THESIS
For MSc in Finance and International Business
Foreign direct investments in Ukraine: progress and
perspectives
Author:
Oksana KIFYAK
Academic Adviser:
Erik Strøjer MADSEN
Associate Professor
Department of Economics
Aarhus, Denmark
2009
Acknowledgements
First of all I am grateful to our God, that He inspired me for making “a
journey” through my land, and gave me strength for completing the paper. I want to
thank my supervisor, Erik Strøjer Madsen, for his guiding and help throughout the
process of writing the thesis.
My sincere gratitude is to my mother - for comments, to my husband - for
support, to my sister in law - for suggestions and to my friend, Viktoriya Fedulova –
for her help. My special acknowledgement goes to my little daughter, Josephina, who
gave me the opportunity to write this paper.
1
Abstract
Nowadays, we can observe fast developing of East European economies. To
develop, economy needs some platform, or capital. Here, the question of foreign
investments arises. The Foreign Direct Investment topic will always be important due
to its big impact on economies development. However, it is not always very easy to
invest in particular country due to existing barriers.
This paper presents Ukrainian FDI progress and perspectives to a reader. It
describes investing climate, reveals barriers and outlines future trends. Ukraine is
compared with the closest neighbors from the investment point of view. Being
neighbors, countries however, have different transitional paths.
In this work present-day investment position of Ukraine is revealed. Current
state of different branches of Ukrainian industry along with market forecast is
presented in the paper. This thesis also includes recommendations for foreign
investors.
Paper is built on analytical researches and includes the cases of foreign
companies-investors.
Key words: FDI, Ukraine, CIS, EEC, crisis, forecast
2
Table of Contents
Acknowledgements ................................................................................................... 1
Abstract ..................................................................................................................... 2
Introduction ............................................................................................................... 1
CHAPTER 1. Theoretical framework of Foreign Direct Investment ............................ 2
1.1. FDI introduction, theories and models ............................................................... 2
1.2 Determinants of Foreign direct Investment ......................................................... 7
1.3. Should countries promote Foreign Direct Investment? ................................... 18
CHAPTER 2. Country analysis ................................................................................... 20
2.1. Ukraine and development path......................................................................... 20
2.2. Investment and Business Climate analysis ...................................................... 21
2.3. Investment barriers assessment ........................................................................ 23
CHAPTER 3. Ukrainian Foreign Direct Investment Analysis .................................... 37
3.1. Level of FDI to Ukraine ................................................................................... 37
3.2. Comparing of the neighbors ............................................................................. 41
3.3. Analysis of the structure of Ukrainian FDI by branches .................................. 47
CHAPTER 4. Recommendations to investors ............................................................. 60
Bibliography ............................................................................................................ 65
Appendixes .............................................................................................................. 73
3
Table of Figures
Tables
Table 1.Foreign Direct Investment Theories ................................................................. 4
Table 2. Determinants of FDI ........................................................................................ 9
Table 3.Ukraine Ratings 2003-2008 ............................................................................ 21
Table 4.Countries Sovereign Credit Ratings 2008 ...................................................... 21
Table 5. Comparing of Countries Ratings ................................................................... 22
Table 6. Index of economic freedom, selective country rankings ............................... 22
Table 7. Interest rates, percent, US dollars .................................................................. 25
Table 8. Export and import requirements in Ukraine .................................................. 31
Table 9. Trade Balance of Ukraine, 2001-2008, billions of US Dollars ..................... 32
Table 10. The degree of openness of the Ukrainian economy 2001-2008 .................. 33
Table 11. Interdependence between FDI determinants and FDI level in Ukraine....... 35
Table 12. Investment attractiveness of Ukrainian regions - 2008 ............................... 41
Table 13. The transition path of selected countries ..................................................... 42
Table 14. FDI in the chosen countries by activity types .............................................. 46
Table 15. FDI in the chosen countries by investors ..................................................... 46
Table 16. The branches of Ukrainian industry, their development and forecast. ........ 62
Figures
Figure 1. Multiplication effect of FDI ........................................................................... 3
Figure 2. Ukrainian GDP per capita, nominal, US Dollars ......................................... 23
Figure 3 Annual GDP Growth, selected countries, percent ......................................... 24
Figure 4 Budget proficit (deficit), percent of GDP ...................................................... 24
Figure 5.Ukrainian nominal Exchange rate (1996-2009), UAH.................................. 25
Figure 6.Ukrainian real exchange rate (2000-2007), percent ...................................... 26
Figure 7.Inflation, end of period, consumer prices, percent ........................................ 26
Figure 8. Legal System ................................................................................................ 30
Figure 9. Current Account of Ukraine, billions of US Dollars .................................... 32
Figure 10. Unemployment, percent ............................................................................. 33
4
Figure 11. Nominal average salary in Ukraine, US Dollars ........................................ 34
Figure 12 Herfindahl-Hirschman Index 2005 .............................................................. 35
Figure 13. FDI as a percent of GDP ............................................................................ 38
Figure 14. FDI Stock in Ukraine, billions of USD ...................................................... 39
Figure 15. FDI inflow to Ukraine, billions, USD ........................................................ 39
Figure 16. FDI inflow to Ukraine in 2008 by countries, percent ................................. 40
Figure 17. FDI Flow per capita, by country, billions, USD......................................... 44
Figure 18. FDI Stock, billions of USD ........................................................................ 44
Figure 19. FDI to Ukraine in 2008 by activity types ................................................... 48
Figure 20. Structure of M&A in Ukraine in 2007, percent .......................................... 60
Figure 21. Volume of M&A in Ukraine, billions of USD ........................................... 60
5
Introduction
Foreign direct investment plays an important role in international business
and in the development of different economies. Many governments have liberalized
their policies to attract investors. Foreign capital is filling the budget, reduces
unemployment, promotes technology and knowledge transfer. It’s impossible to
imagine modern society without FDI. Nowadays, we can observe fast developing of
East European economies. To develop, economy needs some platform, or capital. It is
possible to take it from your ”own pocket” or to ask someone else. Here, the question
about foreign investments arises. The FDI topic will always be significant due to
enormous demand on investments.
Ukraine is the biggest country in the Central-Eastern Europe. Its possession
of land, capital and labour resources creates perennial interest from foreign investors.
During 18 years of independence, Ukraine passed the long way of political and
economical reforms. One of the most important steps was liberalization of markets,
creating the conditions for direct investments. There are still many risks and barriers
for international investors. Along with that investments, made into Ukrainian
economy, brought enormous yields, which are not accessible for developed
economies investors. Recent years stability of macroeconomic figures brought big
inflow of investment to the country, however financial crisis shook the growth
tendency.
This paper gives an overview of Ukrainian Foreign Direct Investment since
Independence, its transitional path, modern situation and attempts to make a forecast
of attractive areas for investor in future. The paper consists of four chapters. The first
describes theoretical background, refers to the main FDI theories, summaries them
and points out on the determinants of FDI. Second chapter introduces Ukraine to a
reader, reveals its investment position and business climate. Here the barriers for FDI
are examined. Chapter three describes the level of FDI to Ukraine in general and tries
to concentrate on specific branches, which attracted the biggest amount of
investments. This part also deals with comparing FDI performance of our closest
neighbors- Hungary, Poland, Romania, Russia and Belarus. The fourth block reveals
the perspectives of FDI and points to the future areas, which can be very interesting to
investors. This part contains forecast of Ukrainian development and suggests possible
FDI trends.
1
CHAPTER 1. Theoretical framework of Foreign Direct
Investment
1.1. FDI introduction, theories and models
The economy of every country has the question of FDI among top-important
ones. FDI appears to be one of the most studied, but still not fully researched topics
in international business area.
Foreign direct investment implies, that a company from one country makes a
physical investment in another country. It is the establishment of an enterprise by a
foreigner. FDI imply investments, made to acquire lasting interest in enterprises
operating outside of the economy of the investor. “Lasting Interest” implies the
existence of long-term relationship between the direct investor and the enterprise and
a significant degree of influence by the direct investor on the management of the
direct investment enterprise. Direct investment involves both the initial transaction
between the two entities and all subsequent capital transactions between them and
among affiliated enterprises; both incorporated and unincorporated (OECD). The FDI
pair consists of a parent enterprise and a foreign affiliate, which form a multinational
corporation. The investment becomes FDI when it affords the parent enterprise
control over its foreign affiliate (Wikipedia). The IMF defines control in this case as
owning 10% or more of the ordinary shares or voting power of an incorporated firm
or its equivalent for an unincorporated firm; lower ownership shares are known as
portfolio investment (IMF, 1993). Foreign Direct Investment is one of the three
components of international capital flows. FDI itself has three components: equity
capital, reinvested earnings and intra-company loans (Vavilov, 2005).
There is traditional thought, that investment activity and the cyclical
processes create economical progress in every economy. What is the impact of
foreign capital on domestic economy? Foreign capital fills the internal sources of the
country. Capital inflow reduces tension in the credit sphere; its influence on interest
rate and banking credits serves as additional stimuli for further investments. FDI is
able to increase production effectiveness, widen the distribution markets due to higher
technological level and better equipment. The rise of productivity level in the sector
with foreign investor presence involves suppliers and related industries development
as well. The development of economy, which follows after, creates demand in
2
qualified labor force: engineers and economists. Moreover, export-oriented MNC rise
export profits of the country.
Figure 1 Multiplication effect of FDI
FDI
Infrastructure
MNC
Distribution
Taxes
Salary
Budget
Further development
Social payments
Source: Dirko A.A.,2004,The impact of FDI on economical development of the recipient country
Foreign capital serves as a major resource of growth and technology
diffusion in the transition economies of CEE countries. MNC’s increase country’s
compatibility on international arena and attract even more investment (Dirko, 2004).
The main theories of FDI try to explain its nature, types and
internationalization process. Main theories are – theory of industrial organization,
theory of the firm, trade theory and theory of location (Table 1).
Theory of industrial organization suggests why firms, which have the
resources to operate internationally achieve technical and organizational advantages
over domestic firms via FDI. Let’s say Hymer (1960) in his Industrial Organization
model argues that some firms achieve advantages that allow them to obtain rents in
foreign markets. Foreign investor is in less favorable situation than the local one. Due
to this fact, international investor must possess monopolistic advantage to receive
higher profits.
Theory of the firm tries to answer the question in which way can the MNC
expand its activity in host country. (Vernon, 1966) has introduced Product Life Cycle
model. Products have a finite economic life and go through 3 phases: new product,
maturity and standardization. FDI occurs when in the maturity phase the innovator
shifts production in developing countries due to lower factor cost advantages.
3
Table 1 Foreign Direct Investment Theories
Macro theories
Micro theories
Theory/hypothesis
Authors
Theory/hypothesis
Authors
Theories of Industrial Organization
Theories of Industrial Hymer (1960, 1968, 1976) Caves (1971, 1974) Teece (1981, 1992)
McCullough (1991)
organization
Theories of the Firm
Product cycle
Vernon (1966), Hirsch (1967), Vernon (1979), Buckley
and Casson(1976)
Coase (1937) Buckley and Casson (1976) Williamson (1975, 1979)
Rugman (1981) Hennart (1982, 2000) Hill and Kim (1988) Prahalad
Transaction Related
and Doz (1987) Bartlett and Ghoshal (1989)Doz, Awakawa, Santos
and Williamson (1997)
Internationalization
Johanson and Vahlne(1977, 1990), Eriksson, et al. Resource
process
(1997)
based/Raw Penrose (1958) Wenerfelt (1984) Nelson and Winter (1982) Cantwell
materials
(1989, 1994) Teece, Pissano and Shuen (1997)
Strategy related (and Vernon (1966) Knickerbocker (1973) Graham (1975)
Flowers
Oligopolistic
(1976) Vernon (1982) Hostman and Markusen (1987) Graham
production)
(1990, 1998)
Option theory
Kogut and Kulatilaka 1994) Rivoli and Solaria 1996) Casson (2000)
Internalisation
Buckley and Casson (1976)
4
Theories of Trade
Macro (country
Kojima (1973 to 1982) Helpman (1984, 1985) Markusen
oriented)
and Venables (1998)
Vernon
Micro (firm oriented)
(1966),
Hirsch
(1976),
Ethier
(1986),
Batra
and
Ramachandran (1980), Gray (1982, 1999), Markusen (1984, 1995,
1998)
Theories of Location
Vernon (1966), Vernon (1974), Hirsch (1967), Dunning
Theory of location
(1972), Root and Ahmed (1979), Davidson (1980),
(General)
Lipsay and Kravis (1982), Krugman (1991, 1993)
Internationalization
Clustering and
agglomeration
Johanson and Vahlne (1977, 1990), Schneider and Frey
(1985), Welch and Luostarinen (1988)
Enright (1991, 1998), Porter (1998), Audretsch (1998), Chen and
Chen (1998), Head, Ries, and Swenson (1995), Markusen and
Venables (2000)
Cohen and Levinthal (1990), Levinthal (1990), Kogut and Zander
Knowledge enchasing
(1992, 1994), Nonaka (1994), Porter (1994, 1998), Dunning (1995,
1997), Kuemmerle (1999)
Market size
Exchange
/currency area
Stevens (1969), Kwack (1972), Schwartz (1976)
rate Aliber (1971), Cushman (1985), Culem (1988), Froot
and Stein (1991), Rangan (1998)
Output
Stevens (1969), Kwack (1972), Schwartz (1976)
Spatial transaction cost Florida (1995), Scott (1996), Storper and Scott (1995)
Taxes, subsidies and/or Hines (1996), Devereux and Griffith (1996), Haufler and Wooton
tariffs and incentives
(1999), Glass and Saggi (2000)
Cheap labour
Riedel (1975), Donges (1976, 1980) Juhl (1979)
Source: Adapted from Jordaan, J. 2004. Foreign direct investment and neighboring influences. University of Pretoria
5
Ten years later, Buckley & Casson (1976) introduce Internalization model. They’ve
pointed out five advantages of internalized transaction over the market. Internalization
increases ability to control and plan, gives the opportunity for discriminatory pricing.
It avoids bilateral monopoly, reduces uncertainty and avoids government intervention.
Trade Theory explains that location of international production is based on
specific advantages. It reveals why is it better to invest in another country rather than
trade. Traditional trade theory suggest that trade should be greatest between countries
that are not similar.
Theory of Location is a framework that determines location of FDI as the
key-point for the future activities. The host countries possess some location
advantages, otherwise the firm would simply operate in a single location. This theory
operates with protectionism, transportation cost, cooperation with downstream firms,
and acquisition of existing distribution networks. This theory uncovers the reasons
that determine the choice of the overseas investment.
As a part of Location Theory, very important were findings of Dunning
(1972). Here he identifies four main types of foreign production, according to their
motive for going abroad: 1) resource-seeking, 2) market-seeking, 3) efficiencyseeking, and 4) strategic asset or capabilities seeking (Pawlik, 2005).
o Resource-seeking - the company tries to gain access to resources not available
at home. Such resources could be: natural resources, raw materials, technological,
innovatory or created assets, including knowledge-based assets embodied in
individual firms. Resource-seeking FDI is mainly undertaken through vertical
integration (Vavilov, 2005).
o Market-seeking – host country company search to expand or to get access
both to domestic and regional markets. This is implemented usually through
horizontal integration. Main reasons for such investment are to overcome trade
barriers and transportation costs.
o Efficiency-seeking – to gain from scope and scale economies, to increase
efficiency by transferring production to low cost areas. The investing firm takes
advantage of differences in availability and cost of traditional factor endowment, of
differences in culture, economic systems and policies, and/or market structures. A
6
mutual efficiency-seeking investment between two countries with broadly similar
economic structures can be explained by additional benefits from economies of scale
and scope and risk diversification that may arise to the investing company (Kern, S.
2005).
o Strategically-motivated – links any of the mentioned above motivations with a
strategic intent (follow the leader, first mover advantage, product adaptation, etc.).
Such type usually takes place in oligopolistic industries where rivals are bound by
mutual recognition of interdependence. The decision may be a defensive strategy to
prevent rival’s advantage. At the same time, MNEs goes for strategic-asset seeking
investment to protect or advance the companies competition position (Pawlik, 2005).
Very important model of FDI was The Eclectic Paradigm of Dunning
(1977). It reveals the sources of competitive advantage for international operators. It
can explain more than just some theories are able. Dunning integrated the most
important theories. According to Dunning FDI emerges when there are: 1) ownership
advantages, 2) location-specific advantages, 3) internalization-incentive advantages.
(O) The firm must have some proprietary ownership advantage. These
advantages usually arise from the possession of firm-specific assets. Dunning defines
assets as “resources capable of generating future income”. These assets may be
tangible, as well as intangible assets such as management or possession of certain
technologies.
(L) are based on economic differences between nations. There must be some
reasons for the firm to change its location of production e.g. labor cost; tariffs;
advantages of being near to the customer.
(I) can be achieved by coordinating international transactions. It is better to
transfer the advantage inside the managerial hierarchy of the firm, instead of via a
contract.
1.2 Determinants of Foreign direct Investment
The determinants of foreign direct investment lay the theoretical basis for
further investing. It is important to find out which are they for the study of particular
economy. I can group them to three groups:
7

Economic factors – exchange rate, inflation, liquidity, financial markets, cost
of capital, market size, labor cost.

