Ukraine: a New Dawn In spite of political upheaval, a reform program, cheaper labor costs and a booming construction industry are enticing investors to contemplate joining in the economic rebirth of the largest country in Europe Ashley Leonard, president and chief executive of NetworkD Corporation, a bourgeoning California-based Internet service provider, was standing in the departure lounge of Kiev International Airport, about to board his plane back to the United States.

Viktor Yushchenko, the President of Ukraine, had just sacked his prime minister, Yulia Tymoshenko, and dismissed the government. This was September, just nine months after the “Orange Revolution” that brought Yushchenko to power. In that time, the country’s economic growth had dwindled from 12 percent to 4 percent. The foreign trade surplus had tumbled from $2.1 billion to $794 million.

Both Yushchenko and Tymoshenko’s popularity was in decline and, in spite of the West’s enthusiasm for the political changes that had set Ukraine on the path to becoming Europe’s largest democracy geographically, foreign investment had increased only minimally by 3 percent.

So was Ashley Leonard leaving, never to return? He was not. He was planning to establish a technical support plant for NetworkD on the outskirts of Kiev. “I’ve spent only a short time in Ukraine, but I can see that it offers huge opportunities for companies that are dynamic and willing to adapt quickly to challenging political and economic conditions,” he said. “Ukraine has the advantage of cheaper labor compared to Poland and because Ukraine’s not in the European Union we feel that labor costs will increase at a lower rate.”
Kiev, he notes, has only a two-hour time difference from London and one hour from Munich/Paris. It is also culturally more similar than traditional out-sourcing centers such as India.

Orange Revolution crowds Independence Square

Leonard is not the only Western businessman exploring Ukraine’s potential as an investment target. Donald Trump is said to be considering a project in the former Soviet state worth half a million dollars. According to Evgen Chervonenko, the former minister of transport and communications, Trump acquired rights in August to develop real estate in Kiev and the Black Sea resort of Yalta.

If it proceeds as envisaged, the investment would involve the renovation of Yalta’s waterfront and the building of hotels and yacht marinas. It would convert Yalta, which is a run-down resort popular with bargain-hunting citizens of the former Soviet republics, into a top quality European destination, says Chervonenko.

"If we participate in a project, it makes the project politically safer."
Kamen Zahariev,
Director, European Bank for Reconstruction and Development in Ukraine (EBRD)


Whether Trump’s interest – or Leonard’s – will materialize remains to be seen. Events from the Orange Revolution in December to Ukraine’s victory in the Eurovision song contest have focused international attention on a country that, despite being the largest in Europe, spent decades in the shadow of Soviet Russia.

Much has been achieved. For the first time in centuries Ukraine is establishing its own sense of identity. The Ukraine language has replaced Russian as the language to be spoken in official circles and in schools, except in Crimea which is an independent republic. The media is free of controls. A flat personal income tax rate of 13 percent has been introduced.

Currency exchange rates have remained stable. Land can be sold and used as collateral and the real estate and construction sectors are booming.

Yet the goals of the revolution – ridding the country of corruption and much touted foreign investment have not matched expectations. Progress has been slow in such matters as introducing transparency into business and political affairs, separating business from politics and reforming the judicial system.

Specialists in the field caution that too much has been expected too quickly. “In five years from now we will look back and will say how naïve it was to expect that after revolutionary change of the political system things would fall into place in a year,” says Kamen Zahariev, director of the European Bank for Reconstruction and Development in Ukraine (EBRD).

“It is clear that there will not be a waterfall of investments in one year. But we have a lot of new investors coming to talk to us. The upheavals like the revolution here create crisis rather than growth. Yet Ukraine is still going to have one of the highest growth rates in Europe.

Even if it creates a budget deficit, this deficit can be easily covered by borrowing from international capital. Of course it is not very nice to have to borrow to balance the budget, but
eastern European countries have had no problems.”

