produce 12,000 freight and cargo trucks annually and potentially

about 1,000 new jobs as early as next year”57.

57

Orysia Kulick “Ukraine’s LuAZ and one of China’s largest carmakers sign contract” , Kyiv Post Jul 13 2006, 02:27, via

www.chinacarforums.com, accessed December 2009.

39

Conclusion

Ukraine’s pace of economic and technological development and level of integration into global

economy will be driven by its ability to attract FDI.

In general Ukraine is an attractive territory for foreign investors due to big internal market size,

geographic location and cheap but educated labor force. On the other hand poor investment

climate prevents Ukraine form realizing its potential to the full extent.

Achievements in several industries have shown that at this point the success lies not in complex

government programs, but in simple but smart decisions which dramatically change FDI

landscape:

Finance - change in legislation allowing foreign banks to enter the market;

Steel – transparent privatization of Krivorozhstal;

Tourism – simplification of visa procedures.

In the short-term perspective there is potential for such simple but very effective

improvements in other sectors:

1. Termination of moratorium on sale of agricultural land;

2. Simplification of gas exploration and extraction legislation;

3. Transparent privatization: Ukrtelecom; Odessa Port Plant; Electricity market etc.

In the medium term government should focus on legislative improvements:

1. Taxation reform and simplification of procedures;

2. Improvements in legislation regulating private-public partnerships and concessions;

3. Improving the easiness of cross-border trade

Most importantly, the suggested decisions are not FDI specific and it’s not a zero-sum game.

Proposed reforms are as beneficial for internal investors as they are for foreign and their

implementation is just a question of political will.

Economy & Finance

Foreign Direct Investments into Ukraine