International compatibility factors – institutions, openness of the economy,
growth, development, trade effects

Red-tape factors – corruption, tax barriers, political instability, legal and
regulatory issues, uncertainties (Ok, 2004).
Exchange rate
The issue of exchange rate has been examined in the literature from different
aspects. In general, foreign firms are more willing to buy a country’s asset when that
country’s currency is weak. The effect of exchange rates on FDI has been examined
both with respect to changes in the level of exchange rate between countries and in
the volatility of exchange rates. Until 1991, it was taught, that changes of the
exchange rate would not alter firm’s decision to invest in a foreign country. Froot and
Stein (1991) postulated that currency depreciation might increase foreign investment
taking into account imperfect capital markets. Internal cost of capital is cheaper than
external one. That’s why appreciation of the currency increases firm’s wealth and
provides low-cost funds (Bloningen, 2005).
Rosengren (1996) states, that exchange rate depreciation increases FDI,
while Blonigen (1997) notice just an affect of it on FDI for a host country.
Other studies found permanent evidence that short-run movements in
exchange rates lead to increased FDI inflow. Those are: Grubert and Mutti (1991),
Swenson (1994), and Kogut and Chang (1996), Klein and Rosengren, (1996). These
findings recall with those of Froot and Stein (1991) and Blonigen (1997).
Very important were investigations of FDI behavior in the presence of
currency crises. Lipsey (2001) researched US FDI into specific areas as they
experienced currency crises (Latin America (1982), Mexico (1994), and East Asia
(1997) and finds that FDI are much more stable during these crises than other capital
inflows. Similarly, Desai et al. (2004a) compare US foreign affiliates with local firms
in the currency crisis and finds that US foreign affiliates increase their investment and
sales while local firms shrink them.
A framework of Cushman (1985) represents the symbiosis of FDI under
exchange rate expectations. His analysis proves that an expected appreciation of the
home currency increases FDI.
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Table 2 Determinants of FDI
Determinant
Authors
Aliber (1970), Cushman (1985), Froot and Stein (1991), Bloningen
(2005,1997), Rangan (1998), Aliber (1970), Klein and Rosengren (1994)
Exchange rate
Gopinath et al. (1998), Stevens (1998), Seo et al. (2002), Campa (1993),
Jordaan (2004), Bende-Nabene and Ford (1998), Wand and Swain (1995)
Schneider and Frey (1985), Asiedu (2002), Chakrabarti (2001), Jenkins
Inflation
and Thomas (2002), Wand and Swain (1995)
Liquidity
Stevens (1969), Stevens (1972)
King and Levine (1993), Beck et al. (2000), Levine et al. (2000), Wurgler
Financial
(2000), Carkovic and Levine (2003), Hermes and Lensink (2000), Alfaro
Market
et al.(2004), Yao and Wei (2007)
Popkin (1965), Hufbauer (1975), Agarwal (1980), Van der Walt (1997),
Cost of capital
Jordaan, (2004), Alfaro et al.(2004), Hirshman (1958)
Habib and Zurawski (2001), Tanzi (1998), Tanzi and Davoodi (1997),
Wei, S. (1997) Wheeler and Mody (1992), Hines (1995), Drabek and
Payne (1999), Kaufmann (1997), Mauro (1995), Husted (1994, 1999),
Corruption
Rose-Ackerman (1975, 1999), Shleifer and Vishny (1993), Braguinsky
(1996), Huntington (1968), Leff (1964), Rashid (1981), Egger and
Winner (2006), Andersson (2002)
Clark (2000), Boskin and Gale (1987), Hartman (1984), Newlon (1987),
Bloningen (2005), Jordaan (2004), Loree and Guisinger (1995), Wei
Tax barriers
(2000), Chakrabarti (2003), Gastanaga et al. (1998), Wheeler and Mody
(1992), Lipsey (1999), Veugelers (1991)
Bloningen (2005), Henisz (2000), Meyer (2001), Bevan et al. (2004), Yiu
Institutions
and Makino (2002), Oxley(1999), Peng (2000), Brenton et al.(1999),
Azzimonti and Sarte (2007)
Rugman (1979), Agmon and Lessard (1977), Lessard (1982), Rivoli and
Salorio (1996), Rangan (1998), Clark, (2000), Estrin and Bevan (2000),
Political
Jun and Singh (1996), Root and Ahmed (1979), Lucas (1990), Azzimonti
instability
and Sarte (2007), Jordaan (2004), Daude and Stein (2001), Loree and
Guisinger (1995), Jaspersen, et al. (2000), Ok (2004)
Legal and
Drabek and Payne (1999), Clark (2000), Guislinger (1992), Bajorubio and
Regulatory
Sosvilla-Rivero (1994), Lee and Mansfield (1996), Borensztein et
uncertainty
al.(1998)
Caves (1996), Grosse and Trevino (1996), Jun and Singh (1996), Ades
and Di Tella, (1994), Wei (2000), Kravis and Lipsey (1982), Culem
(1988), Edward (1990), Pistoresi (2000), Schmitz and Bieri (1972),
Openness,
Ancharaz (2003), Asiedu, (2001), Razin (2002), Lipsey (1999), Tsai
international
(1994), Kreuger (1975), Greenaway and Nam (1988), Yao and Wei
orientation
(2007), Morissey and Rai (1995), Batra and Ramachandran (1980),
Bhagwati and Srinavasan (1983), Grossman and Helpman (1991), Bevan
and Estrin (2004)
Neighbors
Veugelers (1991), Easterly and Levine (2000)
Grubert and Mutti (1991), Kogut and Chang (1996), Blonigen (1997),
Trade effects Belderbos (1997), Figlio (1999), Head and Ries (2004), Swenson (2004),
Morissey and Rai (1995), Bajorubio and Sosvilla-Rivero (1994), Wand
9
Infrastructure
quality
Market size
Labor cost
Growth
Development
Technology
diffusion
and Swain (1995), Brainard (1997)
Asiedu (2001), Ancharaz (2003), Loree and Guisinger (1995), Wheeler
and Mody (1992), Kumar (1994)
Clark (2000), Slaveski and Nedanovski (2002), Schneider and Frey
(1985) Lipsey (1999) Chakrabarti (2003), Edwards (1990), Asiedu
(2001), Ancharaz (2003), Loree and Guisinger (1995), Wei (2000),
Hausmann and Fernandex-Arias (2000), Li and Liu (2004), Bhasin et al.
(1994), Bajorubio and Sosvilla-Rivero (1994), Wand and Swain (1995)
Jordaan (2004), Chakrabarti, (2003), Goldsrough (1997), Saunders
(1982), Flamm (1994), Schneider and Frey (1985), Culem (1988),
Shamsuddin (1994), and Pistoresi (2000), Tsai (1994), Bajorubio and
Sosvilla-Rivero (1994), Wand and Swain (1995), Bevan and Estrin
(2004)
Chakrabarti, (2001) Lim (1983). Bandera and White (1968), Lunn (1980),
Schneider and Frey (1985), Culem (1988), Billington (1999), Tsai (1994),
Nigh (1988), Ancharaz (2003), Razin (2003), Gastanaga, et al. (1998),
Schneider and Frey (1985), Borensztein, et al. (1998), Li and Liu (2005),
Sapsford (996), Blomstrom (1996), Balasubramanyam (1996),
Wang(1990), Dunning (1980), Kobrin (1976), Lunn (1980), Scaperlanda
and Balough (1983) Grosse and Trevino (1996), Wells and Wint (2000),
Nigh (1986), Chuang and Hsu (2004), Lardy (1995), Yao and Wei
(2007), Carkovic and Levine (2003), Durham (2004), Zhang (1999)
Romer (1986, 1987), Lucas (1988), Kosack and Tobin (2006), Markusen
(2002), Nunnenkamp (2004).
Keller (2004), Markusen (2002), Fosfuri et al.(2001), Globerman et
al.(2000), Branstetter (2001), Borensztein (1998), Gregorio and Lee
(1997), Rodrigues-Clare (1996, 2000), Hanson (2001), Görg and
Greenaway (2002), Singh (2003), Findlay (1978), Wang (1990), Hobday
(1995), Chung (1994)
Source: Adapted from Jordaan, J. (2004). Foreign direct investment and neighboring influences. University of Pretoria; own
research
Campa (1993) suggests, that exchange rate uncertainty drives firms to wait
with investing. In the model of Chakrabarti (2003), an appreciating currency causes
either rise or a fall of FDI, due to whether the revenue or the cost effect is larger.
Inflation
The inflation rate is a measure of the overall economic stability of the
country. Asiedu (2002), Chakrabarti (2001), Jenkins and Thomas (2002), argue that
lower inflation attract FDI. High inflation is a sign of country’s instability and
unwillingness of the central bank and the government to balance the budget, to restrict
money supply Schneider and Frey, (1985).
Liquidity
Relation between liquidity and the FDI inflow was viewed by Agarwal
(1980). He found a positive relationship between internal cash flows (liquidity) and
10
investment outflows of a firm (via FDI). This approach is based on the assumption
that the cost of internal funds used to be lower than the cost of external funds(Jordaan,
2004).
Financial markets
A number of scholars pointed out that the financial markets are necessary to
achieve growth and development. Among them are Alfaro et al.(2007), Beck et al.
(2000 a, b) and Levine et al.(2000).
While the empirical evidence on FDI and economic growth is ambiguous,
the connection between financial markets and growth and FDI has been studied
deeply and get more positive conclusions—that well-developed financial markets
promote economic growth and enhance FDI. Previous empirical studies support this
hypothesis, suggesting that financial systems are important for productivity growth
and development. Rajan and Zingales (1998) find that the state of financial
development reduces the cost of external finance to firms, thereby promoting growth.
Wurgler (2000) shows that even if financial development does not lead to
higher levels of investment, it still promotes economic growth. Alfaro et al.(2004) in
turn, examined whether economies with developed financial markets are able to
benefit more from FDI to promote their economic growth. They find, that countries
with well-developed financial markets seem to gain significantly more from FDI
(Alfaro, et al. 2004). Similar results achieved Carkovic and Levine (2003) and
Hermes and Lensink (2000).
Yao and Wei (2007) believe that the lack of development of local financial
markets limits country’s ability to take advantage of FDI benefits. Poor financial
markets may imply that a country cannot deal with short-term capital flows, and full
benefits of long-term stable flows also may not be realized (Yao & Wei, 2007).
Cost of capital
All the investors want to maximize their profit. FDI is a function of
international differences in rates of return on capital investment. The volume of FDI
in a particular country depends on the total revenue and the total cost as well as on the
probability distribution of the rate of return in the host and the home countries
(Jordaan, 2004)
FDI shrinks in countries with low return and blooms in those, where
expected yield is higher returns per unit of capital. (Agarwal (1980), Van der Walt
11
(1997). Culem (1988) states that foreign investors can raise capital outside home
countries, where the interest rate is lower. Culem introduced the nominal interest rate
for the host country, comparing to the rest of the world.
Corruption
The problem of corruption is widespread in the emerging economies. Is it
evil, or maybe, a helping hand for investors? Many scholars have tried to answer this
question. On the one hand, countries with high corruption rank (e.g Mexico,
Argentina, Brazil) receive high level of FDI, while countries with relatively low level
of corruption – Spain, Italy do not receive so much investment. We can conclude,
there are much more factors, influencing the FDI level than just corruption level.
Mostly, researchers consider corruption to be an obstacle for investing. It
worth saying, that impact of corruption on local investment is weaker, than on foreign
ones. Findings of Wei, S. (2000), Tanzi, V. (1998) report corruption as interruptive
effect for FDI. Habib & Zurawski, (2001) argues that corruption remains a significant
problem. However, the impact of corruption is weakend by factors, as openess of the
economy, political stability; developing economic and social state of the country.
Egger, P. and H. Winner (2006) find that corruption is important for intra-OECD FDI,
when it is less relevant for non-OECD members. Along with this, OECD members
conduct mainly horizontal FDI, and non- OECD – vertical. Rashid (1981) states that
bribing helps to achieve Paretto optimality. Hines, J. (1995) states non-significant
relationships, while Wheeler, D., and Mody, A. (1992) do not find any significant
relation. Very interesting for this work were findings of Kaufmann (1997), who made
a series of scholars about Emerging markets and Ukraine, in particular. In his survey–
corruption may not be a biggest obstacle for FDI.
Tax barriers
Another important factor that influences FDI is tax. Country decisions over
the setting of corporate tax level might be different. On the one hand, higher tax rate
is a source of income for the state, made by non-resident investors. On the other hand,
if taxation is too high, inflows of investment that causes economic growth may be
discouraged.
A question then is how sensitive is foreign direct capital inflows to host
country tax burdens?
The hypothesis states, that higher tax discourage FDI. As Bloningen, (2005)
12
points out, the effects of taxes on FDI can vary by type of taxes, measurement of FDI
activity, and tax treatment in the host and parent countries. Important issue is that
MNE potentially must deal with taxes in the host and the home countries. The
milestone of the literature concerning FDI and taxation are works of Hartmann (1984;
1985). He reveals that certain types of FDI may not be very sensitive to taxes.
Slemrod (1990) suggests that double taxation may affect tax responsiveness, which
did take hold in the literature.
Scholes and Wolfson (1990) find that US FDI increased with the increase of
US tax rates. Swenson (1994) continues the latter suggestion and confirms their
findings using data on average tax rates, but reject them using effective tax rates.
Hines (1996) finds that higher tax rates of 1 percent are connected with a 9 percent
larger FDI decrease. The question of another kinds of taxes is not researched enough.
Still, some works shed the light on this area. Desai (2004) finds that indirect business
taxes affect FDI as well, as corporate income taxes.
Institutions
The quality of institutions is an important determinant of FDI activity. This
factor is important for developing economies. Poor institutions create poor
infrastructure and expected profitability falls, which causes FDI shrink. It is not so
easy to measure impact of institution performance on FDI. Scholars, like Stiglitz
(1999), Kogut and Spicer (2002) convinced, that establishment of institutions is as
important as good macroeconomic policy. The research of institutional impact on
entry mode in transition economies was providing by Henisz (2000) and Meyer
(2001). The following topics: choice of entry mode, probability of survival, variety of
expansion strategies were researched by a range of scholars - Henisz (2000), Meyer,
(2001a, b), Yiu & Makino (2002). Along with that, Oxley (1999) and Peng (2000)
find, that investors must adapt their strategies to local institutions.
Brenton, Di Mauro and Lücke (1999) show that economic freedom index is
positively related to FDI inflows. Crucial was the framework of Bevan & Estrin
(2004), they believe, that the stage of development of institutions is crucial to attract
FDI, by reducing the transactions costs of setting up a local operation. They found
that, countries with better-developed institutions in a market economy receive more
FDI inflows.
With strong evidence, countries with greater privatization and more
13
advanced private sector development receive more FDI inflows. Countries with more
extensive and more effective legal systems receive more FDI. At the same time,
suggestion, that countries with more developed regulation and competition policy
receive more FDI inflows was rejected. Finally, scholars find partly evidence that the
liberalization of domestic and international markets has a positive and significant
effect on FDI inflows.
Political Instability
The big number of studies has outlined the political stability as critical
component to encourage FDI. Greater political stability in a location is viewed in a
higher probability of profits by foreign investor in a host country. Political instability
might be the largest deterrent to FDI, as it makes all areas of policy uncertain (Clark,
2000). Thus FDI and political instability are negatively correlated (Chakrabarti
(2003), Agarwal (1980) and Schneider and Frey (1985). However, Jaspersen, et al.
(2000) and Hausmann and Fernandez-Arias (2000) construct their own risk measure
on the find no relationship between political instability and FDI. Loree and Guisinger
(1995) find that political risk had a negative impact on FDI.
Azzimonti & Sarte, (2007) deal with expropriation and divide it to direct and
indirect ones. A direct act of expropriation involves nationalization of MNC. Indirect
(creeping) form imply excessive taxation, capital controls, manipulation of exchange
rates, and bribes. He concludes that:

Countries with higher political instability are more likely to implement
indirect expropriation.