A 5 percent growth rate is certainly insufficient for Ukraine because it has to catch up so much, says Zahariev. It needs rates of 7 and 8 percent and occasionally to have years of 10 percent. Meanwhile, he says, three or four of the big Western law firms are doing a lot of legal preparation for new investors. “If you look into the investors’ kitchen, they are definitely already cooking the meal.”

The same thing is happening in Ukraine, he says, as happened some 15 years or so ago in other parts of central Europe. “It took a long time before the Japanese came, but eventually they did come. They came to Hungary, Austria, and Slovakia. So people wait until some of the building blocks have been put in place: fair application of laws, proper property rights, a real and open banking system. Once those things are in place I think the sentiment will be very positive. Ukraine is a very attractive country. The banks, for instance, did extremely well in those places that were once in crisis, such as Poland, the Czech Republic and Slovenia, and now they are watching. They know there is real potential here.”

The EBRD is Ukraine’s largest investor, financing agricultural, transport, energy and telecom projects, many of which involve small and medium-sized enterprises. The bank’s role, says Zahariev, is to invest – as both a public institution and as a large investor with a special relationship with the government – alongside private foreign investors to lessen the risks.

The bank signed a program of cooperation with the Ukraine government in August which will provide the country with e360 million for the implementation of a variety of projects in the fields of energy, railroad rolling stock and road construction. “If we participate in a project, it makes the project politically safer,” says Zahariev. “We do basic due diligence and ethical due diligence and bridge the time before commercial companies can go on by themselves without any support.

“You get into a virtual circle where we are driving the reform process with more investment and that leads to more reforms which in turn lead to more investment. The proof can be found in the eight countries, which after 15 years of work, have just joined the European Union.”

Zahariev cautions potential investors against waiting until after the next elections which are due in March. These will have particular significance because as a result of changes to the constitution, which are arguably as important as the Orange Revolution itself, the relationship between the president and parliament will be changed considerably with the powers of the president lessened and those of the prime minister enhanced.

“I never say, ‘wait until after the elections’ because there will always be next elections,” says Zahariev. “You have to look at a bigger picture.”

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President's Progress

With parliamentary elections scheduled to take place in March, President Viktor Yushchenko and his supporters have less than four months to convince the Ukrainian electorate that the benefits of the changes brought about by the Orange Revolution outweigh the negative consequences.

Although the revolution was successful and popular in the West, a third of the Ukraine electorate voted against it in the second, decisive election, and support for Yushchenko in the current parliament is razor thin. When he sacked Yulia Tymoshenko, his firebrand prime minister and former ally, and dismissed her cabinet in September, Yuri Yekhanurov, his candidate to replace her as prime minister, won only a narrow parliamentary majority.

In January constitutional changes take effect which will shift power from the president to parliament, particularly the authority to appoint the prime minister.

In an interview with Insight, President Yushchenko spelled out what he regards as the achievements of his administration.

President Viktor Yushchenko

The primary goals, he said, had been:

• To rid the country of corrupt practices and the tax-avoiding shadow economy that accounted for an estimated 40 percent of the overall economy;
• To reform the justice system;
• To introduce transparency in business and politics;
• To enhance freedom of speech.

These goals were being achieved, but he has since admitted that corruption remains a problem and judicial reforms have made little headway.

In the economic field the target had been to ensure fiscal and price stability. “We formulated the non-debt budget for 2005 and managed to accomplish that goal,” he said.

In the first quarter of the year industrial growth had been 6.7 percent, growth of GDP was 5 percent and inflation had been kept to 5.1 percent.

“In the next couple of years we would like to turn Ukraine into one of the modern markets. This is why we are revising our fiscal policy with an emphasis on tax reduction. The income tax rate is now 13 percent, which is one of the lowest tax rates in Europe. We are working on the social tax, which will be around 20 percent, and we are also working on reducing the VAT rate from 20 to 15 percent.”

To combat Ukraine’s widespread poverty, he said, the government had taken action which had resulted in a 25 percent increase in the real revenues of the population. Pensions in Ukraine were among the highest in the former Soviet states.

The government, he said, had achieved a positive trade balance, a moderate level of inflation, a stable currency “and we are completing the process of privatization.”

