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

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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..............................................................................................................72

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

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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

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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

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FDI

Infrastructure MNC Distribution

SalaryTaxes

Budget

Social paymentsFurther development

qualified labor force: engineers and economists. Moreover, export-oriented MNC rise

export profits of the country.

Figure 1 Multiplication effect of FDI

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.

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Table 1 Foreign Direct Investment Theories

Macro theories Micro theories

Theory/hypothesis Authors Theory/hypothesis Authors

Theories of Industrial Organization

Theories of Industrial

organization

Hymer (1960, 1968, 1976) Caves (1971, 1974) Teece (1981, 1992)

McCullough (1991)

Theories of the Firm

Product cycle Vernon (1966), Hirsch (1967), Vernon (1979), Buckley

and Casson(1976)Transaction Related

Coase (1937) Buckley and Casson (1976) Williamson (1975, 1979)

Rugman (1981) Hennart (1982, 2000) Hill and Kim (1988) Prahalad

and Doz (1987) Bartlett and Ghoshal (1989)Doz, Awakawa, Santos

and Williamson (1997)

Internationalization

process

Johanson and Vahlne(1977, 1990), Eriksson, et al.

(1997)

Resource based/Raw

materials

Penrose (1958) Wenerfelt (1984) Nelson and Winter (1982) Cantwell

(1989, 1994) Teece, Pissano and Shuen (1997)

Strategy related (and

Oligopolistic

production)

Vernon (1966) Knickerbocker (1973) Graham (1975) Flowers

(1976) Vernon (1982) Hostman and Markusen (1987) Graham

(1990, 1998)

Option theory Kogut and Kulatilaka 1994) Rivoli and Solaria 1996) Casson (2000)

Internalisation Buckley and Casson (1976)

Theories of Trade

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Macro (country

oriented)

Kojima (1973 to 1982) Helpman (1984, 1985) Markusen

and Venables (1998) Micro (firm oriented)

Vernon (1966), Hirsch (1976), Ethier (1986), Batra and

Ramachandran (1980), Gray (1982, 1999), Markusen (1984, 1995,

1998)

Theories of Location

Theory of location

(General)

Vernon (1966), Vernon (1974), Hirsch (1967), Dunning

(1972), Root and Ahmed (1979), Davidson (1980),

Lipsay and Kravis (1982), Krugman (1991, 1993) Clustering and

agglomeration

Enright (1991, 1998), Porter (1998), Audretsch (1998), Chen and

Chen (1998), Head, Ries, and Swenson (1995), Markusen and

Venables (2000)

Internationalization Johanson and Vahlne (1977, 1990), Schneider and Frey

(1985), Welch and Luostarinen (1988) Knowledge enchasing

Cohen and Levinthal (1990), Levinthal (1990), Kogut and Zander

(1992, 1994), Nonaka (1994), Porter (1994, 1998), Dunning (1995,

1997), Kuemmerle (1999)

Market size Stevens (1969), Kwack (1972), Schwartz (1976) Output Stevens (1969), Kwack (1972), Schwartz (1976)

Exchange rate

/currency area

Aliber (1971), Cushman (1985), Culem (1988), Froot

and Stein (1991), Rangan (1998)Spatial transaction cost Florida (1995), Scott (1996), Storper and Scott (1995)

Taxes, subsidies and/or

tariffs and incentives

Hines (1996), Devereux and Griffith (1996), Haufler and Wooton

(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) efficiency-

seeking, and 4) strategic asset or capabilities seeking (Pawlik, 2005).

oResource-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.

oEfficiency-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

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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).

oStrategically-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:

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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

Exchange rate

Aliber (1970), Cushman (1985), Froot and Stein (1991), Bloningen (2005,1997), Rangan (1998), Aliber (1970), Klein and Rosengren (1994) Gopinath et al. (1998), Stevens (1998), Seo et al. (2002), Campa (1993), Jordaan (2004), Bende-Nabene and Ford (1998), Wand and Swain (1995)

Inflation Schneider and Frey (1985), Asiedu (2002), Chakrabarti (2001), Jenkins and Thomas (2002), Wand and Swain (1995)

Liquidity Stevens (1969), Stevens (1972)

Financial Market

King and Levine (1993), Beck et al. (2000), Levine et al. (2000), Wurgler (2000), Carkovic and Levine (2003), Hermes and Lensink (2000), Alfaro et al.(2004), Yao and Wei (2007)