Direct expropriation is lower when there is greater political instability
Daude and Stein (2001) state that one deviation of political institutions
quality improvement increases FDI by a factor of 2.2. In summary, empirical
literature states that low quality of political institutions; alternative forms of
expropriation, and absence of commitment of policy have negative effects on FDI
inflows (Azzimonti & Sarte, 2007).
Legal and Regulatory uncertainty
Other important factor, used in this work, is the host country is Legal and
Regulatory uncertainty. FDI can be fulfilled if laws, regulations and administrative
issues do not serve as hurdles for foreign investor.
It is very important for rules, regulations and administrative procedures to be
14
clear and easy to minimize uncertainties and not to create additional problems. Clark
(2000) points out on significant negative relationship between FDI level and
administrative uncertainty. These findings are reflected in the Drabek Z., and Payne
W. (1999) work, which also observed negative correlation between this pair.
Openness of the economy
The question of the biggest importance appears to be the openness of the
economy. The direction, country chooses, influence primarily on FDI inflows. Wei
(2000) mentions, that international orientation is positively correlated to FDI level.
Numbers of studies have been made on the European Union membership
perspective. It is noticed, that future EU membership drives big amount of
investment. It worth mentioning, that export-orientation has significant positive
correlation with FDI level Caves (1996).
Nonetheless, mixed evidence exists regarding the influence of openness. It is
measured by the ratio of trade (imports plus exports divided by GDP). Sachs and
Warner (1995) consider economy as closed if it shows one of five features: high
import tariffs, high non-tariff barriers, a socialist economic system, a state monopoly
on important exports, or a big gap between official and black-market exchange rates.
Asiedu (2002) consider that the impact of openness on FDI depends on the type of
investment. He distinguishes two reasons of investments, they are: market seeking
and export-oriented. Bevan and Estrin (2004) highlight the importance of EU
membership, or prospects of EU membership. This is a sign of reducing country risk,
improved quality of management and institutional development.
Neighbors
Veugelers (1991) in his cross-section analysis tested the influence of
neighboring countries on host countries. He found that neighbors have a significantly
positive influence on the host country. Easterly and Levine (2000) argued the impact
of neighbouring growth performance on host country. Policy choices are also
contagious across borders. Worth mentioning, that growth effect is even stronger,
when neighbouring countries act together (Jordaan, 2004).
Trade effects
It is assumed, that higher trade protection force MNE’s to substitute affiliated
production for exports to avoid the costs of trade production. This occurrence is called
tariff-jumping FDI. Grubert and Mutti (1991), Kogut and Chang (1996), and Blonigen
15
(2005) studied the impact of different trade protection programs on FDI inflow. The
results of Blonigen (2005), Belderbos (1997) and Figlio (1999) prove this relation.
There are evidences of negative correlation between FDI and trade (Bloningen (2005)
as well as positive one Ries (2004), Swenson (2004). International agreements on
trade and investment also influence the patterns and volume of FDI - Morissey and
Rai (1995).
Infrastructure quality
Well-developed infrastructure attracts potential investors to a country and
stimulates FDI flows towards it. Asiedu (2001) and Ancharaz (2003) were
discovering the impact of infrastructure on FDI. Still, Asiedu researches only the
availability, not the reliability of the infrastructure.
Market size
An important factor is the size of the market. Potential investors tend to look
at the big markets first, when smaller markets do not provide the same economies of
scale. FDI is boosting with the existence of a large potential market and greater
purchasing power, where demand for certain goods has been not filled, and firms can
receive a higher return on their capital (Clark, 2000). Schneider and Frey (1985)
conclude that the higher is GNP per capita, the better the nation’s economic state and
the prospects for profitable investment.
Labor cost
Higher wage causes lower level of FDI and creates higher price for all goods,
making them less competitive both at home and in foreign markets (Chakrabarti,
(2003). Low-cost labor attracts FDI to developing countries. Schneider and Frey
(1985) and Culem (1988) find that higher wages discourage FDI. Tsai (1994) notice
strong positive correlation between cheap labor and FDI.
Growth
Generally, growing economy provides relatively better profit opportunities,
thus, it crowds FDI. Schneider and Frey (1985), Razin (2003), Culem (1988) and
Billington (1999) observe a significantly positive effect of growth on FDI. Nigh
(1988) finds weak positive correlation for the less developed economies and a weak
negative correlation for the developed countries. Yao and Wei (2007) suggest that the
link between FDI and growth is causal, where FDI promotes growth through financial
markets. Moreover, Luiz and De Mello (1997) conclude, that FDI - growth pair is
16
sensitive to country-specific factors and impact FDI on growth depend inversely on
the technological gap between the countries.
Developed countries are expected to have a higher level of human capital and
hence to benefit more from FDI than developing countries. This thesis was
confirming by Xu (2000). Li and Liu (2004), in their study, observe strong
complementary connection between FDI and growth. Along with this, they observe
strong positive interaction between FDI and human capital. Borensztein et al. (1998)
conclude that FDI has positive overall effect on economic growth. Hence, the impact
is dependent on a sufficient level of human capital, which limits the absorptive
capacity of a developing country. FDI to countries with low level of human capital
has a negative impact.
Development
Economic growth a measure of capacity; the extra money on its own do not
guarantee that a population is improved, more educated, healthier, or, indeed, that the
economy is in a better position to grow any further. Development differs from growth.
It includes income and measures of human capital—health and education— things
person need to live a successful life and to contribute to a country's economic
progress. Development contributes to economic growth by increasing the capacity of
the workforce, which touches organization and raises economic output. In turn,
economic growth contributes to development by directly increasing government
revenue. Markusen (1999) suggests, that multinational entry has a competition effect.
FDI act as catalyst: causes development of a particular industry, which might be very
strong.
To achieve the effect from FDI country must have sufficient level of human
capital. The stock of human capital in the host country limits the absorptive capability
of a developing country (Kosack and Tobin, 2006). Otherwise, country would better
receive aid, which can cause positive changes. As Nunnekamp (2004) concludes, for
FDI to bring development shift two conditions must be met. Developing countries
must be attractive to foreign investors and host-country environment must be
conductive to favor FDI, economic spillovers and income growth. Though, many
scholars suggest, that FDI does not provide a panacea for a developing countries.
Technology diffusion
Technology diffusion plays a key role in the economic development. Recent
17
literature describes the dependence of growth from technology. For most countries,
developed technology creates 90 percent of growth. The reason of worldwide
technical change is in technology diffusion that implies technological flows between
the countries. International technology diffusion is very important, and the channel for
it is FDI.
The diffusion of technology involves market transactions and externalities.
Many scholars believe that technology diffusion happens via externalities (spillovers),
not by market transactions. Markusen (2002), Rønde et al. (2001) observe positive
impact of MNE’s to technology diffusion. Some scholars, however, find no effect,
this is due to studies of micro-level productivity (Keller, 2004).
FDI causes technical progress through a “contagion” effect from the more
advanced technology, management practices (Borensztein et al,1998). Wang (1990)
reveals this thesis with a model, assuming that the increase in knowledge applied to
production is determined as a function of FDI.
Another determinants of FDI
Xu (2000) tried to estimate the extent to which FDI leads to productivity
increase. He finds positive relationship between FDI and productivity growth, which
is stronger in richer than in poorer countries. Aitken and Harrison (1999) observe a
negative effect between FDI and productivity at Venezuelan plants. FDI raises
productivity within plants that receive investment but lowers that of domestically
owned plants—thus he seriously doubts in the spillover theory.
Wheeler and Mody (1992) find that FDI enforces even more FDI.
Borensztein et al. (1998) researches the connection between FDI and domestic
investment. He finds no significant sensitivity to the productivity of FDI. BendeNabende et al. (2003) find that long-term impact of FDI on output is significant and
positive for Philippines and Thailand, but negative for economically advanced Japan
and Taiwan.
1.3. Should countries promote Foreign Direct Investment?
Foreign direct investment created growing interest around the world. During
last dozens of years countries reduced their investment barriers and tried to attract
more investment. The common view is that FDI increases economic progress in the
host country. Findings of Hanson (2001) support this statement - multinational firms
create jump-start process of industrial development, creating linkages.
18
At the same time, FDI shares the knowledge capital with the less developed
countries, which in turn, increase labor quality. Foreign Investment induces domestic
firms to raise their standards due to the competition factor. As mentioned before,
multinational serve as a catalyst effect in a host economy and attract more investors
(Markusen and Venables (1999).
FDI bring new technology to a host country,
involving it into technology diffusion process; local firms gain a lot from this process.
Very important is the influence of FDI on a growth of economy and subsequent
overall development.
Many scholars discussed the question of FDI spillovers. Some find the direct
influence of investment on productivity. Early scholars discovered positive correlation
between average industry productivity and multinational presence – Blomstrom and
Kokko (2003). Borensztein et al. (1998) reveals relationship between FDI and GDP
per capita; Aitken and Harrison (1999), however find negative one. Another point of
FDI spillovers is that multinationals give access for domestic firms to foreign
markets. Several authors had found evident proof of this hypothesis (Hanson, 2001).
Thus, we conclude, that attracting foreign direct investment is vital for every
economy.
19
CHAPTER 2. Country analysis
2.1. Ukraine and development path
The research of investment into economy has always been in the spot of
economics. This is because investment is the root of economic activities; they define
the process of growth. My research of investments in Ukraine starts with the country
overview. Then, country macroeconomic analysis is conducted. The analysis of
foreign direct investment is continued in third chapter.
Ukraine is an Eastern European State washed from its south with the Black
and Azov seas. The total area of Ukraine is about 603,500 sq. km., which makes it the
second biggest country in Europe, and 21st biggest in the world. The country consists
of 24 regions and the Autonomous Republic of Crimea. It has a population of 46,4
million people. Ukraine is a multinational country: 73% of the country's population is
Ukrainians. The official language is Ukrainian, although majority of the population is
bi-lingual, speaking both Ukrainian and Russian fluently. Approximately third part of
the population lives in large urban centers. The capital - Kiev, has around 3.5 million
inhabitants.
Ukraine was the center of the first Slavic state, Kievska Rus, which during
the 10th and 11th centuries was powerful and the largest state in Europe. After Tatar Mongol invasions, Kievska Rus was incorporated into the Polish-Lithuanian
Commonwealth. During the 17th century a new Ukrainian state, the Cossack
Hetmanate, was established. During the second part of the 18th century, the Russian
Empire conquered most of the Ukrainian territory. After the Collapse of czarist Russia
in 1917, Ukraine had a short-lived period of independence (1917-1920), but was reconquered again. It endured brutal Soviet State that engineered two artificial famines
(1921-22 and1932-33) where over 8 million people died. Second World War caused
7-8 million more deaths. Despite continuous Russian pressure, Ukrainians tried to
sustain national identity for three centuries. In August 1991 Ukraine proclaimed
independence.
Since than, Ukraine shifted from a centrally planned economy to a market
environment. On the 28th of June 1996 the New Constitution was adopted. During
1991-1999, Ukraine went through an economic decline, which was followed by
negative GDP. In addition, high inflation, unemployment, political uncertainties and
corruption level, caused poor investment climate. However, during the last eight
20
years, Ukraine has implemented significant economic and legal reforms, created
positive image across the world. Foreign investors reacted with sharp rise of
investments. The arrival of new, “western-oriented” President and Government serves
also as a positive message for investors. Today Ukraine is a republic with
parliamentary-presidential system.
2.2. Investment and Business Climate analysis
Nowadays every country in the world is under a big loop: hundreds of
specialists and researchers examine the potential of particular economy. The three
biggest rating agencies Moody's, Standard & Poor's and Fitch use liquidity and
solvency as a base for their ratings (see Appendix 1).
Ukrainian credit score was improving during last years, and, since 2000 has
reached maximum in 2006, still being a risky place to invest (Table 3). However,
financial crisis 2008 has struck Ukrainian economy resulting in fall of the country
rank. There has been a sharp discussion in a society after S&P downgraded Ukrainian
sovereign rating to CCC+, which means 40% probability of default. A number of
economists disagree with this conclusion (see Appendix 2)
Table 3 Ukraine Ratings 2003-2008
Credit Rating
Standard & Poor’s
Moody's
Fitch
2003
B
B2
B+
2004
B
B1
B+
2005
B+
B1
B+
2006
BB
B1
BB
2007
BB
Ba3
BB
2008
CCC+
B1
BB-
Source: E&Y-Doing Business in Ukraine 2007, own findings
While comparing Ukraine with the chosen neighbors we can see, that
Ukraine follows Russia and Romania, when Poland and Hungary considered being
more stable countries.
Table 4 Countries Sovereign Credit Ratings 2008
Investment Grades
Junk Grades
Hungary
Poland
Russia
Ukraine
Romania
Belarus
BBB (S&P)
A2 (Moody’s)
Baa1 (Moody’s)
B1 (Moody’s)
BB+ (S&P)
B (S&P)
Broadening the country credit rating I compare different rankings of our economy.
Unfortunately, the economic and political state wishes to be better. Inward FDI
Potential Index, however, requires more attention. OECD ranks Ukraine as one of the
21
very attractive country to invest. UNCTAD sees Ukraine as high FDI attractive
country (see Appendix 11).
Table 5 Comparing of Countries Ratings
Hungary
Poland
Romania
Russian
Federation
Ukraine
Belarus
Economic
Freedom 2009
(179)*
Corruption
Perception Index 2008 (180)
Global
Competitiveness
Report - 2009
(134)
Inward FDI
Potential Index
2004-2006 (141)
Country Risk
Classification 2009 (7)**
44
82
65
47
58
70
62
53
68
41
43
69
4
2
3
146
147
51
20
4
152
167
134
151
72
-
44
48
7
7
Source: The World Bank, Transparency International, World Economic Forum, Heritage Foundation, OECD
* Total number of countries in brackets. Biggest number means lower position.
** The maximum grade in brackets. Biggest number means higher risk.
We can notice, that Hungary and Poland go close to each other the same
pattern is observed in Ukraine – Russia pair. Russia, however, is more attractive
country to invest in due to its huge territory, resource and industrial potential.
Table 6 represents one of the most popular – Index of Economic Freedom.
Ukraine and its neighbors have strong differences in Business, Investment and
Financial freedom rankings, while Trade reform and Fiscal freedom are roughly the
same.
Table 6 Index of economic freedom, selective country rankings
Source: Index of Economic Freedom, Heritage Foundation
Still, integrative rankings and indexes cannot reflect business climate fully. I
will try to explain the underlying components more in detail later.
22
2.3. Investment barriers assessment
There are several works that suggest barriers for investment (Appendix 6). I
group them in a list below:
1. Macroeconomical
2. Financial
3. Corruption
4. Tax
5. Institutional
6. Political
7. Legal & Regulation
8. Trade
9. Infrastructure
10. Market
11. Labor
Macroeconomical
A change in economic situation creates a major change in expected return of
the investment. For defining barriers economists examine current monetary and fiscal
policy of the country. I’ll start the overview with major economic indicators.
The current GDP level is at the 178 billions US Dollars (State Statistic
Comitee of Ukraine). GDP per capita makes 3870 US Dollars. We observe a stable
growth since 2000. Ukrainian economy still remains behind its neighbors – Russia,
Poland, Hungary and Romania (IMF).
Figure 2 Ukrainian GDP per capita, nominal, US Dollars
4000.00
3500.00
3000.00
2500.00
2000.00
1500.00
1000.00
500.00
0.00
Source:EconStat, State Statistics Committee of Ukraine
The transition process is not completed yet. For longer-term perspectives,
analysts focus on long-run growth factors. The GDP growth correspondingly
remained sluggish during the first independence years. The small GDP growth
number for 2005 is explained by the political changes in Ukraine. In 2008 Ukrainian
GDP growth was 6,4 percent and, unfortunately, economic crisis throw back the
23
country to 1998 – GDP in 2009 will decline on 3 percent (State Statistic Comitee of
Ukraine). While comparing Ukraine with neighboring countries we might see, that it
performs almost in the same manner during last couple of years, which is positive
sign.
Figure 3 Annual GDP Growth, selected countries, percent
10%
4%
Belarus
-2%
Hungary
-8%
Poland
Romania
-14%
Russia
Ukraine
-20%
-26%
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
Source: EconStat
To evaluate fiscal policy, analysts examine the government’s debt situation
(Meldrum, 2000). Ukrainian Gross External Debt makes up 103.236 billions US
Dollars (Appendix 5). Foreign debt is mostly presented by banks borrowings and
private sector. State debt remains roughly the same (Appendix 5). The currency
reserves are greater than State debt. This is one more insight in favor of thesis that
Ukraine will not go default.
Figure 4 Budget proficit (deficit), percent of GDP
1.00%
0.50%
0.00%
-0.50%
2002
2003
2004
2005
2006
2007
2008
2009
-1.00%
-1.50%
-2.00%
-2.50%
-3.00%
-3.50%
Source: State Statistics Committee of Ukraine, PhoenixCapital
Due to imprudent Government spending policy, country’s budget went
further in deficit: in 2009 3% budget deficit was adopted (see Figure 4).
24
Analysts examine the impact of monetary policy and financial maturity on
economic growth through inflation, interest rates, and exchange rates (Meldrum,
2000). During 2001-2004 it was very popular among the Ukrainians to save money on
deposit accounts. Due to risky and undeveloped capital market – banks and real estate
were an alternative.
Table 7 Interest rates, percent, US dollars
Interest rates
2001
2002
2003
2004
2005
2006
2007 2008
2009
Refinancing rate 12.5%
7%
7%
9% 9.5% 8.5% 8.4% 12%
12%
Deposit rate
11% 7.9%
7% 7.8% 8.6% 8.4% 8.9% 9.7% 11.4%
Lending Rate
32.3% 25.4% 17.9% 17.4% 16.2% 15.2% 11.1% 16%
17%
Source: IMF, National Bank of Ukraine
Since 2004 consumption boom has started that was also reflected in lowering
of lending rates. Unfortunately, the trust of Ukrainians in national currency was
undermined, which reflected in wide use of US Dollar. Deutsche Bank highlights, that
banking sector is strongly dollarized. 49% of Lends and 33% of Deposits are in US
Dollars. This, of course, causes problems with exchange rate and inflation (Deutsche
Bank).
Exchange rate
At the Figure 5 nominal exchange rate of the Ukrainian Hryvnia against US
dollar and Euro is depicted. Since 2000 Ukrainian currency is pegged to USD only,
this resulted in more-less stable exchange rate.
Figure 5 Ukrainian nominal Exchange rate (1996-2009), UAH
12
10
USD
8
6
EURO
(until
1999
ECU)
4
2
0
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Source: National Bank of Ukraine
At the end of 2008 exchange rate was revalued within a widened trading
band. In contrary, real exchange rate was not so stable.
25
Figure 6 Ukrainian real exchange rate (2000-2007), percent
200
Euro
150
100
Dollar
50
0
marts 2000
marts 2001
marts 2002
marts 2003
marts 2004
marts 2005
marts 2006
marts 2007
Source: Interntional Monetary Fund
First, Ukrainian Hryvnya was appreciated, and then financial crisis 20082009 brought sharp depreciation. IMF warned Ukraine that Dollar peg could cause a
financial crisis of over and under-valuation. To slow down the inflation Ukraine must
free its exchange rate. According to the theory exchange rate currency depreciation
either attract FDI or has no impact on it.
Inflation
Since Independence, Ukraine faced hyperinflation due to thoughtless money
emissions. After short stabilization period, in 1998-1999 country went through
technical default.
Figure 7 Inflation, end of period, consumer prices, percent
Ukraine
80
70
CIS
60
50
Europe
40
30
20
Emerging
and
Transition
economies
10
0
Source: EconStat
2000 is characterized as a year of successful foreign debt restructuring and
stabilization of inflation (Figure 7). Subsequent years were stable with moderate level
26
of inflation. Ukraine closed 2008 year with unprecedented 22,3%, triggered by global
financial turmoil. The 2009 Government’s planned inflation is 9,5%. Nonetheless,
recently EBRD has increased its inflation forecast from 12% to 16,4% for 2009 year;
10% in 2010 and 8% in 2011. Boosting consumption policy, sharp rose of social
transfers, fast salaries rise created demand growth. Massive capital inflow drove
expansion of bank loans, further deepening the supply-demand spread, derived to
price increase. High inflation is one of the most dangerous economic problems
Ukraine is facing at the moment.
Unfortunately, high inflation distracts investors; moreover high inflation is a
sign of country’s instability (Schneider and Frey, 1985).
Financial Markets
Financial Markets serve for

