Foreign investment in Ukraine

February 2014  |  FEATURE  |  FINANCE & INVESTMENT

Financier Worldwide Magazine

Given the perilous state of Ukraine’s economy, improving the country’s investment climate has been of paramount importance for some time. Over the last few years the Ukrainian economy has been staring firmly down the barrel of default. In 2013, Ukraine had a current account deficit equivalent to more than 8 percent of GDP and a budget deficit over 6.5 percent. The country must repay $8bn worth of foreign debt during 2014, including $3.7bn on a 2008 loan from the International Monetary Fund (IMF). Ukraine also suffers from a large current account deficit and a considerable budget deficit.

The dire state of Ukraine’s economy was brought into even sharper focus in late 2013 by the tug of war between the European Union and Russia for the future of the country. Both parties spent considerable time and effort attempting to persuade Ukraine to accept their own respective trade agreements. Given the historical context of the countries involved, the standoff, despite the larger question of Ukraine’s economic stability, quickly escalated into a wider geopolitical argument.

In the West, the EU offered Ukraine the chance to enter into a comprehensive free trade agreement covering a number of key areas. Whereas normal trade deals are only applicable to goods, the deal proposed by the EU hoped to simplify cross-border trade in services. However, the EU deal would have required Ukraine to make a number of concessions, aligning its trade regulations to match those within the EU. Ukraine would also have been asked to overhaul its public procurement, competition policy and international property rights. The EU had pledged loans of around $827m to Ukraine, while a €1bn loan from the IMF had also been mooted.

Perhaps more importantly, the EU’s deal would have seen Ukraine’s institutional and legal framework significantly improved and the rule of law strengthened. These improvements would no doubt have made Ukraine a far more welcoming investment destination for domestic and, crucially, foreign investors. Historically, foreign direct investment (FDI) in Ukraine has been particularly poor. In 2012 Ukraine attracted just $6bn worth of FDI; by comparison its EU neighbours Poland and Czech Republic each drew $10bn worth of FDI during the same period.

Ultimately, however, the decision taken by the Ukrainian government and President Viktor Yanukovich to embrace Russia above the European Union will have real implications for the future of business in the country. The repercussions will be felt by companies and investors, both domestic and foreign.

In order to boost Ukraine’s flagging economy, Russia has pledged to invest $15bn into Ukrainian bonds. Russia will also settle a long disputed gas bill and temporarily reduce the price of natural gas. It will also end some customs controls and import quotas recently imposed on Ukraine. Although there was no talk of Ukraine being forced to join a Russian-led customs bloc with other former Soviet states, the scale of the Russian deal will undoubtedly increase its influence over Ukraine in the coming years.

In early November it appeared as if the Ukrainian leadership had decided to sign the EU’s agreement, which according to Brussels would have brought widespread investment into the country. Ukraine’s energy and agri-business sectors both stood to benefit handsomely if the country opted to enter the EU free trade agreement. Agriculture and the food industry serve as cornerstones of the Ukrainian economy, accounting for approximately 15 percent of the nation’s GDP, as well as providing significant employment opportunities in rural areas. With significant investment in agri-business, Ukraine has the necessary natural resources, climate, arable land, ice-free seaports and agricultural heritage to greatly enhance its status as a leading producer and exporter of agricultural commodities.

Similarly there would also have been ample opportunities for investment in the Ukrainian energy sector. The American Chamber of Commerce in Ukraine urged the Ukrainian government to spurn the advances of Russia and enter the European trade agreement. In a statement the chamber noted that the signing of the agreement “would open up new opportunities for both domestic and international businesses operating in Ukraine, which will help move the economy down the road towards a more prosperous future through enhancing production and exports of agricultural production, including processed food products, strengthening the country's energy independence, and receiving additional investments due to establishment of a more predictable, stable and level playing field, as well securing a freer flow of goods, services, investment and labour.”

However, Ukraine ultimately decided to embrace its Russian neighbour rather than the EU. Although the markets initially welcomed the news, which will probably prevent Ukraine from collapsing into insolvency, for long term foreign investors in Ukraine the deal is less welcome. Indeed, conducting business within Ukraine may soon become increasingly problematic as the country becomes further entrenched in a political and economic relationship with Russia.

For foreign businesses, operating in Ukraine can be troublesome enough. With accusations of bribery and corruption already lingering, the decision to ally Ukraine with Russia economically will further muddy the waters for firms looking to invest. The deal with Russia has, in all likelihood, secured Ukraine’s economic future in the short term. However, President Yanukovich’s decision to tie the country’s fiscal – and political – future to Russia may ultimately prove to be rather damaging for FDI in Ukraine.

© Financier Worldwide

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Richard Summerfield