Cost of capital Popkin (1965), Hufbauer (1975), Agarwal (1980), Van der Walt (1997), Jordaan, (2004), Alfaro et al.(2004), Hirshman (1958)

Corruption

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), Rose-Ackerman (1975, 1999), Shleifer and Vishny (1993), Braguinsky (1996), Huntington (1968), Leff (1964), Rashid (1981), Egger and Winner (2006), Andersson (2002)

Tax barriers

Clark (2000), Boskin and Gale (1987), Hartman (1984), Newlon (1987), Bloningen (2005), Jordaan (2004), Loree and Guisinger (1995), Wei (2000), Chakrabarti (2003), Gastanaga et al. (1998), Wheeler and Mody (1992), Lipsey (1999), Veugelers (1991)

InstitutionsBloningen (2005), Henisz (2000), Meyer (2001), Bevan et al. (2004), Yiu and Makino (2002), Oxley(1999), Peng (2000), Brenton et al.(1999), Azzimonti and Sarte (2007)

Political instability

Rugman (1979), Agmon and Lessard (1977), Lessard (1982), Rivoli and Salorio (1996), Rangan (1998), Clark, (2000), Estrin and Bevan (2000), Jun and Singh (1996), Root and Ahmed (1979), Lucas (1990), Azzimonti and Sarte (2007), Jordaan (2004), Daude and Stein (2001), Loree and Guisinger (1995), Jaspersen, et al. (2000), Ok (2004)

Legal and Regulatory uncertainty

Drabek and Payne (1999), Clark (2000), Guislinger (1992), Bajorubio and Sosvilla-Rivero (1994), Lee and Mansfield (1996), Borensztein et al.(1998)

Openness, international orientation

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), Ancharaz (2003), Asiedu, (2001), Razin (2002), Lipsey (1999), Tsai (1994), Kreuger (1975), Greenaway and Nam (1988), Yao and Wei (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)Trade effects Grubert and Mutti (1991), Kogut and Chang (1996), Blonigen (1997),

Belderbos (1997), Figlio (1999), Head and Ries (2004), Swenson (2004), Morissey and Rai (1995), Bajorubio and Sosvilla-Rivero (1994), Wand

9

and Swain (1995), Brainard (1997)Infrastructure

qualityAsiedu (2001), Ancharaz (2003), Loree and Guisinger (1995), Wheeler and Mody (1992), Kumar (1994)

Market size

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)

Labor cost

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)

Growth

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)

Development Romer (1986, 1987), Lucas (1988), Kosack and Tobin (2006), Markusen (2002), Nunnenkamp (2004).

Technology diffusion

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. Bende-

Nabende 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 re-

conquered 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 2003-2008Credit Rating 2003 2004 2005 2006 2007 2008Standard & Poor’s B B B+ BB BB CCC+Moody's B2 B1 B1 B1 Ba3 B1Fitch B+ B+ B+ BB BB 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 GradesHungary BBB (S&P)Poland A2 (Moody’s)

Junk Grades

Russia Baa1 (Moody’s)Ukraine B1 (Moody’s)Romania BB+ (S&P)Belarus 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

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.

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)**

Hungary 44 47 62 41 4Poland 82 58 53 43 2

Romania 65 70 68 69 3Russian

Federation 146 147 51 20 4

Ukraine 152 134 72 44 7Belarus 167 151 - 48 7

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. Macroeconomical2. Financial3. Corruption 4. Tax5. Institutional6. Political7. Legal & Regulation8. Trade9. Infrastructure10. Market11. 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

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 20080.00

500.00

1000.00

1500.00

2000.00

2500.00

3000.00

3500.00

4000.00

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

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

-26%

-20%

-14%

-8%

-2%

4%

10%

Belarus

Hungary

Poland

Romania

Russia

Ukraine

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

2002 2003 2004 2005 2006 2007 2008 2009

-3.50%

-3.00%

-2.50%

-2.00%

-1.50%

-1.00%

-0.50%

0.00%

0.50%

1.00%

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 2009Refinancing 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 Rate32.3

% 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

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 20090

2

4

6

8

10

12

USD

EURO (until 1999 ECU)

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

marts 2000 marts 2001 marts 2002 marts 2003 marts 2004 marts 2005 marts 2006 marts 2007