The raising of capital (capital markets);

The transfer of risk (derivatives markets);

International trade (currency markets) (Wikipedia)
Ukrainian financial market exists about 18 years since independence but, in
fact, institutional establishment is not completed yet. Capital market is mostly
represented by debt market when stock market is still undeveloped and poorly
regulated The biggest problem is that financial market does not provide sufficient
demand and supply of investments that set fair market prices. Ukrainian financial
market has low liquidity, non-transparency, legal and regulation imperfections, risk
uncertainties (see Appendix 3). Additionally, Ukrainian government underestimates
the importance of developed financial market (World Bank)
Ukraine’s financial system remains weak. The restructuring of the banking
sector is going slowly, and about 150 small banks have not sufficient capital (Heritage
Foundation, 2009). To develop financial markets, some steps must be done: change of
regulatory framework and encourage of investor initiatives. Establishing the legal,
regulatory, and institutional framework must take place. Financial market
uncertainties are sources of concern, for countries with rapidly expanding current
account deficits, countries that rely on capital inflows, which is Ukraine.
Corruption
Citizens around the world are critical about their government’s attempts to
27
fight corruption. Every second citizen believes that his government is not doing a
good job in diminishing corruption. Every third believes the opposite – that
government efforts are effective (Transparency International, 2007). Corruption is one
of the very important deterrent for foreign investors that want to invest in Ukraine.
Non- transparency causes many problems, especially while obtaining different
permits. According to the Transparency International's Year 2007 Corruption
Perception Index Ukraine possesses 134th place out of 180 countries. It felt down
from 99th in 2006 down to 118th in 2007 (see Table 5).
An interesting fact is that more bribes come from firms with domestic HQ
comparing to domestic firms and firms with HQ abroad. 35% of the firms with abroad
HQ pay public procurement kickbacks comparing to 30% those of domestic HQ and
25% of domestic firms (Appendix 7). Corruption makes the process of investing long
and exhausting. For investors the spheres where they pay most of the bribes are
registry and permit services and judiciary sector (E&Y, 2007). However, a number of
scholars suggest that corruption might be not a barrier for market-oriented investors.
Moreover, corruption might help with specific cases.
Tax pressure
To analyze fiscal policy of the country, analysts examine tax policy. Taxes
and mandatory contributions are measured at all levels of government and include
turnover tax, corporate income tax, all labor taxes and contributions paid by the
company (including mandatory contributions paid to private pension or insurance
funds), property tax, dividend tax, capital gains tax, financial transactions tax, vehicle
tax, sales tax and other small taxes (such as fuel tax, stamp duty and local taxes).
Businesses are concerned about what will they get back for their taxes and
contributions, e.g. quality of infrastructure or social services. Efficient tax systems
have simpler tax arrangements, and laws (World Bank, 2009).
The Ukrainian tax system is evolving rapidly. The direction of reforms is
generally positive; tax laws are revised very often, however, sometimes with
unpredictable results. There are still disagreements between taxpayers and tax
authorities. The unified Tax Codex is very vital to be adopted (E&Y, 2007). The VAT
is 20%, and corporate tax is 25%, which are one of the biggest rates in Europe.
Several attempts to lower tax burden were made in 2003, 2004, and 2006 but were
blocked by president or parliament. Ukraine is not very attractive country to pay
28
taxes. The World Bank in Ease of Doing Business 2009 ranks it as 145 among 181
economies, when tax burden is ranked as 180 from 181 countries (Appendix 12). If
calculate the total amount of taxes paid by a business we get 58.4%, it require 99
payments and 848 hours per year to be completed (Appendix 8). Taxation is
considered to be a biggest obstacle for investors states IMF (Appendix 6).
There is a persistent risk that taxes will be an unfavorable condition to
foreign firms even if they appeared to be non-discriminatory. An additional risk
derives from sudden changes in the tax environment that leave businesses too little
time to perform (The Economist Intelligence Unit Limited, 2006).
Institutions
As a number of international rankings state, the Ukraine’s weak point is
institutional framework. Companies are complaining regularly about the State
structure up to the highest instances, e.g. special government institutions prevent fair
competition (Deutsche Bank). Total government expenditures, are very high and
made up 45.1 percent of GDP in 2008 Despite widespread privatization, the economy
is restrained by government intervention in the private sector (Heritage Foundation,
2009). The most problematic areas are: transparency of government policymaking;
juridical independence, reliability of police services (Appendix 14).
One of the biggest problems remains bureaucracy. To start a business in
Ukraine takes 27 days and requires 10 procedures, which is a very long process, and
thus it distracts potential investors. (Appendix 15) Moreover, triggering inspections
and difficulties with different permits obtaining adds more “minuses” to the
institutional framework. To obtain all the necessary permits from government bodies
in the process of business activity takes 39 days in average; along with this, average
time of inspection at the firms takes more than 8 days (Appendix 9).
Legal & regulatory system
As foreign investor launches business in Ukraine, the first thing to deal is
national legislation. The biggest problems of the legal & regulatory sphere in Ukraine
are contradictions and non-transparency. Contracts are difficult to enforce and
regulation is not impartial. Low quality of legislation and lack of adequate laws
causes many disputes in courts and makes investment climate even worse. In some
areas of investing several powerful local players dominate; they exclude foreign
capital.
29
Deutsche Bank depicted an interesting relationship: GDP per capita to level
of legal system (Figure 8). Unfortunately Ukraine is far away from West-European
economies.
Figure 8 Legal System
Source: Deutsche Bank Research
Protection of property and shareholder’s rights along with efficiency of legal
framework left Ukraine behind in the Global Competitiveness Index (Appendix 14).
However, the risk of foreign investors' assets expropriation is low. Local accounting
standards are below accepted levels in the EU and the US (The Economist
Intelligence Unit Limited, 2006).
Despite of number of reforms and adoption of several Codes, Ukraine
remains with out-of-date legislation and corrupt regulation.
Political Instability
Economic risk very often overlaps with political risk in some areas. Political
Instability implies risk of major changes in power authorities, social, or other noneconomic spheres. It causes internal and external conflicts, or even expropriation risk.
Political risks derive from:

type of political structure

range and diversity of ethnic structure

civil or external strife incidents (Meldrum, 2000).
Due to historical heritage Ukraine is divided into western, or pro-European
30
and eastern, pro-Russian parts. This led to “Orange Revolution” in 2004. The
important political shift came, but still, Ukraine is rived between different political
groups causing economic downturn. Political instability is considered to be one of the
most important deterrent for foreign investor (see Appendix 6). In Ukraine it was
demonstrated by a sharp fall of investment volume in 2004 - middle 2005. Recent
constitutional changes shifted power from the president to parliament, which create
the risk of inter-institutional struggle and periodic political paralysis. The risk of
further political instability is still high (The Economist Intelligence Unit Limited,
2006).
Trade
Index of Economic freedom considers Trade Freedom as one of the highest
importance factor among other business freedoms in Ukraine (Appendix 13).
Weighted average tariff rate is 3 percent. Ukraine gradually progresses in liberalizing
trade regime, diminishing of export restrictions, services barriers, import taxes and
fees. Complex standards, sanitary regulations, government procurement and slow
enforcement of intellectual property rights make trade more complicated and costly
procedure. Ukraine’s accession to the World Trade Organization in May 2008 was a
very positive sign for investors (Heritage Foundation, 2009).
Table 8 Export and import requirements in Ukraine
Selected Economy
Ukraine
Documents Time
for export
for
(number)
export
(days)
6
31
Cost to
Documents Time
export
for import for
(USD per (days)
import
container)
(days)
1230
10
36
Cost to
import
(USD per
container)
1250
Source: Doing Business in Ukraine 2009,World Bank
The biggest barrier for importers is Ukrainian corrupt system of certifying
imports. International customs recognize products, certified by accredited bodies in
partner states, with internationally recognized accreditation procedures; when Ukraine
requires all products to be certified or re-certified again, thus increasing importers’
costs.
Ukraine gained reputation as a non-responsible trading partner when
embargoes imposed on grain exports in 2006 and 2007. They were initiated by some
groups commercial interests, that are close to the government. They wanted to re-sell
quotas to grain exporters, raising substantial profit. This fraud cost legitimate grain
31
exporters $200 million, moreover it harmed Ukrainian farmers – they lost the harvest
in the storages. Since then, commodity traders are prudent with the Ukrainian market
because of high risks of export embargoes and quotas (Crane & Larrabee, 2006).
Unfortunately, Ukraine exports not very sophisticated goods; it serves mostly
as raw materials and unfinished foodstuffs base (see Appendix 10)
Discriminatory tariffs are under low risk; still there is a moderate risk of
excessive trade protection, and some capital controls. Currency controls were
loosened in recent years: 50 percent of export earnings must be converted into the
domestic currency.
Table 9 Trade Balance of Ukraine, 2001-2008, billions of US Dollars
Trade balance
Merchandise
exports
Merchandise
imports
2001
0.198
17.09
1
16.89
3
2002
0.71
18.66
9
17.95
9
2003
-0.269
23.73
9
24.00
8
2004
3.741
33.43
2
29.69
1
2005
-1.135
35.02
4
36.15
9
2006
-5.194
38.94
9
44.14
3
2007
-8.152
64.00
1
72.15
3
2008
-14.52
85.612
100.13
2
Source: IMF, National Bank of Ukraine
Table 9 reflects the summary of merchandise trade for last 8 years. Due to
increasing consumption and vast crediting program, Ukrainians consumed far more
than they produced. Negative trade balance is favorable for foreign exporters but
causes many problems for country’s economy. In 2008 current Account reached
12.933 billions US Dollars (Figure 9)
Figure 9 Current Account of Ukraine, billions of US Dollars
8
6
4
2
0
-2
-4
-6
-8
-10
-12
-14
Source: State Statistics Committee of Ukraine, National Bank of Ukraine
The following indicator to analyze is the degree of openness of economy,
which calculated as exports plus imports/GDP (Meldrum, 2000). The smaller is the
country the more open it should be. Say, Singapore had the degree of openness 2.9 in
32
1996, while Brazil only 0.160 and world average was 0.436.
Table 10 The degree of openness of the Ukrainian economy 2001-2008
2001
2002
2003
2004
2005
2006
2007
0.894
0.864
0.952
0.973
0.826
0.780
0.969
2008
1.044
* Rule: the bigger the number - the more open economy is
From Table 10 we may see that Ukraine is the open country for international trade.
Infrastructure
Infrastructure plays very important role in supporting the business, it include:
transport infrastructure, electricity and telecommunications. Infrastructure risk is
moderate. As the heritage of Soviet Union, Ukraine got a worn infrastructure. The
biggest problem is quality of the roads, highways and bifurcations (WEF, 2009). The
advantage of railroad infrastructure is vast, accessible and cheap. Port facilities have
improved over the past three years, but are in need of further upgrading. Air transport
provision has deteriorated, is expensive and need to be changed49. Power generation
capacity is also sufficient, however it is reliable on Russian gas and oil supplies.
Modernization of the telecommunication market, in mobile telephony and
Internet areas, has improved the efficiency and availability of telecommunications
over the past decade. The distribution network is one of the low qualities. Information
technology infrastructure is inadequate for a country with Ukraine's level of education
(The Economist Intelligence Unit Limited, 2006).
Labor
Efficient labor market is critical for investors; it is the competitive advantage
of Ukraine. Global Competitiveness Report highlights the efficiency of use of talent
in Ukraine, many people got higher education and are ready to over-work comparing
to their fellows in Europe. Still, many talented people left their country in seek of
better living conditions; this is reflected in the lack of professional managers.
Figure 10 Unemployment, percent
33
6.00
5.00
4.00
3.00
2.00
1.00
0.00
2000
2001
2002
2003
2004
2005
2006
2007
Source: State Statistics Committee of Ukraine
Figure 10 reflects gradual fall of unemployment rate. However, it still
remains at 3% level creating natural competition among labor force. A low salary is
also favorable factor for investors.
Figure 11 Nominal average salary in Ukraine, US Dollars
350
300
250
200
150
100
50
0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Source: State Statistics Committee of Ukraine
Figure 11 depicts average salaries tendency over couple of years. They are
much lower than in European countries. The highest average salary is in capital, Kiev,
– 516 US Dollars and the lowest – 218 US Dollars (Korrespondent).
Labor market risk is low. Labor laws have the direction towards the
employee and against the employer. The labor Unions have little power in fighting for
workers rights50. However, relative difficulties with firing people create additional
problems.
Market
With a population of 46 millions, market size is one of the biggest
competitive advantages of Ukraine. The geographic position of Ukraine attracts
investors both from CIS and Europe. However, competition in Ukraine remains too
week. Figure 12 represents the HHI index, which shows there is too little competition
at the market.
34
We can see, that the most monopolized are Electricity and Metallurgy
Industries. However, all the economy of Ukraine needs more competitive entrants.
OECD concludes that Ukraine needs more “creative destruction”: more entrance to
the market, more exits and more competition.1
Figure 12 Herfindahl-Hirschman Index 2005
Food Industry
Light Industry
Construction
Wood working
Timber and Paper Ind.
Mashinery
Chemical
Electricity and Metalurgy
0
0.2
0.4
0.6
0.8
Rule: Index below 0.1 - unconcentrated index., between 0.1 to 0.18-moderate concentration.
above 0.18 - high concentration.
The closer to 1.0 – the more monopolistic is market
Source: OECD
To summarize the chapter I draw the table of interdependence between
determinants of FDI and the level of FDI in Ukraine in different periods. The table is
prepared through detailed study of all major changes in different areas of Ukrainian
political, economical and social life. It visualizes improvement (or decline) of selected
FDI determinants and the consequent FDI level. The changes in only one area do not
influence on FDI inflow, but shifts in several factors can attract or distract investors.
Table 11 Interdependence between FDI determinants and FDI level in Ukraine
Year/
EXC INF FIN COR TAX POLI LEG TRA INFR LAB GRO FDI
Factor
91-94  








