By Oleksander Plotnikov
Before the financial crisis of 2007-2008, Ukraine, with large industrial and scientific potential, fertile land, cheap and educated labour resources, and the population of over 48 million people, was considered as one of the most attractive emerging markets for foreign investors.
After the Orange Revolution of 2004new government talked a lot about the need to attract foreign investments and favourable conditions to be created for investors. At that time certain psychological factor triggered and in the forefront of common uplift and statements about democratic reforms, many investors believed and rushed to Ukraine.
Unfortunately, the power went no further populist talks what had not been expected by investors. In Ukraine they faced within known rules and conditions of work. Their schemes and business models proven successful in other countries, did not give expected effect in Ukraine for various reasons.
As a result, now we can often hear voices of disappointment in Ukraine. They usually indicate political instability, imperfection of local legislation and tax system, and high level of corruption as the main disadvantages of the Ukrainian market. And to be honest, we have to agree with this statement.
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However, notwithstanding all these negative factors, a lot of foreign companies successfully operate in Ukraine showing high financial results which are hardly achievable in countries with developed economies and tough competition.
So, what is the real situation in Ukraine and whether it is possible to develop successful business here?
We should recognize that the situation is quite complicated. Speaking of attractive investment climate, we purport conditions to which a foreign investor is accustomed and that are comfortable for him. This actually means conditions of developed market, with all its legal and financial instruments. But the Ukrainian market is still very far from this today.
From my experience I can say that in practice the main problem for foreign companies operating in Ukraine is neither political situation nor the corruption. Ukrainian legislation provides foreign investors with high level of protection and national regime of business activity in Ukraine, and their rights are not infringed in any way in comparison with national companies. But undeveloped local legislation prevents foreign companies from using legal and financial instruments available in developed markets. And of course this is a significant disadvantage. For example, there is no derivatives market in Ukraine and there are no efficient mechanisms for currency risk hedging.
Particular stress should be made on the Ukrainian currency legislation. Due to the high dependence of the Ukrainian economy on foreign currency, a policy pursued by the authorities, and in particular by the National Bank of Ukraine, aimed primarily at tough control of foreign currency transfer from Ukraine. Therefore, the national currency legislation is rather strict and conservative.
Although the right of a foreign investor to free return of an investment abroad is declared by the legislation, such a return is possible only in compliance with strict rules and subject to certain documents proving the initial transfer of a foreign investment in Ukraine. Without such documentation, the return of an investment is almost impossible.
Therefore, before deciding whether to invest in Ukraine, particularities of the local market and legislation should be studied thoroughly. One should answer the question: “Are you really ready to work in accordance with these rules?”. If you rely on setting your own rules upon coming to Ukraine, then you are doomed to failure.
According to official statistics, the volume of foreign investments in Ukraine in 2011 equals to 6.5 billion U.S. dollars. And the total volume of foreign investments in Ukraine as of 1 January 2012 equals to 49.4 billion U.S. dollars. However, these official figures do not reflect the real situation with foreign investing in Ukraine.
If you look at countries leading in investing in Ukraine, the top five are: Cyprus, Germany, Netherlands, Russia and Austria, where Cyprus has 25.6% of the total volume. The UK is on the 6thplace with 5.1 per cent of the total volume.
The fact is that considerable part of investments from Cyprus, the Netherlands and the UK is nothing but a return of capital, derived from the Ukrainian economy by national industrial groups offshore.
In reality, the flow of foreign investment in Ukraine is almost stopped now. However, the main reason for this is not the above mentioned negative factors that already existed seven years ago, and can be effectively coped with, but the difficult economic and financial situation in the world. Potential investors are focusing on well-developed markets now, not seeking expansion in emerging markets. We quite often hear from our European clients that considering an investment in Ukraine and in a country of the EU, they would rather choose the second due to lower risks and predictable perspective, irrespective of much higher investment profitability in Ukraine.
But I am sure that the situation will change, because with all the negative aspects, there are a lot of undeveloped sectors of business in Ukraine which promise significant profit. And in such circumstances it is important to choose the one in which you will have the least competition at your level.
Today, the most attractive areas of business for foreign investors in Ukraine are agriculture, alternative energy, infrastructure, pharmaceuticals, metallurgy and mining.
But you should keep in mind that in each of these industries, except maybe the infrastructure and pharmaceuticals, a foreign investor will face significant competition with national industry groups, which own considerable assets in these spheres. This is especially true for metallurgical and mining industry, which is highly dependent on energy resources and raw materials. These sectors are monopolised by national industry groups, which dictate their rules to the market. So I would say that the capital investment in this sector is not justified. However, the cooperation with a Ukrainian partner which has necessary infrastructure, access to resources, and is interested in attracting foreign investments, may be very profitable.
At the end of the day, a lot depends on the policies pursued by the authorities. Elections to the Ukrainian parliament, which will take place this autumn, could be an indicator of the political situation within the next few years. And there is a hope that elections will change the balance of powers in the parliament, which may contribute to more active implementation by Ukraine of the European standards.
Oleksander Plotnikovis a counsel at Arzinger, a Ukraine-based independent law firm