0

20

40

60

80

100

120

140

160

180

200

Euro

Dollar

Source: Interntional Monetary Fund

First, Ukrainian Hryvnya was appreciated, and then financial crisis 2008-

2009 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

0

10

20

30

40

50

60

70

80Ukraine

CIS

Europe

Emerging and Transition economies

Source: EconStat

2000 is characterized as a year of successful foreign debt restructuring and

26

stabilization of inflation (Figure 7). Subsequent years were stable with moderate level

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 non-

economic 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 Documents for export (number)

Time for export (days)

Cost to export (USD per container)

Documents for import (days)

Time for import (days)

Cost to import (USD per container)

Ukraine 6 31 1230 10 36 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

31

quotas to grain exporters, raising substantial profit. This fraud cost legitimate grain

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  2001 2002 2003 2004 2005 2006 2007 2008Trade balance 0.198 0.71 -0.269 3.741 -1.135 -5.194 -8.152 -14.52Merchandise exports

17.091

18.669

23.739

33.432

35.024

38.949

64.001 85.612

Merchandise imports

16.893

17.959

24.008

29.691

36.159

44.143

72.153

100.132

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

19921993199419951996199719981999200020012002200320042005200620072008

-15

-10

-5

0

5

10

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

32

country the more open it should be. Say, Singapore had the degree of openness 2.9 in

1996, while Brazil only 0.160 and world average was 0.436.

Table 10 The degree of openness of the Ukrainian economy 2001-20082001 2002 2003 2004 2005 2006 2007 2008

0.894 0.864 0.952 0.973 0.826 0.780 0.969 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

2000 2001 2002 2003 2004 2005 2006 20070.00

1.00

2.00

3.00

4.00

5.00

6.00

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

2000 2001 2002 2003 2004 2005 2006 2007 2008 20090

50

100

150

200

250

300

350

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.

MarketWith 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.

We can see, that the most monopolized are Electricity and Metallurgy

34

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

Electricity and Metalurgy

Chemical

Mashinery

Timber and Paper Ind.

Wood working

Construction

Light Industry

Food Industry

0 0.1 0.2 0.3 0.4 0.5 0.6 0.7

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 UkraineYear/ Facto

r

EXC INF FIN CO

RTAX

POLI

LEG

TRA

INFR

LAB

GRO FDI

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.

1 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)

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

19941995199619971998199920002001200220032004200520062007200820090.00

5.00

10.00

15.00

20.00

25.00

30.00

35.00

Ukraine

CIS

Europe

Emerging and Develop-ing economies

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

19941995

19961997

19981999

20002001

20022003

20042005

20062007

2008200

0.000

5.000

10.000

15.000

20.000

25.000

30.000

35.000

40.000

45.000

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

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 1Q

0.50

1.50

2.50

3.50

4.50

5.50

6.50

7.50

8.50

9.50

0.60 0.77 0.69

1.411.72

7.81

5.60

9.89 10.69

1.18

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

6.05.0

20.0

20.08.07.0

7.0

16.4

3.6

3.6 3.4Russia USA

Cyprus Germany

Netherands Austria

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 pro-

eastern 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 - 20081 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 high-

technological 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

Post-communist state, revolution in 1990Slow privatizationGovernment is oriented on attracting FDI Russian Financial crisis slumped economyCountry strives with inflation and corruption Invitation to join EU EU Ascension, political disputs inside the countryPartial development and FDI growth

Painful transition, economic slowdownGDP growth has decreased, rise of inflationStandby agreement with IMFNegative effect of russian Financial crisisSecond standby agreement with IMFGDP positive growth, inflation decreasesThird standby agreement with IMFInvitation to join EU, joining NATO, 55% of industrial assets are privatizedEU Ascension in 2007 , low labor cost brought massive FDI

1992 reforms launched, hovewer recession deepensFurther decline, GDP decline, inflationSlow recovery signsFirst GDP growth, FDI riseFinancial crisis, deep recession, coutry’s defaultStabilization of inflation, slight GDP growthVast privatization, the transport system reformation. Huge FDI inflowSeveral terracts, unsafety, FDI shrinksPolitical and Economical stabilization, rise of FDI

In 1994 autoritarian president was elected, who remains on the post until nowSeveral EBRD projects was stopped by the President Economy is in poor state, goods are non-compatibleGovernment new program: FDI rise from 19% to 26%of GDP. Investor - Russia6 free econ. zones created with investors; Poland, Russia, and Germany, USASeveral state- owned enterprise was privatizedPresident rejects USD 10 bil. FDI because of „unacceptable terms“The country is still in economical isolation