95-97 







98-99   




00-03
 


  

04-05








06









07-08










09







 
Legend: EXC – exchange rate, INF – inflation, FIN – financial markets, COR – corruption, TAX – tax uncertainty, POLI –
political instability, LEG – Legal and Regulatory issues, TRA – Trade openness, INFR – Infrastructure, LAB – Labor market,
GRO – Growth, FDI – Foreign Direct Investment.
Joseph Schumpeter described his process of “creative destruction” as the driver of economic development: growth and progress
will be stronger over the long run when competitive conditions allow new players freely to enter the market, forcing
unproductive firms to restructure or exit and free the capital and labour for more productive use (OECD)
1
35
- growth, comparing to previous year, - fall, comparing to previous year, - no significant changes
- factor is in undeveloped condition, even thou some positive changes might occur
The summarized findings are not always consistent with the theory. E.g. in
1991-1994 depreciation of Hryvnya, hyperinflation, worsening of financial market
conditions, striving corruption, improvement of tax climate and legal issues,
liberalization of trade, decline at labor market and overall economy decline attracted
bigger FDI inflow comparing to 1990. The latter periods (since 1998) show better
elasticity. I explain this effect that investors desire of to set on Ukrainian market was
so high, that they could endure temporary losses.
I want to highlight that bigger number of stagnated areas (grey cells) result in
bigger FDI decline in the Ukraine. Thus, the long-term tendency of some factors
impact investment decisions more, than short-term improvement or declines.
Ukraine needs new mechanisms for attracting investors:
a. develop mechanisms of protecting investors rights
b. reform of legal-regulatory system
c. lower tax rates
d. solve the land plots issues
e. develop financial sector of Ukraine
f. strive to diminish corruption and political instability
g. increase the international investment image of Ukraine, to work out the
national strategy concerning investment attractiveness.
36
CHAPTER 3. Ukrainian Foreign Direct Investment Analysis
3.1. Level of FDI to Ukraine
The question of foreign direct investment attracts an everlasting interest not
only among the economists, but in societies also.
Investment activity is an important macroeconomic figure. FDI in developing
economies serves as catalyst for the economic growth. The foreign investors have
long-term interest and could sustain short –time losses. According with the researches
and surveys, the interest of foreigners is in big Ukrainian market (Appendix 6). The
positive impact of FDI on economy was described in first chapter.
Let’s discuss different types of foreign investors, which are present at the
Ukrainian market according to their political and economical interests, and methods
of doing business.
1.
Strategic investors – those are mostly MNC. Their priority is to use
widely natural resources of Ukraine and to get profit via exporting them and
launching own production. They come from USA, Germany, South Korea.
2.
Fund investors – deal with different funds. They exist everywhere and
try to diversify their risks
3.
Massive investors – have the aim to launch industrial and household
goods production. They use local funds, raw materials, cheap labor, and
infrastructure. These are that kind of investors, who make country richer in
technological and organizational levels. The most desirable are ones, who invest in
imports-cutting industries.
4.
Expansionists – main activity is to import investment materials
(constructing, first of all) and finished goods to Ukraine (goods expansion); to buy
raw materials and half-finished things to export from Ukraine.
5.
Filials – those who invest to satisfy HQ demands in their export-
widening aims.
6.
Post-Socialistic – investors, mostly from CIS states, who, basing on
the new principles, are trying to cooperate with Ukraine. They use informal relations,
industrial networks and knowledge of the market very often.
7.
Adventurists or criminals. First ones, having heard about “new
Ukrainians” (who as if became millioners immediately), decided to get rich. But there
are no such miracles nowadays and they return home. The second group is those, who
37
got rich from illegal activities.
8.
Experts. They are connected to consulting business and can act as
investors as well as experts. Only 10% of foreign experts act effectively, the rest are
just making the money. World statistics states, that only 7-8 % of investment projects
find real strategic investors (financehub).
The level of FDI to Ukraine increased drastically after the first Independence
years until now. Figure 13 represents investments level as a percent of GDP. The
figure depicts also the average data for CIS, Europe and Emerging economies groups.
Ukraine was left behind due to poor political and economical state. Hyperinflation
and then state default distracted investors. Since 2000-2001 significant economical
changes came GDP growth was followed by rise in FDI.
Figure 13 FDI as a percent of GDP
Ukraine
35.00
30.00
CIS
25.00
20.00
Europe
15.00
10.00
Emerging
and
Developing
economies
5.00
0.00
Source: EconStat, State Statistics Committee of Ukraine
The total Foreign Direct Investment in Ukraine from 1994 to 2007 accounted
USD 41.929 billion (Figure 14). It is visible, that there was almost no growth between
1998-99, and, in contrary big inflow of investment is observed in 2005.
38
Figure 14 FDI Stock in Ukraine, billions of USD
45.000
40.000
35.000
30.000
25.000
20.000
15.000
10.000
5.000
2009 1Q
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
0.000
Source: United Nations, World Investment Report
The detailed inflow of FDI is presented in a figure below. We can observe
the sharp rise of investment since 2005. This level reflects investor expectations due
to “orange revolution”. The next year’s political crisis caused investment shrink. The
2007 and 2008 were the years of increased investment inflow. Only the forth quarter
of the 2008 was sluggish. The crisis impact on Ukrainian economy become very
visible in 2009, in the first quarter Ukraine received only USD 1.18 billions. The
expected amount of FDI inflow in 2009 varies between USD 4 and 6 billion.
Figure 15 FDI inflow to Ukraine, billions, USD
9.89
10.69
9.50
7.81
8.50
7.50
6.50
5.60
5.50
4.50
3.50
2.50
1.50
1.72
1.41
0.60
0.77
0.69
2000
2001
2002
1.18
0.50
2003
2004
2005
2006
2007
2008
2009 1Q
Source: Economic Intelligence Unit
Despite of all odds, the inflow of FDI increased during the last couple of
years this occurred due to:
a. desire to set in perspective market
b. desire to receive high profit on long-term basis
39
c. desire to achieve access to cheap resources
d. desire to use cheap labor
Around 77% of FDI come to Ukraine from EU-25 countries. The
neighboring element in FDI seems to be important. Another issue is that 20% of
investments come from Cyprus, 3.6 % from Virginians, or from offshore zone. This
effect exists in Russia, Belarus, and other CIS countries. Ukrainian entrepreneurs
move money to offshore and than reinvest them back in Ukraine. Looks like Ukraine
invest itself. It’s not possible to struggle with these frauds, because businessmen will
definitely find the other ways to hide money.
Figure 16 FDI inflow to Ukraine in 2008 by countries, percent
Russia
3.6
3.6
3.4
6.0
USA
5.0
16.4
Cyprus
20.0
Germany
Netherands
7.0
7.0
Austria
8.0
20.0
UK
Other
France
Virginians
Sweden
Source: State Statistics Committee of Ukraine
The better way to raise taxes is to set them on a reasonable level. The Cyprus
money mostly derives from east, manufacturing groups. East-oriented parties and
governments support these economic groups. Thus, when in Ukraine govern proeastern authorities (Appendix 17) – investment from Cyprus come to Ukraine.
However, the biggest investor from accumulated FDI point of view is Germany.
Investment activity of Germany increased 8 times and Austrian 4 times after the
Orange revolution (Appendix 16). Austria and Germany invest in construction and
real estate sector mostly. In turn, UK and United States increase their investment
portfolio in Ukraine gradually. Russian investment activity in Ukraine decreased since
new, pro-European political elite came.
The following question to unveil is the investment attractiveness of
Ukrainian regions.
40
Table 12 Investment attractiveness of Ukrainian regions - 2008
1
Kyiv
10 Poltava reg.
19 Rivne reg.
2
Kyiv reg.
11
Lviv reg.
20
Mykolayiv reg.
3
Dnipropetrovsk reg.
12
Sevastopol
21
Vinnytsya reg.
4
Ivano-Frankivsk reg.
13
Zaporizhzhya reg.
22
Kirovograd reg.
5
Kharkiv reg.
14
AR Crimea
23
Ternopil reg.
6
Zakarpattya reg.
15
Chernivtsi reg.
24
Chernigiv reg.
7
Odesa reg.
16
Lugansk reg.
25
Sumy reg.
8
Volyn reg.
17
Cherkassy reg.
26
Zhytomyr reg.
9
Donetsk reg.
18
Khmelnitsky reg.
27
Kherson reg.
Source: Kontrakty
Recent years among the investment leaders were industrial cities of Ukraine,
while today plants appear to be not very important. Profitability, innovation, saving,
customers activity and infrastructure become the major factors. The first question
investor asks if there is an airport and METRO Cash & Carry chain in the city. The
best conditions to start business are in the regions with low prices and average
salaries. Once depressive regions win today due to developed infrastructure and hightechnological industries.
Investments go to the regions, which are already developed (Kyiv,
Dnipropetrovsk, Odessa, Kharkiv), leaving peripheral regions behind (western regions
of the country). Thus regional disproportions increase in the country. The solution
might be – creation of tax-heaven zones.
3.2. Comparing of the neighbors
As discussed in previous chapters, FDI depends on the number of factors.
Difference in macroeconomical and political situation resulted in a distinctive level of
FDI in countries and thus different economy development. The common fact for the
sample of countries is that they’ve gone through the same stages of development. All
the economies shifted from communism and planned economy to democracy and
market economy. The neighboring to Ukraine countries had common history and
similar mentality, still different phases of transition. In the late eighties, new-EU
countries entered the transition period, this moved them forth comparing to CIS.
Table
13
gives
a
brief
outlook
of
the
major
changes
in
societies.
41
Table 13 The transition path of selected countries
Hungary
Slump
economy,
reforms begun in
1991
Poland
Post-communist
state, revolution
in 1990
Romania
1997
Painful
transition,
economic
slowdown
Russia
1996
1992 reforms
launched,
hovewer
recession deepens
Further
decline, GDP
decline,
inflation
Slow recovery
signs
Ukraine
1995
Troubles of
transition,
hyperinflation,
black market
accounts to 60%
of GDP
Vast
privatization
launched
Several free
economic
zones are
created
Belarus
1991-94
In 1994
autoritarian
president was
elected, who
remains on the
post until now
1998
1999
2000
2001
Stabilization
plan, Joining
NATO
IMF loan,
massive FDI
come to
country
Stabilization
plan bore
fruits – loan
repaid
Slow
privatization
Government is
oriented on
attracting FDI
Russian
Financial
crisis slumped
economy
Country
strives with
inflation and
corruption
GDP positive
growth,
inflation
decreases
2002
GDP growth
has decreased,
rise of
inflation
Standby
agreement
with IMF
Negative
effect of
russian
Financial
crisis
Second
standby
agreement
with IMF
First GDP
growth, FDI
rise
Financial
crisis, deep
recession,
coutry’s
default
Stabilization of
inflation, slight
GDP growth
Russian
Financial
crisis caused
technical
default
Strive with
economy
slump brought
first results
Debt is
restructured,
economy
achieves FDI
Further
economic
growth,
currency
stabilization,
Dollar peg
Economy is in
poor state,
goods are
noncompatible
Government
new program:
FDI rise from
19% to 26%of
GDP. Investor
- Russia
6 free econ.
zones created
with investors;
Poland, Russia,
and Germany,
USA
Several EBRD
projects was
stopped by the
President
Third standby
agreement
with IMF
2003
2004
2005 -…
Invitation to
join EU, the
most
advanced
candidate
EU Ascension
Subsequent
development
and FDI
growth
Invitation to
join EU
EU
Ascension,
political
disputs inside
the country
Partial
development
and FDI
growth
Invitation to
join EU, joining
NATO, 55% of
industrial assets
are privatized
EU Ascension
in 2007 , low
labor cost
brought
massive FDI
Vast
privatization, the
transport system
reformation.
Huge FDI inflow
Several terracts,
unsafety, FDI
shrinks
Political and
Economical
stabilization,
rise of FDI
„Orange
Politcal
Revolution“.
instability
The Political
decreases FDI,
elite shift
but the tendence
bring
enormous FDI remains growing
Several stateowned
enterprise was
privatized
President
rejects USD 10
bil. FDI
because of
„unacceptable
terms“
The country is
still in
economical
isolation
42
The first to transition path stepped Hungary, in 1980s, and achieved steady
stream of investment, well balanced across various sectors of the economy. Hungary,
with a population of 10 million accumulated more than EUR 60 billon of investments
and has biggest FDI per capita – EUR 6900 (IDT Hungary, 2009). The country
attracted third part of all FDI to CEE countries since 1989. In Hungary, where FDI
inflow was the highest, the percent of hi-tech industries is the highest today.
Restructuring in 1993-2000 pushed middle and high technological branches forth,
while low-technological areas shrunk. Hungary serves as a model for countries going
through market reforms. Corporate tax is 18%, local business tax set at 2% of
turnover and normal VAT makes up 25% (Encyclopedia of Nations).
The follower of Hungary appears to be 36 million populated Poland. After
the revolution country quickly absorbed into new capitalistic market. The Economic
Transformation Program adopted in January 1990. Economic possibilities didn’t catch
up with the political climate. Reforms were not such successful as in Hungarian
economy. Since1999 country attracted more investors and, after 2002 (invitation to
join EU), the level of FDI increased drastically. Until 2008 Poland accumulated
around USD 132,5 billion of investment. Corporate income tax is 27%; payroll taxes
from 36% to 39%. There are four VAT rates: 22% on most goods and some services;
7% on processed foodstuffs and construction materials; 3% on unprocessed
foodstuffs; 0% on exported goods and services. (Encyclopedia of Nations).
The transition path of Romania was the longest among the new EU countries.
By 1992, GDP had fallen by 30%, industrial production had fallen 47% and inflation
had reached 300%. In 1997, 1999 and 2001 the government entered into three
arrangements with the IMF for standby agreements. In 2002 Romania was not ready
to enter EU, thus it had joined in the next round of EU enlargement in 2007.
Nonetheless, the crucial moment came in 2002 (see Figure 17). Cheap and skilled
labor force, low taxes, no dividend taxes, liberal labor code and a favorable
geographical location attracted investors to Romania. The country gradually lowered
its tax rates: from 38% to 25% in 2000, and then to 16% both for corporation and
individuals; and VAT from 22% to 18%. Many services are exempt from VAT:
healthcare, scientific, educational and charitable activities, banking and financial
services, and schoolbook editing.
43
Figure 17 FDI Flow per capita, by country, billions, USD
0.900
0.800
0.700
Hungary
0.600
Poland
0.500
Russia
0.400
Belarus
0.300
Romania
0.200
Ukraine
0.100
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
0.000
Source: OECD, EconStat
Figure 18 represents accumulated investments from our closest neighbors
perspective. The leader is Russia. It’s obvious, that such a huge and fast developing
country attracts foreigners, despite of political pressure inside the country. Russia is a
vivid example that political and legal misfits inside the country do not create a barrier
for investing, if there are big possible profits.
Figure 18 FDI Stock, billions of USD
per capita
per country
250
150
10.000
132.5
63.48
50
251.28
6.323
5.000
53.61
6.84
1.777
41.929
-50
5.589
3.488
0.000
0.318 0.916
Source: State statistic information portals of the countries
However, if we compare FDI per capita level – the numbers are opposite.
The best performer is Hungary. It’s obvious: to compare the level of investment in
countries with different territory and population would be unfair. Thus, FDI per capita
is a better figure.
The economical and political development of Russia has another pattern than
new-EU neighbors. With it’s population over 142 million, the country appears to have
44
the most attractive market at the CEE area. After Independence country faced
economic slowdown: industrial production fell to 55%. 1992’s economic reform was
the next step to market-oriented economy. Still, by 1995, 25% of the population lived
in poverty, and the economy went "underground". In 1997 Russia received the highest
FDI of USD 4.87 billion, but then it felt to USD 2.76 billion in 1998 due to Asian
financial crisis. Since 2002 country attracted extremely high amount of investment.
Cumulative FDI in Russia in 2009 makes up USD 251.279 billions. World crisis 2008
halved the investment inflow to the country. The corporate income tax is 24%, VAT
makes up 16% with reduced rate of 10% to educational books, newspapers,
pharmaceuticals and medical equipment. Russia today remains authoritarian country,
vague business laws, an incoherent tax system, corruption and slow reforms distract
investors (Encyclopedia of Nations, 2007).
The Belarus path is most tragic. Authoritarian President controls the country.
All the possible freedoms are diminished in the country; investors have many
problems with the government bodies. Recently, Ford has withdrawn its investments,
Coca-Cola and McDonald’s also quarreled with the authorities. The corporate income
tax for resident companies is 30%. The VAT standard rate is 20% and a reduced rate
is 10%. The accumulated FDI in Belarus amounted USD 5.013 billions. Country, with
its population of 9.6 million might be a perspective market in future. However
country’s political and economical barriers do not allow investors to set up
businesses.
The next step in comparing neighbors is to compare FDI by activity types.
Table 14 depicts the areas where FDI goes in specific countries.
For most of the countries, manufacturing absorbs the biggest share of the
investments, however, this is not the case of Poland. Real estate and construction
became very popular business in CEE countries, recently. While Poland’s biggest FDI
share went directly there, Hungarian index didn’t perform in that manner. Belarusian
wholesale and retail trade sector appears not to attract so many businessmen, while
this sector is the second larest for CIS countries. It’s interesting that Finacial
intermediation and insurance sector attracted many investments. This percent is also
high for Ukraine where, recently, was a boom of M&A in banking and insurance
sectors has passed.
45
Table 14 FDI in the chosen countries by activity types
36%
5%
-
Poland
2006
23.7%
-
Romania
2007
32.9%
3%
-
Russia
2008
35%
4.5%
-
Belarus
2008
42.9%
29.8%
Ukraine
2008
27.6%