More than a million Ukranians were receiving land entitlement which was the largest such process in Europe. “As a result of this there will be a unique agricultural revival which cannot be compared to any other eastern European country,” said the president.

Social security payments for orphans and families with young children had been tripled and the salaries of teachers, doctors and people in the cultural field had increased by 57 percent.

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Grab a Slice of the Breadbasket of Europe

The Orange Revolution riveted international attention on Ukraine. It was a good news story. In spite of the deliberate poisoning of the pro-Western presidential candidate, Viktor Yushchenko, a central European country was liberated from the grip of the
post-Soviet neo-communist Kuchma regime and set on the road to become Europe’s largest democracy with an increasingly free-market economy.

So Yushchenko’s victory was welcomed by the West. Yet nine months later much needed foreign investment has amounted to only an extra 3 percent. Why so little?

Ukraine has all the fundamentals required to attract international companies – it is the breadbasket of Europe, rich in minerals and natural resources, with an educated workforce and a relatively well developed infrastructure. It offers an internal market of 48 million consumers to which can be added millions more consumers in neighboring countries.

Jorge Zukoski, president of the American Chamber of Commerce of Ukraine, says that the dramatic changes brought about by the Orange Revolution inevitably created instability and scared potential investors. It also raised unrealistic expectations among some Ukrainians, including members of the government.

Ukraine has a market of 48 million consumers

“The new government will need time to establish its leadership role, make coherent policy and communicate it consistently,” says Zukoski. “Investors look for two things: predictability and stability.”

Having made those points, Zukoski says that international investors cannot afford to ignore Ukraine’s market potential. Firstly, it is on the border of the new larger Europe and thus provides an ideal export platform; secondly, it can become part of what is referred to as the common economic space incorporating Belarus, Russia, Kazakhstan as well as Ukraine, allowing free movement of capital and goods between them; and thirdly, because there are millions of Ukrainians with a growing disposable income who are becoming more sophisticated in their purchasing patterns and habits.

Yushchenko’s decisive action in September in sacking the prime minister, Yulia Tymoshenko, and dismissing the government drew cautious praise from the business community and international analysts. Most took the view that, for all her electoral popularity, Tymoshenko’s interventionist approach to the economy and plans to backtrack on some of the controversial privatizations were unnerving potential investors.

“The new government will need time to establish its leadership role, make coherent policy and communicate it consistently.”
Jorge Zukoski,
President, American Chamber of Commerce of Ukraine

Under her leadership steps were taken by the government to interfere in the economy in a way that was not consistent with market principles, said one international observer, citing measures aimed at increasing the price of gasoline and meat.

There was also a great deal of confusion about what would happen with companies that had been privatized under questionable circumstances, leading to speculation that thousands of businesses might be reprivatized.

Tymoshenko was accused of wasting a 50 percent increase in state revenues and accelerating inflation by persisting with wage increases and higher social welfare payments during her seven months in office. Under her leadership many officials from the old Kuchma regime quickly changed sides and convictions and integrated with the new administration. Western business circles were also concerned at the lack of radical liberal reform.

Another government success that should reassure potential investors has been its measures to ensure that taxes are applied objectively and not simply to favor some companies and penalize others.

Western diplomats point to the increase in revenues from customs duties, which have risen by 300 percent. The implication is that charges that were previously being pocketed privately are now finding their way into the government’s purse.

Zukoski says there are four sectors of interest to investors:
Firstly, anything vertically integrated in the agriculture sector. Investors are already actively involved in the provision of inputs such as seeds and fertilizers to managed farming, food processing and commodity exports. More privatization is needed in this area, he says, but when Ukrainians are able to purchase land the sector will develop rapidly.

Secondly, vertically integrated businesses in the construction sector from material to do-it-yourself stores. Home décor stores and furnishings are attractive for investment because Ukrainians are demanding quality and affordable furnishings produced locally.

Thirdly, fast-moving consumer goods and, lastly, the light manufacturing sector including high-tech items.

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