Belarus

Slump economy, reforms begun in 1991Stabilization plan, Joining NATOIMF loan, massive FDI come to country Stabilization plan bore fruits – loan repaid Invitation to join EU, the most advanced candidate EU AscensionSubsequent development and FDI growth

Hungary

Rom

aniaPoland

Russia

Troubles of transition, hyperinflation, black market accounts to 60% of GDPVast privatization launchedSeveral free economic zones are createdRussian Financial crisis caused technical defaultStrive with economy slump brought first resultsDebt is restructured, economy achieves FDIFurther economic growth, currency stabilization, Dollar peg„Orange Revolution“. The Political elite shift bring enormous FDIPolitcal instability decreases FDI, but the tendence remains growing

Ukraine

Table 13 The transition path of selected countries 1991-94 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 -…

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

19911992

19931994

19951996

19971998

19992000

20012002

20032004

20052006

20072008

0.000

0.100

0.200

0.300

0.400

0.500

0.600

0.700

0.800

0.900

HungaryPolandRussiaBelarusRomaniaUkraine

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

HungaryPoland

RussiaRomania

BelarusUkraine

0

50

100

150

200

250

63.48

132.5

251.279

53.61

6.835741.929

per country

Hungary Poland Russia Romania Belarus Ukraine

0.000

2.000

4.000

6.000

8.000

10.000

6.323

3.488

1.777

5.589

0.318 0.916

per capita

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

Sector Hungary 2008

Poland 2006

Romania 2007

Russia 2008

Belarus 2008

Ukraine 2008

Manufacturing 36% 23.7% 32.9% 35% 42.9% 27.6%Electricity 5% - 3% 4.5% - 0.5%Services - - - - 29.8% -Financial interme-diation, insurance 12.3% 11.2% 23.3% 4.3% - 16.3%

Transport and Communication 11 % 8% 6.5% 3% - 4.3%

Wholes. and retail trade, repairing - 14.2% 14% 23.6% 8.5% 10.4%

Real estate, construction 20 % 32% 7.8% 17.5% - 14.1%

Other 15.7 % 10.9% 12.5% 12.1% 18.8% 26.8%Total 100% 100% 100% 100% 100% 100%

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

Romania 2007

Russia 2007

Belarus 2008

Ukraine 2008

Germany 25% 18% 11.7% 10.63% - 20%Cyprus - - 4.7% 24.92% 8.5% 20%UK 3% 8% - 19.95% 10.9% 7%France 5% - 8.8% 8.27% - 3.6%Netherlands 14% 9% 16.3% 14.51% - 8%Luxemburg 6% 24% - 10.20% - 1%Switzerland 1% - 5.1% 3.81% 18.8% 2%Virginians 2% - - 4.30% - 3.6%Russia 1% - - - 33.2% 6%Austria 13% - 21.40% - - 7%Greece - 9% 7.5% - - 0.5%Italy 2% 7% 6.1% - - 0.5%Spain - 7% - - - -Sweden - - - - - 3.4%Poland - - - - - 2%Hungary - - - - - 2%EU-15 79% 82% 82% 96% 78%USA 5% 4% 1.4% 3.42% 6.8% 5%Other 23% 14% 11.9% 0.00% 21.8% 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

5.3%3.9%

5.7%

3.6%

10.4%16.3%4.3%

22.3%

8.6%5.5%

1.9%

3.6%0.5%

by percentage Food Industry

Chemical and oil industry

Metalurgy

Machine Building

Trade

Financial services

Transport and communication

Other sectors

Real estate operations

Constructing, engineering

Agriculture

Extractive industry

Light industry

5.571

81.38

16.19230.564

47.939

25.506

4.266 12.769

by billions of USDAgriculture

Industry

Constructing, engineering

Trade

Financial services

Real estate operations

HoReCa

Communication

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 wagon-

building 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

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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 semi-

manufactured 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

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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.

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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 40-

60 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", 18 th 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 supply-

distribution 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. Recommendations 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

48%

15%

30%

4% 2% 1%

Metallurgy

Insurance

Banking

Machine building

FMCG

Other

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

20052006

20072008

0.5

1.5

2.5

3.5

4.5

5.5

6.5

7.5

8.5

9.5

7.7

4.9

14.520

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 3-

5 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.

