There was also the perception that foreign investors were not playing in a "level-playing field", this last perception accentuated by the one-sided treatment received during large privatisations.
I predicted that this impression would change as throughout 2002-2003 (many of them taking effect from 1 January 2004) Ukraine introduced significant legal reforms, which would likely increase its attractiveness as an investment destination. I also felt that these reforms if accelerated, coupled with external factors, mainly EU enlargement to Ukraine’s borders and strong economic growth could lead to a dramatic increase in foreign direct investment, provided Ukraine introduced greater transparency in its dealings with foreign investors.
In 2004, my predictions became partially true, and 2004 year saw increased foreign investment. However, it is 2005 that has seen a dramatic increase in foreign investment, and this year will be remembered as a turning point for the Ukrainian investment climate. Unprecedented growth in the economy for several years in a row, coupled with a new legal and tax regime, that although still requires many reforms, has improved considerably, and all this in a framework of increased trust by the foreign business community in the new Government is leading to an unprecedented increase of foreign direct investment in 2005. Statistics indicate that well over one billion dollars was invested in Ukraine by foreign investors in 2004, and although no statistics are yet available for 2005, I am sure that the level will be much higher than that accomplished in 2004.
Despite the increased levels of investment that I am seeing in 2005, one must not forget that although Ukraine’s investment climate has improved significantly, Ukraine still lags far behind in foreign direct investment levels as compared to neighbours. In fact, the levels of foreign investment into Poland for 2000 to 2004 average around 7 billion to 8 billion US dollars per year and in 2000 even exceeded 10 billion US dollars. This compared to approximately 7 to 8 billion US dollars of total cumulative foreign investment in Ukraine since independence gives a clear indication that much remains to be done. In other words, Ukraine has come a long way but still has a very long way to go in order to realize its full potential.
Foreign Investors Want Stability
Stability is at the top of most investors’ wish lists. In the legal arena, stability is associated with a legal system experiencing few changes enabling investors to forecast with some accuracy the potential outcome of projects. The reason is clear, if a legal system undergoes constant changes, investors naturally feel uncertain as to whether the assumptions made at the beginning of an investment project will hold true for the life of the project, and thus whether all other things being equal, the expected results of the project will be accomplished. Thus, a country with an unstable legal system is not normally viewed as an attractive destination for investment.
However, in the case of Ukraine investors would agree to a certain degree in waiving the requirement for stability, provided that the legal system improves and reforms are aimed at enhancing the business environment. With few exceptions these have been the legal reforms implemented in the past years, which have been significant. Thus, waiving the requirement for stability, most investors welcomed the adoption as from 1 January 2004, of the Commercial Code, Civil Code and Customs Code, cornerstones of any legal system, and also the 2004 tax reform, new Mortgage Act, new law on registration of business entities and reforms to many other key laws, again most of them very positive. In summary, the concession of waiving the requirement for stability for positive reforms paid back.
However, another key stability element to attract investors is honouring commitments, like the tax benefits granted with the aim of attracting investors. In this area the track record has recently deteriorated, with the tax holidays granted in the Free Economic Zones cancelled before the expiration of their term. I am not going to argue whether a Ukraine needs to grant tax benefits or not to attract foreign investors. My only comment here is that the country has to honour its commitments, as otherwise it acquires a reputation of unstable and looses the trust from investors. I also understand that the abuses (tax evasion) of dishonest businesses let the Government to take this measure. However, serious investors do not have to be punished for the dealings of dishonest investors. The logical solution should have been to tighten up the tax controls to stop the tax evasion.
Foreign Investors Want Predictability
Legal predictability flows from legal stability. In the case of Ukraine, the legal element of predictability is whether the legislative changes follow a clear path, which investors may predict and cherish as progressive. Analysing this element we may conclude that in general the legal reforms introduced have been progressive and ought to improve the business climate.
However, some of the tax reforms recently enacted through the amendments to the 2005 Budget Law are very far from predictable, already causing serious concerns from investors since they were not discussed or consulted with the private sector, they were totally unexpected and thus they were not predictable. Although I understand that a big hole in the budget required these urgent measures, it is not less true that the reforms were not welcomed by investors.
They Also Want Transparency and Enforceability
Transparency and enforceability flow from stability and predictability. Investors want laws enforced in a fair and timely manner. The openness of a legal system in resolving disputes and enforcing the law is required for transparency to exist and for the laws to be enforceable. Investors want at the very least incorruptible courts, regulators and government officials who enforce the law without discrimination, and decisions based solely on the law. One’s legal arguments should be the only relevant thing for authorities and courts.
There is still a strong perception among many investors that the legal process in Ukraine is not completely transparent. In my view, landmark judicial reform for 2005 should be a top priority of the new government, the next logical step in Ukraine’s development. One key element here is an independent and powerful judiciary, which must exist to maintain the rule of law. Without enforceability, attracting foreign investors can only be a dream and will never be a reality.
I believe that Ukraine is making progress in this area, and if the review of previous and not-always privatisations deals is carried out with absolute transparency, then Ukraine will really reach a landmark in the eyes of foreign investors. In any case, there is still a lot of work to be done to improve the perception of the level of enforceability and transparency of the Ukrainian legal system.
Moving Forward – Market Economy and WTO
Ukraine’s investment climate has improved dramatically, and after the events and results of the last Presidential election, the country is in the eyes of the foreign investment community with a triple A in potential, but also in the list of "watch carefully". Thus, the opportunity is now to demonstrate stability, predictability, enforceability and transparency.
Investors are starting to take notice of the speed and depth of legal reforms introduced in Ukraine. Here, a significant and necessary step in this process is Market Economy Status and WTO accession. The WTO, and the principles it signatories (over 140 countries) must abide by, are in essence the principles upon which global trade and investment operates. In this area Ukraine has implemented aggressive strategies and policies to realize WTO accession in 2005. If Ukraine were to receive Market Economy Status and join the WTO in the near future, this would significantly improve Ukraine’s overall image as a stable investment market.
Foreign Investors Sectors of the Economy
The situation of Ukraine (centrally located between the enlarged EU and Russia), the diversity of natural resources and industries that it posses and some of the competitive advantages that it could offer translate into converting it in an excellent potential destination for a wide array of industries. Thus, I predict that foreign investors are not going to come to Ukraine to invest only into particular industries or regions, but that the investment will flow all over Ukraine (although with some concentration of EU-export-oriented industries in western Ukraine) and in many sectors of the economy. This is in fact already happening, with investment coming into many sectors of the economy, and even on the services (such as IT and software development) and financial sector. I recognise that certain sectors for which Ukraine has global reputation could well receive the lion’s share of the first wave of investments. However, my forecast is that the next waves will flow into many sectors, even on some sectors, which Ukraine never thought it had potential for.
Ukraine in 2005 and beyond
Foreign investors come to a market based on the competitive advantages over other markets. However, they must have a high level of certainty that the legal condition will improve or at least will not deteriorate. External factors such as WTO accession and EU enlargement will play a pivotal role, and investors will be looking for Ukraine to aggressively continue passing and implementing reform-minded policies. Provided this occurs, 2005 could be a defining turning point for Ukraine.
By Jorge E. Intriago
Partner of PricewaterhouseCoopers and Tax and Legal Leader for Ukraine
Vice-President of the Board of the European Business Association