0.5%
-
12.3%
11.2%
23.3%
4.3%
-
16.3%
11 %
8%
6.5%
3%
-
4.3%
-
14.2%
14%
23.6%
8.5%
10.4%
20 %
32%
7.8%
17.5%
-
14.1%
15.7 %
100%
10.9%
100%
12.5%
100%
12.1%
100%
18.8%
100%
26.8%
100%
Sector
Hungary 2008
Manufacturing
Electricity
Services
Financial intermediation, insurance
Transport and
Communication
Wholes. and retail
trade, repairing
Real estate,
construction
Other
Total
Source: State statistic information portals of the countries
Very important in comparing countries is to understand where the investment
comes from (see Table 15).
Table 15 FDI in the chosen countries by investors
Country
Hungary 2008 Poland 2006
Germany
Cyprus
UK
France
Netherlands
Luxemburg
Switzerland
Virginians
Russia
Austria
Greece
Italy
Spain
Sweden
Poland
Hungary
EU-15
USA
Other
25%
3%
5%
14%
6%
1%
2%
1%
13%
2%
79%
5%
23%
18%
8%
9%
24%
9%
7%
7%
82%
4%
14%
Romania
2007
11.7%
4.7%
8.8%
16.3%
5.1%
21.40%
7.5%
6.1%
82%
1.4%
11.9%
Russia
2007
10.63%
24.92%
19.95%
8.27%
14.51%
10.20%
3.81%
4.30%
96%
3.42%
0.00%
Belarus
2008
8.5%
10.9%
18.8%
33.2%
6.8%
21.8%
Ukraine
2008
20%
20%
7%
3.6%
8%
1%
2%
3.6%
6%
7%
0.5%
0.5%
3.4%
2%
2%
78%
5%
8.4%
Source: State statistic information portals of the countries
46
More than 82% of FDI for Poland and Romania and 79% for Hungary come
from EU-15. The first or the second biggest investor in the CEE countries is
Germany. The Netherlands appears to be major participant also. The proof of
neighboring approach to FDI is very vivid in the table. The big part of investments
goes to neighboring country: e.g. Austria invests to Hungary and Romania, Russia to
Belarus, Poland and Hungary to Ukraine. The very important thing in the table is that
huge percent of investment come from Cyprus in the case of Russia, Ukraine and
partly Belarus. As mentioned before, huge amounts of money flee from CIS countries,
and set in areas with low tax pressure (offshore). Afterwards, the money, freed from
home taxation, return into parent country as investments. Russia and Ukraine invest
themselves by their own means; this, of course, is not good. A positive sign of
investment activity is a big number of middle and small investors, what is not the case
of Belarus.
It worth to mention, that FDI patterns respond to the theory. E.g.
announcement of EU ascension bring great investment inflow to the country. Political
situation in the country, orientation of the authorities plays the biggest role. Table 3,
Table 4 and Table 5 summarize countries position in different international ratings.
Taking into account all the ratings and the FDI inflow to the specific countries, the
size of the market - I rated all them and made up my conclusion of attractiveness of
the countries. The top-country to invest in appears Poland, Hungary followed, being
the second. The third attractive to investor is Russia, Ukraine set the fourth position
and Belarus appears to be the least desirable country to invest.
3.3. Analysis of the structure of Ukrainian FDI by branches
The next issue we are going to deal with is the structure of Ukrainian FDI
(see Figure 19). The biggest sector of investment in Ukraine is manufacturing,
23,5% of foreign capital went there (State Statistic Comitee of Ukraine).
Manufacturing, however consists of several big branches, the most dynamic are
metallurgy, machine building, transport and chemical industry. The second biggest is
Financial intermediation; here many M&A, Greenfield’s and business developments
took place. Banking and insurance were the most growing and dynamic sectors in the
recent five years. Retail sector, constituted of “new economy”, made up 10% of total
investment. Extremely profitable, real estate sector amounted to USD 25 million.
47
Figure 19 FDI to Ukraine in 2008 by activity types
Food Industry
by percentage
8.6%
5.5%
Chemical and oil
industry
Metalurgy
3.6%
1.9%
0.5% 5.3%
3.9%
22.3%
Machine Building
Trade
by billions of USD
4.266
10.4%
16.3%
Transport and
communication
Other sectors
25.506
81.38
Real estate
Constructing,
engineering
Agriculture
Extractive industry
Constructing,
engineering
Trade
47.939
3.6% operations
4.3%
Industry
12.769 5.571
5.7%Financial services
Agriculture
30.564
16.192
Financial services
Real estate operations
HoReCa
Communication
Light industry
Source: State Statistics Committee of Ukraine
Let’s go in details to the specific sectors of Ukrainian economy, give them
brief overview and try to forecast which of them are the perspective for investing.
Machine building
The economy of Ukraine traditionally relies on state machine building
complex – the locomotive of technical progress. In the world’s machine building there
are only ten countries, capable to produce all the machine nomenclature. One of them
is Ukraine. During many years Ukraine places good position in projecting and
producing avian-cosmic techniques, ship-, workbench-, energetic- and transport
building.
In 2009 most of the machine building companies shrank volumes of
production on 55,6% comparing to 2008, demand become sluggish. The fastest
segment of machine building was transport machine building (lorry, automobile,
railway wagons) this was due to increased demand; and in 2007-2008 – mining
machines.
Ukraine produces 40 000 railway wagons every year. However, there is still
a deficit of them in the international market. All the four biggest Ukrainian wagonbuilding companies announced about broadening of productive capacities. This will
result in strategic benefits and financial profits in future.
The biggest problem for the industry is the devaluation of UAH. Several
plants are involved in credit programs and repay debt they must in low demand
conditions. However, companies diversify their production and thus believe they will
handle with the crisis. Some of the machine building companies feels themselves
perfect in 2009: e.g. producers of equipment for energetic and oil-gas branches. The
48
companies, who export their production abroad showed rise in sales on 27%
(Business, №11, 2008).
Metallurgy
Metallurgy is the main industry in Ukraine. It is the second main component
of Ukrainian GDP; it defines the other sectors of national economy. Why to invest in
metallurgy? Ukraine sets 6th place in the worlds production capacity of metals and
mining.
After the recession in a third quarter of 2008 Ukrainian mining and smelting
complex began to recover. In summer 2009 the rise of production volumes is possible.
Ukrainian metallurgy can compete with foreigners, the prime cost decreased in 2-3
times. Metallurgists save money on everything and optimize production. Ukrainian
steel today is the cheapest in the world; it is exporting even to China. Devaluation of
national currency helped the industry to decrease prices in USD. The industry brings
enormous profits to the owners. Cheap resources and labor make the branch very
attractive to investors (Kontrakty, №13. 2009). The evident example of huge investors
interest in the industry is presented in the case below.
ArcelorMittal Kryvyi Rih
Is one of the biggest ferrous metal manufacturers. In the beginning of 2008 the company
employed 46967 people. In October 2005 93,77% of Kryvorizhstal concern was bought by Mittal Steel
Germany for USD 4,8 billions. The profitability of sales was 19.2% in 2007, profitability of own
capital – 30.2%. With the arrival of foreign investor Kryvorizhstal obtained key markets for sales.
ArcelorMittal will invest in Kryvorizhstal USD 2,4 billions more until 2010. The first investment of
USD 1.5 billion were held until 2009.
Unfortunately, with the financial crisis the problems touched the company. Arcelor Mittal
announced that they would close high-cost production factories. Those are situated in USA and
Western Europe. Ukrainian subsidiary looks like a “piece of heaven“ in this crisis. Company managed
to achieve profits even in the worst period. In April 2009, Arcelor Mittal Kryvyi Rih increased
production of finished steel by 6.2%. Metallurgical sector shall revive after autumn 2009; this will be a
good period for the company.
Non-ferrous Metallurgy
As its brother, ferrous metallurgy, non-ferrous metallurgy produces semimanufactured articles. There are two non-ferrous metal productions, which are
interesting for investing: titanium and aluminum.
Ukraine sets 5th place in the world on titanium minerals resources. Country’s
titanium production needs USD 1 billion investment. Aluminum market is also
49
attractive one for investors. Nowadays the world’s alluminium market turns to deficit
stage, thus Ukrainian factories are very attractive. 40% of the global production of
manganese ore is located in Ukraine (Business, №19, №25 2008). The foreign
presence in this sector is minimal. The reason is that non-ferrous metallurgy is under
control of national business groups, however, the possibilities of investing still exist.
Chemical industry
Chemical industry is one of the most important branches of heavy industry. It
consists of mining, main (fertilizers), polymer, and paintwork chemistry.
All that is needed for fertilizers production is cheap natural gas and closeness
to sales market. These conditions created in Ukraine chemical industry. Since 2004
chemical industry become very attractive for investors. The resources like phosphor
and potassium, chemical fertilizers like carbamides and nitrates are present in
Ukraine, but they are not fully exploited. Investment of EUR 700-800 mln might pay
off and bare profits in several years. The prices on chemical products rose in 2008,
but dumped in the end of the year due to crises and increased prices for natural gas.
European chemical market becomes very closed last time. After joining
WTO, Ukraine still cannot export its chemicals abroad. We face different quotas and
anti-damping export duties. Experts are united that to enter the oligopolistic European
market of chemicals good dealers network is needed, like the ones that big chemical
companies have. There are several big investors in Ukrainian chemicals market e.g.
Russian Eurochem, presented in the case below.
Eurochem Ukraine
Daughter enterprise “Eurochem Ukraine” is a part of Eurochem (Russia). The company
exists more than 10 years and is one of the biggest companies in European market. The HQ invested in
Ukraine USD 10 million and plans to increase its presence on CIS market. Eurochem Ukraine got into
the TOP100 companies of Ukraine. Its commission to quality and social responsibility plays the
important role. In the competitive market company not only set its place, but also demonstrates high
growth of profits and business activity. Eurochem is famous for its distribution networks, which are
like those in oil-producers. Unfortunately with the world fall of prices on chemical production
company is in a hard times, however the management looks in future with confidence.
Many investors were interested in chemical industry of Ukraine, but
Ukrainian authorities didn’t allowed neither them, nor Ukrainian investor to start the
business. Still, the industry still has a god potential. In two- three years the industry
50
will find its investors (Business, № 9, №13, 2009; №16, 2008) (Kontrakty, №01,
2007).
Transport
Transport is one of the most important branches of Ukrainian economy. It
provides manufacturing and non-manufacturing needs of production, and the needs of
people. There are elevated, water, air and electronic kind of transport. In total,
transport system of Ukraine needs USD 27 bn of investment. These investments are
crucial for EURO - 2012 preparation. The ministry of transport worked out 270
investment projects using all their limit of fantasy. The main projects concerning
water transport system, aviation transport, and road system.
Ukrainian ports. In the nearest couple of years six foreign companies plan to
invest USD 2 billions in Ukrainian ports. Along with this 12 companies, which are
present in Ukrainan market, want to invest USD 2,41 bn. in total. Singapore,
Germany, and Israel are the countries who plan to develop ports infrastructure in
Ukraine. However, investors face several problems: the lack of acceptable conditions
for work of investors (investors can only rent ports, but can not have them as their
own property) and inconsequence of state policy in the branch.
Aviation transport. Recently, low cost airlines Wizz Air and Air Arabia
entered Ukrainian market. Aviatraffic branch is not filled,there are many possibilities
still. The minister of transport plans to invite three-four airline companies to the
market. However, the main objects for investors are 24 Ukrainian airports, that belong
to the State property
The main concern of investors is their doubts that their investment might be
nationalized (Korrespondent № 18, 2008,) (Business, № 13, 2008 № 5 2009).
Construction and real estate
Historically, real estate has always been traditional way of making long-term
investment. The rising demand in 2000 - 2008 caused rapid tempo of construction.
These years were the most rich for the industry. Every year, the volume of
constructing works grew on 10-15%, thus investments have risen as well. In 2009,
real estate in Ukraine lost its attractivity to foreign investors. If, before, sky-high
profitability rates in commercial and retail sectors crowded foreigners, - now they
look at the market with dread. This thesis is supported by case of Mirax Group.
51
Mirax Group
One of the biggest developers at the russian market. Company’s turnover in 2008 made up
USD 2 billion profitability reaches 40-45%. Mirax group entered Ukrainian market in 2006 having
ambitions plans. They’ve announced about construction of 50 big business, living and trade complexes.
3 of those with a worth of USD 2 , 1 and 1 billion were at the stage of constructing, when company
faced economic crisis and further problems. Mirax group frozed all the unfinished projects, refused
from continuing investing in Ukrainian retail market and closed its affilate in Kyiv. The company has
USD 200 million available and USD 900 million in debt.
However there are several western and russian investors with 200-300 mln.
USD portfolios, who want to invest in the market. The most popular are the land plots
and unfinished projects.
There arises a great opportunity of very cheap investments: wait 1-2 years
and 10 - 15 years have good profitability. The most probable investments will come
from France, Netherlands, Spain, Portugal and Russia (InvestGazeta № 1-2, 2009).
Agriculture
Due to its natural conditions, Ukraine is the world producer of agricultural
production. The agricultural sector seems to be the only one branch of world's
economy, which didn't suffered from global financial crisis. Agro-IPO is the
investment idea of 2008 – 2009: agrarians attract investors actively. Agricultural and
food producing companies are very popular among investors in the world
commodities price rising times This thesis was supported by managing director of
Nestle Ukraine. Agricultural boom is a world tendency (see the case below).
Trigon Agri
The Danish agriculture company Trigon Agri has under its possession land in Russia, Ukraine
and Estonia (135 thousands ha in Ukraine) and five Ukrainian grain storages with total capacity of 322
thous. tonns. In Ukraine Danish mainly grow grain-crops, besides, 40 thous. ha. used under milk
farming. Trigon Agri plans to increase land possession up to 200 thous. ha in this year and to 300
thous. ha. in the following one. The profit made up EUR 4,47 mln. in Ukraine. In 2008 company went
for SPO and raised EUR 105 mln to broaden its activities. In Ukraine it is prohibited to buy land, but
investors have the possibility to rent the land for 25-, 50- years period with the possibility of further
rent prolonging.
Most of the countries exhausted their land resources, while Ukraine has great
possibilities to increase harvests. 56% of Ukraine’s land is arable and 1/3 of the
world’s “black soil” is found in Ukraine. To enter the branch is very cheap: man can
52
buy the company, which owns the land for USD 200-300 per 1 ha, and pay USD 4060 per ha for rent per year. EBITDA from 1 ha is USD 500 in average.
The main investing incentive in Ukraine – are big plots of land to rent.
Western investors hope, that they might buy this land in future. After the cancellation
of moratorium the land prices can jump up to five times. The best investment for the
next year is in oil-yielding crops and vegetable oil production. In particular, EBRD
invests in 2009 EUR 220 mil. in the agricultural sector of Ukraine. Among the
priorities of EBRD – production of sunflower seeds, sunflower oil, corn, milk
production and retail trade (Kontrakty, № 21, №38, 2008).
Food industry
Ukrainian food industry is one of the most rapidly developing branches.
There is not only a constant increase in production, but the rise in quality standards as
well. Positive changes arise not only from country’s economic development, but also
with substantial investments in industry, implementation of foreign experience.
Due to bad times in 2008 food industry lost 26% of profits. However these
are mostly imported products, which become expensive due to Hryvnya default.
National goods in turn become more popular. Bad management together with
financial crisis forces some companies to review their successful expansion at
Ukrainian market, see the case below.
Anheuser-Busch InBev Ukraine
Anheuser-Busch InBev is the biggest brewering company in the world, presented on more
than 30 markets. It is the company №1 or №2 in 20 key markets. More than 120 thousands employees
work for the company worldwide. Portfolio of the company includes around 250 brands.
After “InBev” (SUN InterBrew in past) takeover of "Anheuser-Busch", 18th of November
2008, SUN InBev Ukraine present "Anheuser-Busch InBev" company at the domestic market. Sun
InBev Ukraine strated it’s activity since 2000 in Ukraine and represent the oldest tradition of brewery
since 1366. The company is leader at the Ukrainian market 9 years already, having share of about 40%.
Since 2000 till 2007 SUN InBev invested EUR 300 million in the developmet of brewering culture in
Ukraine, and more than EUR 60 million in HoReCa segment.
After USD 52 billion takeover of Anheuser-Busch in autumn 2008, combined net profit
falled to EUR 2.1 billion in 2008, down from EUR 3 billion in 2007. Anheuser-Busch InBev has
reached debt of to USD 40.7 billion and probably will sell some share of Ukrainian and Russian
market, states FT.
The demand for food production is inelastic, thus the industry will catch up
with the lost very soon. The sector is very dynamic, it attracted 5% of all investments
53
and made up to 13% of national GDP. Foreign companies struggle for attractive
market and put many affords to achieve bigger share. Even the “big sharks” of world
food industry like Coca - Cola and PepsiCo do their best to outbid the competitor.
Cocа-Cola Beverages Ukraine and PepsiCo Ukraine
"Cocа-Cola Beverages Ukraine Ltd." – is a part of Coca-Cola HBC and is the leader in
Ukrainan market. The company is one of the biggest investors in Ukrainian economy. Coca Cola is
presented in 26 countries, serves 500 mln.people and employ 30 000 people. In Ukraine there are more
than 1500 people working in the company.
The market of sweet mineral water is one of the biggest in the world. Two main competitors