- 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

The difficulties with investment process are connected with different level

№ Industry 2000-2007

2008-2009

2010-2012

2013-2015

Investment strategy

1 Agriculture Invest now2 Food industry Invest now3 Pharmaceuticals Invest now4 Metallurgy Buy cheap and wait till end

20095 Chemical

industry Wait until autumn 2009

6 Machine building Invest after 20107 Retail Buy cheap8 Transport Wait till 2010-20129 Construction Buy cheap and wait till

201210 Fin.

Intermediation Buy cheap and wait till

201011 Light industry Wait

62

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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Черкас Н. А., 2006,Прямі іноземні інвестиції, як чинник розвитку технологічного сектору економіки, Львівська комерційна Академія/ Cherkas N.I., 2006, Foreign Direct Investment as a catalyst for technologicalsector of economy, Lviv Commerce Academy

Internet sites, news, reports, statistical information AAA consulting agency (news) -http://www.aaa.com.ua/ A. T. Kearney, global management consultants - http://www.atkearney.com/ Business Environment in Ukraine 2003, International Finance Corporation – The

World Bank Group http://www.ifc.org/ Business Environment in Ukraine 2007, International Finance Corporation – The

World Bank Group http://www.ifc.org/ Business in Ukraine -http://biz-in-ua.com/n/79

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Business Portal (news, companies information)- www.liga-net Business Portal (news)- www.biznes-ukraina.ua/ Doing Business 2009. The World Bank. http://web.worldbank.org/ Transparency International. 2007. Global Corruption Report 2007-

http://www.transparency.org/publications/publications Economic blog - http://www.financehub.ru/ Ernst & Young. (2007). Doing Business and investing in Ukraine 2007 -

http://www.ey.com ErsteBank Ukraine (company information) - www. erstebank .ua/ Eurochem Ukraine (company information) - http://www.dobriva.com.ua/ Federal State Statistic Service http://www.gks.ru/bgd/regl/b08_06/Main.htm Financial Times - www.ft.com Flemings/SARS Consortium, Report “The Legal and Economic Environment for

Foreign Direct Investments in Ukraine” - http://biz-in-ua.com/ Heritage Foundation. 2009. Index of Economic Freedom -

http://www.heritage.org/Index/Ranking.aspx Hungarian investment and trade developing agency

http://www.itdh.com/engine.aspx?page=Itdh_Foreign InBev Ukraine http://www.suninterbrew.ua/ Institute of reforms http://www.ir.org.ua/ Investment Portal (news) - www.investor.ua Konnov & Sozanovsky, attorneys at law - http://konnov.com/ Magazine Business - http://www.business.kiev.ua/ Magazine Kommersant -www.commersant.ua/ Magazine Korrespondent - www.korrespondent.net National bank of Poland http://www.nbp.pl/en/publikacje/ziben/ziben2007n.pdf National Bank of Romania

http://www.bnro.ro/files/d/Pubs_en/temp/E20081107fdi.pdf National Statistical Committee of the  Republic of Belarus

http://www.belstat.gov.by/ Nestle Ukraine (company information)- www.nestle.com.ua News portal -www.rbk.ua Newspaper InvestGazeta -http://www.investgazeta.net/ Country Risk Classification – 2009, OECD,

http://www.oecd.org/dataoecd/47/29/3782900.pdf Official promotional website of the Republic of Poland http://www.poland.gov.pl/?

document=468 Phoenix Capital Investment Bank www.phoenix-capital.com.ua Polish Information and Foreign Investment Agency http://www.paiz.gov.pl/index/?

id=d2ddea18f00665ce8623e36bd4e3c7c5 PricewaterhouseCoopers, EM20 Index, Emerging markets: Balancing risk &reward,

June 2008 Promoting FDI in emerging markets, www.FDI.net Smart Money, magazine http://www.smoney.ru/article.shtml?2008/11/17/7202 The Encyclopedia of the Nations http://www.nationsencyclopedia.com/ Trigon Agri (company information) - http://www.trigonagri.com/ - Ukraine risk: Risk overview, EIU Riskwire - Overview, The Economist Intelligence

Unit Limited New York, 2006 UNCTAD -http://www.unctad.org/Templates/WebFlyer.asp?

intItemID=2472&lang=1 Global Competitiveness Report - 2009, World Economic Forum,

http://www.weforum.org/en/initiatives/gcp/Global%20Competitiveness%20Report/index.htm

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Appendixes

Appendix 1. Sovereign ratings, explanation table

Moody's Standard&Poors Fitch

Inve

stm

ent G

rade

sAaa AAA AAAAa1 AA+ AA+Aa2 AA AAAa3 AA- AA-A1 A+ A+A2 A AA3 A- A-Baa1 BBB+ BBB+Baa2 BBB BBBBaa3 BBB- BBB-

Junk

Gra

des

Ba1 BB+ BB+Ba2 BB BBBa3 BB- BB-B1 B+ B+B2 B BB3 B- B-Caa1 CCC+ CCC+Caa2 CCC CCCCaa3 CCC- CCC-ca CC CCC C C

Selective Default SD SDDefault   D  

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

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Table 2. Selected rating- per countries economic data for 2008, sorted per GDP per capita

Source: Phoenix Capital Investment Bank www.phoenix-capital.com.uaNote. 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.

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Appendix 4. Gross external debt position of Ukraine, Millions of USD

Source: National Bank of Ukraine

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Appendix 5. Currency reserves and Foreign Debt

Source: Deutsche Bank Research

Appendix 6. Investment barriers in Ukraine

Table 1. Risk impact by investment type

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 obstacleIssue 2002 2001 2000Taxation 70 70 83Unstable Legislation 69 63 n/aAnti-Competitive Practices 56 45 53Political Instability 51 40 n/aCorruption 51 39 46Inflation, Economic Instability 48 45 65Regulatory Environment 43 38 44Obtaining external Finances 41 42 24Lack of Skilled Labor 41 41 n/aLocal Authorities Interference in Business Activities 40 23 24General Government Authorities InterferenceIn Business Activities

35 19 n/a

Criminal Pressure 26 13 15Source: IFC, Business Environment in Ukraine 2003

Risk Category

Direct investment

Short term Financial Short tem Loan Long term Loan

Private Sector Private Sector to Government to GovernmentEconomic High Low Low Low to ModerateTransfer Moderate High High Moderate

Exchange High None to High None to High HighLocation High Moderate Low ModerateSovereign Low Low High HighPolitical High Low Moderate High

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Table 3. Deterrents for Companies Investing in Ukraine

Rank Problem Total1 Instability and exorbitance of regulations 1.032 Ambiguity of the legal system 1.213 Uncertainty of the economic environment 1.274 Corruption 1.345 High tax burden 1.466 Problems establishing clear ownership conditions 1.567 Depressed disposable income levels 1.698 Difficulty negotiating with government and privatization authorities 1.799 Volatility of the political environment 1.8210 Lack of physical infrastructure 2.0911 Problems in accessing domestic and export markets 2.16“major reason”=1; “minor reason”=2; “not a reason”=3

Source: Flemings/SARS survey

Table 4. Motives for Companies Investing in Ukraine

Rank

Problem Total

1 Market size and potential for market growth 1.052 Access to a new regional (Central/Eastern Europe, CIS) market 1.923 Skill of labor force 2.154 Availability of low-cost inputs (e.g., cheap labour; energy; raw materials) 2.275 Production capacities 2.326 To improve competitiveness in supplying established markets (Europe) 2.537 Tax incentives 2.698 A chance to access research and technological expertise available in Ukraine 2.71“major reason”=1; “minor reason”=2; “not a reason”=3

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, June-July 2000

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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

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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

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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

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Appendix 14. The Global Competitiveness Index

Source:WEF, Glebal Competitivenness Report 2009

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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

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Appendix 17. Political and governmental historical data of Ukraine.

Prime ministers of Ukraine

Parliament elections in Ukraine

Political Party 2002 2006  2007

Party of regions (Yanukovych ), E - 32,14% 47%

BYT (Tymoshenko) W 7,26 % 22,29% 26%

Our Ukraine (Yushchenko) W 23,57% 13,95% 17%

Communist Party 19,98% 4% 5%

Prime-minister Term of governing OrientationYushchenko V. 12’ 1999 – 05’ 2001 WKinakh Y. 05’ 2001- 11’ 2002 EYanukovych V. 11’ 2002 – 01’ 2005 EAzarov M. 01’ 2005 ETymoshnko Y. 01’2005 – 09’ 2005 WYehanurov Y. 09’ 2005 – 08’ 2006 E-WYanukovych V. 08’ 2006 – 12’ 2007 ETymoshnko Y. 12’ 2007 – until now W

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