– Pepsi and Coca Cola are fighting for it 100 years already. Last dozen of years companies seek for
new markets at the East Europe area. Recently, the place of a great interest becomes Ukraine.
The leader in Ukraine is Coca-Сola with 19,4% of the market, while Pepsi obtains only 3,1%. Pepsi had always a chance to be number one at Ukrainian market. Only Pepsi got permission in
70’s to sale in Soviet Union. 20 years after (in 1992) came Coca-Cola, in 1994 the first factory was
launched and in 1996 the first factory was build. Coca-cola first implemented direct distribution chain,
- this spread the drinks over all the country. Good advertisement policy, good strategy, corrects
branding and merchandising made Coca Cola the leader in Ukraine.
Since it existence Coca Cola invested around 300 mln.USD, when PepsiCo didn’t even
started to build it’s factories in the country. PepsiCo Ukraine had only signed a contract with BBH
Ukraine for producing Pepsi. This year Coca-Cola plans to invest additional USD 34 million in
productive capacities in Ukraine.
PepsiCo Ukraine decided to repair an omission and bought 80% of the biggest ukrainian
juice producer “Sandora” for USD 542 million. Experts suggest, that with a good strategy Pepsi might
need 2-3 years to catch up with Coca- Cola. The Sandoras’s share at the juice market is 47%, while
Coca-Cola attained only 5,3% The 2009 brought new dimension for PepsiCo Ukraine – it started to
produce and bottle vine. Since its existence in Ukraine PepsiCo invested around USD 100 million and
plans to invest USD 50 million more in 2009.
With the rise of Ukrainian’s incomes and influence of the Western market
consumption preferences in Ukrainians had modified. Low trade barriers in the
Ukrainian food supplements and ingredients market crowded British, Belgian, French,
German, Danish, Dutch and Russian investors. Food industry has the biggest foreign
presence in the sector and is very attractive to investors now, even in the midst of
crisis. The story of Nestle fits to this statement.
54
Nestlé Ukraine
Nestlé is one of the world's largest food company, founded in 1866. It owns 500 factories in
87 countries. The company is dedicated to providing a complete range of products to meet the needs
and tastes of people from the entire world. Nestle Ukraine – is one of the biggest companies in the
sphere of production of the foodstuffs. First of all, Nestlé Ukraine strengthens its positions and spread
its presence through investments in local production and industrial infrastructure; active support and
promotion of trademarks, developing of international sales. 12th year the company demonstrates growth
of Nestlè model – organic growth of the business minimum 5-6% per year, despite of economic
conditions. The following directions present Nestle business in Ukraine: coffee and drinks, sweets, cold
souses, soups, children and special nutrition, ready food, pets fodder, ice cream, mineral water.
Company entered Ukrainian market in 1994. In 1998 Nestlé bought the majority shares of
the most successful Ukrainian sweets producers "Svitoch". Since 1994 Nestle invested in Ukrainian
economy USD 200 million. In December 2003 Nestlе acieved 100% shares of “Volynholding”, that
produced very popular cold souse trademark “Torchyn product” In 2008 Nestle Ukraine increased sales
to 16% that is USD 0.48 billion. Almost all of the segments showed rise in sales from 13 to 43 percent
“Food – is the very last thing where customers save money”,- says press secretary of Nestle
UkraineTo the question “How the company is going to deal with crisis?”, top manager of Nestle
Ukraine, Edward Smith answered,- “We don’t plan to fire people, moreover, since January 2009 we
increased salaries. Our budget 2009, planned in August, remains the same”. This statement was proved
by the announcing of company’s future investment plans – Nestle will invest USD 53 million in the
constructing of two new plants to produce cold souses.
Some companies concentrate on profits, some aim to become a market leader
and some combine all mentioned and do some more: collect the most attractive pieces
of real estate. ”Our aim - the restauraunt in 100 m. from Lenin statue”, - McDonald’s.
McDonald's Ukraine
McDonald's is the world's largest chain of fast food restaurant serving nearly 52 million
customers daily, more than 31000 restaurants in 119 countries with 400 thousands employees. Ukraine
became 102nd country where McDonalds launched its activity in 1997. Today the restaurant chain
possesses 67 objects. McDonalds Ukraine is one of the bigger investors in the domestic economy. The
company invested over USD 100 million in the country during its activity in the country. In nearest 10
years company plans to double the number of current restaurants up to 240 investing in each of them
USD 0.5-2 million. McDonalds Ukraine sustains partner relationship with several dozens of Ukrainian
manufacturers, who produce more than 54% of the production, used by the company. At the same time
the company aimed to broad own production possibilities. In April 2006 it launched the first cattle farm
and the workshop for producing beef semi-finished goods.
Attracted by Ukrainian market potential, McDonald's benefits from local assets exploitation.
Along with this, low cost of production and skilled labor create additional insights for further investing.
Thus, McDonald's is committed to enlarge its position in Ukrainian market.
55
Financial intermediation
Ukrainian financial sector faced rapid development since 1991 until the end
of 2008. Last two-three years banking sector was one of the fast growing in ukrainian
economy: the quantity of banks increased on 10-15 per year, credit portfolio grew
minimum on 50%. Banks loaned to companies and people due to cheap international
loans: since 2006 dozens finance groups appeared in Ukraine. Moreover, banks issued
eurobonds, attracted credits abroad. Until 1st of April 2008, 20.6 % of deposit
investors were non-residents; they invested around USD 400 million. Banking sector
was very dynamic and attractive for M&A. Only in 2007 there was M&A on USD
4.045 billion (Business №19, №49, 2008).
Today, 50 among 190 Ukrainian banks are with foreign investments; 18 of
which are wholly owned by foreign companies. The share of foreign capital in
Ukrainian banks approaches 36% (Konnov & Sozanovsky). Due to inflation, financial
crisis and foreign loans Ukrainian banking system was catched. Some small banks
with foreign capital plan to shut down their affiliates in Ukraine. See the case below.
Erste Group
ErsteGroup started its activity in Ukraine in 2006. Erste Bank AG is one of the most
dynamically developing banks in Ukraine Erste Bank is a part of Erste Group, that was founded in
1819. Today it holds 23rd position among banks in Ukraine and has 1% of banking sector. There are
2000 employees in 100 affilates in Ukraine. Since 2006 Erste Bank planned to invest in banking
business in Ukraine EUR 400 million until 2010: open 400 affilates and increase bank's share to 4%.
Along with Erste Bank , Sparkassen Immobilien planned to invest EUR 500 million in real
estate market since it came to Ukraine in 2007
Changes into the company strategy came with crisis 2008. Erste Bank announced their
refusal of aggressive market achieving. Along with this, Sparkassen Immobilien paused all the projects
in Ukraine. Political instability and crisis influenced investments withdrawal. “We want to feel
ourselves in safety”,- said Andreas Treihel.
Growing instability and uncertainty on world financial markets, and
decreasing access to international financial resources, resulted in recession of
Ukrainian financial system. This led to subsequent correction of the financial
activities and monitoring strengthening of Ukrainian banks and their services by
National Bank of Ukraine. In October 2008 in 12 of Ukrainian banks temporary
administration was set.
Insurance companies followed the pattern of banks; the sector was very
dynamic and fast growing. In 2008 the sector earned USD 5 billions, while in 2009 it
56
will not be more than USD 1 bn. Until the end of the crisis, 20% of the insurance
companies will not survive.
Nonetheless, financial intermediation institutions with foreign capital are in
much better position and have more chances to handle the crisis times (Kontrakty №5,
№ 16, 2009). The insurance market of Ukraine is still at the early development stage:
only 10% of risks are insured in Ukraine. Experts predict further growth of the market
after overcoming the consequences of the crisis.
Retail
Internal retail trade remains one of the most fast growing and attractive
sectors of Ukrainian economy. It is developed from a simple rented place to well –
organized trade. Some foreign companies – investors equal in age with Ukrainian
Independency. Their commitment to the market and recreational investing attract even
more investors to Ukraine. See the case below.
Procter & Gamble Ukraine
Procter & Gamble is a worldwide leader in consumer products sales and manufacturing.
Production of Procter & Gamble appeared in Ukraine in 1990. The main incentive of launching P&G
operations in Ukraine was new market perspectives. Since 1993 it was obvious, that biggest country in
Europe needs more than just imports. In 1997 the company bought the first plant. More than 80% of its
production is exporting to East and West Europe as well to North and Latin America.
Procter & Gamble was the first in Ukraine, who started the struggle against falsificates. The
company has many social projects. In 2001 was honored as perfect taxpayer. In 2004 second big
factory was bought. Procter&Gamble Ukraine employed 2000 people; represent 40 trademarks. Its
distribution chain unites 1000 more employees. Since 1995 the company invested around USD 200
millions. Procter&Gamble Ukraine became the national leader in the FMCG sector. Partnership of
Ukraine and Procter&Gamble is a long-term perspective. Ukrainian market is crucial for the company.
The problem of the country is still not – developed investment climate. Procter&Gamble appreciates
positive changes in Ukraine since its independence and plans to broad productive capacities.
Increasing purchasing capacity of Ukrainians along with the multiplicity of
Ukrainian customers over the recent few years created even bigger interest for the
industry. The quantity of trade areas per 1000 citizens is low: 180 sq.m. in Kyiv,
while in Warsaw – 590 sq.m, in London – 1100 sq.m. (A.T. Kearney) This tells that
retail trade in Ukraine didn’t reach the maturity stage.
Today manufacturers, distributors and retail-sellers face different challenges
and must have a well-organized mechanism of delivery, sophisticated network and
57
sales system. These features exist in foreign investor’s experience, thus it can easily
become the leader in the branch. See the case below.
METRO Group
"METRO Group" has the headquarter in Dusseldorf (Germany) and it’s turnover in 2008
made up EUR 68 billion. METRO Group include the following affilates: "METRO Cash & Carry"
"Real", "Media Markt", "Saturn" and "Galeria Kaufhof".
There are more than 80 thousand of employee works in 600 shops in 29 countries of the
world. "METRO Cash & Carry" Ukraine started it’s activity in 2003. Since than, investments made
reached EUR 460 million, with the 7000 of working places. The company has 18 stores in the country.
90% of the goods in "METRO", supplied by Ukrainian manufacturers, distributors and importers.
Metro Cash & Carry Ukraine increased sales in 2008 to 24%, - EUR 1016 million (EUR 818 million in
2007). Here in Ukraine, company broadened it’s own trademark portfolio to 20%. Metro Group is one
of the biggest players in Ukrainian retail sector. Company has ambitious plans and bright perspectives
at the Ukrainian market.
Crisis 2008 touched the industry as well. Irresponsible policy of the state
together with financial crisis undermined national retail. Profits of retailers remained
in Hryvnya and credits in US Dollars. Retailers ask someone to repay their
management mistakes. Unthinkable expand for the cost of cheap credits become the
biggest headache for the owners. Nevertheless, today the Ukrainian supplydistribution system is gradually regenerating. Thus the activation of M&A in retail
sector is expected (Kontrakty №31, 2008) (Busiess №7, 2009).
Light industry
Light industry is a developing sector of Ukrainian economy. The volume of
works and services realisation in 2008 made up USD 1.2 bn. Internal clothing market
turnover is more than USD 10 bn. per year, however national seamstresses overloaded
with foreign orders: 90% of enterprises sell their production abroad. Companies from
Northern America and Europe give Ukrainian enterprises the material and models and
in turn, receive ready clothes. Thus Ukrainian workforce is used which is very low
paid. During 17 years the share of light industry felled from 20% to 0,8% GDP.
Market is filled with foreign production; still while Europeans spend 7% of their
income for clothing, ukrainians use 15%. The biggest problem is so called “grey
import” mostly from China and Turkey. It is impossible to compete with costumes for
USD 4-5. The industry could be perspective if government put more efforts to support
it. However, expensive import gives the chance to the branch (Korrespondent № 8,
2009).
58
Telecommunication
Since Independence, telecommunication industry has always been attractive
to investors. The market almost didn’t exist in Soviet Union. Since independence, the
profitability reached 300% for some players (Kyivstar).
Development of telecommunications is followed by further merge with the
television sphere. Such convergence appears in combining television, telephony and
broadband Internet services in an integrated proposal for a customer. Ukraine is not
an exception from the world tendency. The important event of 2009 is the
introduction of the third generation network (3G) to the Ukrainian mobile operators.
Telecommunications in Ukraine have a great potential, however the
ambiguity and non-transparency of legal system might lead to international scandals
(see the case below).
Kyivstar GSM Ltd.
Is a national mobile operator, the biggest in Ukraine, that serves over 24 mln. customers.
The company was founded in 1994. Kyivstar covers over 90% of the Ukrainian territory. The
shareholders are Telenor (56,52%) (Norway) and Storm (Alfa Group) (43,48%) (Russia). The
shareholders became loggerheads with each other. The problem was that Alfa wanted to buyout TM
Beeline (competitor of Kyivstar), and Telenor was against it. Telenor won several court cases and New
York arbitral cort case, that prescribed Alfa to sell its share to Telenor. As New York arbitral court
cannot force Alfa to fulfill the judgment, the case is still in process. Since than Telenor tried to buyout
Alfa’s share, but even in the October 2008 crisis russians preferred to save the position. In 2009, after 4
year pause, the shareholders meeting was held. Due to the international pressure and problems inside
Alfa, Telenor might obtain bigger share of the company.
The profitability of Kyivstar is 30,6%. Nowadays, Telenor Group is the biggest investor in
telecommunication industry of Ukraine, which makes up to 7% of national GDP. Telenor has
purchased internet provider and a share in Ukrainian Telecommunication Systems.
Total Telenor investments in Kyivstar reached more than USD 2 billion. Company continues
its expansion at the Ukrainian market offering new products for the customer and enchasing the quality
of telecommunication industry. The biggest barrier for Telenor at the Ukrainian market was, of course,
non-transparency of legal and regulatory system.
Nowadays the industry is in a strong competition, however M&A at the
market are very possible in the next couple of years.
59
CHAPTER 4. Recommendation s to investors
The interest to what is going on in Ukraine now – is very high. The most
perspective branches from investor’s perspective are metallurgy, chemical industry,
agriculture and electricity. Today many national companies are undervalued
comparing to foreign players from developed economies.
Figure 20 Structure of M&A in Ukraine in 2007, percent
2%
4%
1%
Metallurgy
30%
48%
Insurance
Banking
Machine
building
FMCG
15%
Source: Kontrakty № 05, 2008
In 2008 Ukrainian metallurgical enterprises cheapened in 1.5 - 2 times
comparing to their western neighbors. This is a big chance for foreign investors.
Market of M&A will be very rich next couple of years. The locomotive of M&A in
2009 might be also the sale of national objects.
Figure 21 Volume of M&A in Ukraine, billions of USD
9.5
8.5
7.5
6.5
5.5
4.5
3.5
2.5
1.5
0.5
14.5
20
7.7
4.9
2005
2006
2007
2008
Source: Kontrakty № 05, 2008
The volume of M&A activity in Ukraine is very high. Investors prefer to buy
60
the company that obtained a permanent share in the market and has good
opportunities, instead of starting in the competitive area from scratch. Figure 21
reflects the volume of M&A market in Ukraine. The country has the largest consumer
market in Europe. The biggest activity of foreign investors is expexted in the branches,
directed to individual consumption – foodstuff, light industry, agriculture. Moreover,
according to the Law of Ukraine “About special economic zones” the priority
industries in Ukraine are agriculture, food industry, FMCG and high-technical
production. Still, investment level will depend on political and economical stability in
the country, pespectives of development in future 1-2 years as well. Most obvious,
investments will reach the peak in autumn. Foreign companies, which exist in the
market, will try to extend their presence through buyout of competitors or close to
their activities productions. Very interesting for investors are big agricultural holdings,
which posses big areas (30-40 thous. ha ) and industrial possibilities. Potential
investors for Ukraine in 2009 are French and Dutch. Ukrainian food industry is very
attractive for Russians, but they don’t have enough resources right now. Middle-size
retail networks with developed sales system are very interesting for foreigners.
Crisis gives a time to think, and, maybe to get richer. A rich for investments
might be next couple of years for farmaceutical industry (InvestGazeta № 1-2, 2009).
In the crisis period very attractive become IT-services and telecommunications.
Before investing, businessmen have to check the following things:
Regular times
 Market development forecast for 3-5 years , potential firm’s share in the future
 Forecast of profitability of the company, it’s value after 5 years
Crisis times
 The value of firm’s assets
 The existence of debts
 Volume of required financing, managing of the company
The usual sum of investment in one company is USD 10-50 million for the term of 35 years (InvestGazeta № 5, 2009).
Table 16 is a short summary of the branches and guide for investors what to
do in Ukrainian market
61
Table 16 The branches of Ukrainian industry, their development and forecast.
№ Industry
1
2
3
4
Agriculture
Food industry
Pharmaceuticals
Metallurgy
5
Chemical
industry
Machine building
Retail
Transport
Construction
6
7
8
9
10 Fin.
Intermediation
11 Light industry
20002007




20082009




20102012




20132015
































Investment strategy
Invest now
Invest now
Invest now
Buy cheap and wait till end
2009
Wait until autumn 2009
Invest after 2010
Buy cheap
Wait till 2010-2012
Buy cheap and wait till
2012
Buy cheap and wait till
2010
Wait
 - the branch is developing, growing and yields high profits
 - the branch is stagnated, in debt, not attractive for investor
 - there is neither positive nor negative trends in the branch, the profit is ambiguous.
Where to invest? Branches as retail, construction, and financial intermediacy
gravitate to developed infrastructure and social-economic development of the region.
Thus it’s preferable to invest in TOP attractive regions for investing (Table 12): Kyiv,
Ivano-Frankivsk, Dnipropetrovsk, Kharkiv. Agriculture is connected to fertile land
plots, or to the least attractive, agriculture regions. These are last 7 regions in rating:
Khmelnitsky, Kirovograd, Ternopil, Chernigiv, Sumy, and Kherson. Food, light and
pharmaceutical industries are not bound to the source or market, but rather to labor
force. This production is preferable to locate in regions where there is enough of
workforce and it is cheap: thus, the last twelve regions in the table can fit to the
investing. Metallurgy, machine building, some part of Transport industry and chemical
industry gravitate to cheap resources. They are located only where the sources allow:
mostly east south of the country, and some of them on the west. These are:
Dnipropetrovsk, Donetsk, Kharkiv, Odessa, Ivano-Frankivsk.
Conditions for FDI in Ukraine are not perfect, thus investor have to rely on
his wit. Foreigners have to follow some recommendations:
o
Involve all decision-making levels
62
The difficulties with investment process are connected with different level
authorities. Thus, it is very important to establish good relationships with various
decision-making authorities, which are involved in transaction and keep in
contact with all of them throughout the investment process.
o
Always perform professional due diligence
Ukraine has a lack of disclosure rules and inadequate local accounting standards.
Therefore, it is necessary to perform due diligence involving reliable legal and
audit firms. It is often a difficult process, while management of the target
company might not want to open their real books. Investor has to get to know the
company as soon as possible.
o
Consider choosing a local partner
It is often wise to enter the new market with a local partner – for example, a
local investment or trading group. Long–term relationships between
entrepreneurs, companies, and regional administrations are very important
(Business in Ukraine).
63
Conclusion
This paper is an attempt to follow and forecast FDI in Ukraine during
transition period. I analyzed the state of FDI in Ukraine, described the areas of
investing, discussed barriers for them and gave a short forecast for investors. Deriving
from my empirical research I made the following conclusions:
1. Ukraine performed a big job on the conversion from planned to market
economy. The shift changes have passed and the economy transferred from
chaotic to more-or-less developed State.
2. Foreign Direct Investment in Ukrainian economy are held without state
program and support, this remains investment bazaar. Investment barriers that
exist in Ukraine are unprecedented for a European country. Seems that, thank
to this mess in Ukraine someone can achieve big profits. Thus, the decisions,
necessary for complete transition are not implemented.
3. The rise of interest to Ukraine during last couple of years proves that country is
reliable place to invest money. The sky-high profits, huge market, great
existence of resources, skilled labor and low competition - are the driving
forces for investors.
4. There are many unfilled niches in Ukrainian economy. Around 2000
enterprises in Ukraine need investment on a total amount of USD 50 billions.
To develop fast until 2015 we need USD 50 billions more; to catch up with
United States development – USD 3 trillions.
5. A bunch of branches of Ukrainian economy are very attractive: agricultural
sector, metallurgy, food industry, machine building. Due to crisis 2008 many
objects become very cheap and thus create additional interest for investors.
6. The results of the work are consistent with academic theories and conclusions
of studies regarding FDI barriers and determinants.
7. Gradual integration of Ukraine in capitalistic society and availability of natural
and human resources open big perspectives for the country in future.
64
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Appendixes
Appendix 1. Sovereign ratings, explanation table
Standard&Poors
Fitch
Aaa
AAA
AAA
Aa1
AA+
AA+
Aa2
AA
AA
Aa3
AA-
AA-
A1
A2
A3
Baa1
A+
A
ABBB+
A+
A
ABBB+
Baa2
BBB
BBB
Baa3
Ba1
Ba2
Ba3
B1
B2
B3
Caa1
Caa2
Caa3
ca
BBBBB+
BB
BBB+
B
BCCC+
CCC
CCCCC
BBBBB+
BB
BBB+
B
BCCC+
CCC
CCCCC
C
Selective Default
C
SD
C
SD
Default
D
Junk Grades
Investment Grades
Moody's
Source: Institute of reforms http://www.ir.org.ua/
Appendix 2. Selective countries ratings and appraisals
Table 1. Selected CEE countries, sorted by external debt/GDP, 2008
73
Table 2. Selected rating- per countries economic data for 2008, sorted per GDP
per capita
Source: Phoenix Capital Investment Bank www.phoenix-capital.com.ua
Note. Depressed economies coloured in red.
The ratings imply that Ukraine is in the same position as Pakistan with the worst world risk. Some of the countries
are involved in armed conflict, some have very poor economic.
Appendix 3.EMBI Global Annual Spreads and Standard and Poor’s Credit
Ratings
* The graph reflects countries position in the EMBI Global Index against S&P credit ratings (1 corresponds to AAA, 23 to SD).
Higher position reflects lower credit worthiness.
** The J.P.Morgan Emerging Markets Bond Index Global ("EMBI Global") tracks total returns for traded external debt
instruments in the emerging markets. It includes U.S.dollar-denominated Brandy Bonds loans, and Eurobonds with an
outstanding face value of at least $500 million.
Source: Borri, N., & Verdelhan, A. (2008, 12 ). “Sovereign Risk Premia”. Boston.
74
Appendix 4. Gross external debt position of Ukraine, Millions of USD
Source: National Bank of Ukraine
75
Appendix 5. Currency reserves and Foreign Debt
Source: Deutsche Bank Research
Appendix 6. Investment barriers in Ukraine
Table 1. Risk impact by investment type
Risk Category
Economic
Transfer
Exchange
Location
Sovereign
Political
Direct
investment
Private Sector
High
Moderate
High
High
Low
High
Short term
Financial
Private Sector
Low
High
None to High
Moderate
Low
Low
Short tem Loan
Long term Loan
to Government
Low
High
None to High
Low
High
Moderate
to Government
Low to Moderate
Moderate
High
Moderate
High
High
Source: “Country Risk and Foreign Direct Investment” Duncan H. Meldrum Business Economics , Jan, 2000
Table 2.Comparison of Barriers to Business Development, 2000-2002, % of firms
citing factor as a major or significant obstacle
Issue
Taxation
Unstable Legislation
Anti-Competitive Practices
Political Instability
Corruption
Inflation, Economic Instability
Regulatory Environment
Obtaining external Finances
Lack of Skilled Labor
Local Authorities Interference in Business Activities
General Government Authorities Interference
In Business Activities
Criminal Pressure
2002
70
69
56
51
51
48
43
41
41
40
35
2001
70
63
45
40
39
45
38
42
41
23
19
2000
83
n/a
53
n/a
46
65
44
24
n/a
24
n/a
26
13
15
Source: IFC, Business Environment in Ukraine 2003
76
Table 3. Deterrents for Companies Investing in Ukraine
Rank
1
2
3
4
5
6
7
8
9
10
11
Problem
Total
1.03
1.21
1.27
1.34
1.46
1.56
1.69
1.79
1.82
2.09
2.16
Instability and exorbitance of regulations
Ambiguity of the legal system
Uncertainty of the economic environment
Corruption
High tax burden
Problems establishing clear ownership conditions
Depressed disposable income levels
Difficulty negotiating with government and privatization authorities
Volatility of the political environment
Lack of physical infrastructure
Problems in accessing domestic and export markets
“major reason”=1; “minor reason”=2; “not a reason”=3
Source: Flemings/SARS survey
Table 4. Motives for Companies Investing in Ukraine
Rank
1
2
3
4
5
6
7
8
Problem
Market size and potential for market growth
Access to a new regional (Central/Eastern Europe, CIS) market
Skill of labor force
Availability of low-cost inputs (e.g., cheap labour; energy; raw materials)
Production capacities
To improve competitiveness in supplying established markets (Europe)
Tax incentives
A chance to access research and technological expertise available in Ukraine
“major reason”=1; “minor reason”=2; “not a reason”=3
Total
1.05
1.92
2.15
2.27
2.32
2.53
2.69
2.71
Source: Flemings/SARS survey
Appendix 7. Bribes as a Percentage of Firm Revenues in Transition Economies
Source : J. Hellman, G. Jones, and D. Kaufmann “Are Foreign Investors and Multinationals Engaging in Corrupt Practices in
Transition Economies?” The World Bank/The William Davidson Institute/Stockholm Institute for Transition Economies, JuneJuly 2000
77
Appendix 8. Paying Taxes in Ukraine
Source : World Bank, Doing Business 2009
Appendix 9. The duration of inspections in Ukraine
Source: IFC, Business Environment in Ukraine 2009
78
Appendix 10. EXPY to GDP per capita, 2003
Rule: The higher to the top right corner is the country – the higher quality of the exported goods is.
Source: Hausmann, Hwang, J., & Rodrik, D. (2005). What You Export Matters. BREAD Working Paper , 108.
Appendix 11. Matrix of inward FDI performance and potential 2006
79
Appendix 12. Ukraine's ranking in Doing Business 2009
Source : Doing Business 2009,World Bank
Appendix 13. Ukraine’s Economic Freedom Score
Source: Index of Economic Freedom, Heritage Foundation
80
Appendix 14. The Global Competitiveness Index
Source:WEF, Glebal Competitivenness Report 2009
81
Appendix 15. List of Procedures to start a business in Ukraine
1. Notarize company charter and execute premises (if
needed)
2. Open a bank account for initial capital
3. Pay registration fee at the bank
4. Register at the Registration Office
5. Register at the State Statistics Committee
6. Register VAT at the State Tax Authority and obtain a
VAT number
7. Approval of Ministry of Internal Affairs to prepare a
company seal
8. Prepare a seal
9. Open a permanent bank account
10. Notify the District Tax Inspectorate of the opening of
the permanent bank account
Source: IFC, Business Environment in Ukraine 2009
Appendix 16. Countries investors to Ukraine, 1996-2008, millions of USD
Source:State Statistics Committee of Ukraine
82
Appendix 17. Political and governmental historical data of Ukraine.
Prime ministers of Ukraine
Prime-minister
Term of governing
Yushchenko V.
12’ 1999 – 05’ 2001
Kinakh Y.
05’ 2001- 11’ 2002
Yanukovych V.
11’ 2002 – 01’ 2005
Azarov M.
01’ 2005
Tymoshnko Y.
01’2005 – 09’ 2005
Yehanurov Y.
09’ 2005 – 08’ 2006
Yanukovych V.
08’ 2006 – 12’ 2007
Tymoshnko Y.
12’ 2007 – until now
Parliament elections in Ukraine
Political Party
Party of regions (Yanukovych ), E
BYT (Tymoshenko) W
Our Ukraine (Yushchenko) W
Communist Party
2002
7,26 %
23,57%
19,98%
Orientation
W
E
E
E
W
E-W
E
W
2006
32,14%
22,29%
13,95%
4%
2007
47%
26%
17%
5%
83