Major improvements in the business environment in Ukraine since the country gained independence in 1991 have opened up the market for foreign direct investment (FDI).
Like many other former soviet republics, Ukraine is trying to maintain a centrally planned economy—but based on market principles. There is a law on foreign direct investment, an extensive privatization program has been carried out since the mid-nineties, and several new commercial laws now regulate foreign trade, taxation and banking. The legal and regulatory framework for investment and commerce is in place. Moreover, Ukrainian laws are now easier to understand and should encourage FDI.
Most FDI has been invested in banking, retail, food processing, machine building, steel, power generation, transport, communication and chemicals. The cities of Kyiv, L’viv, Odesa, Dnipropetrovsk, Donetsk, and Uzhhorod have attracted more than 70% of overall investment and are clearly all geographically strategic for FDI.
The legal framework for FDI has become better over time. The original Law on Foreign Investment provided huge tax holidays of up to 10 years for certain industries and for investments over a certain size. But this failed to attract the expected large inflows of foreign direct investment.
The government’s top policy priority is to attract more FDI and it has set up a National Agency for Reconstruction and Development. NARD is responsible for attracting increased investment and improving the legal environment by streamlining existing rules and regulations. The Ukrainian State Credit and Investment Company is able to finance investment projects and is responsible for the government’s investment program. Although it normally focuses more on domestic investment, to the extent that foreign investment is important to support certain projects, it also works closely with NARD and relevant ministries. There are other government bodies, such as the Cabinet of Ministers, the Ministry of Finance, and the Ministry of Economy that also handle matters related to FDI.
Certain areas of Ukraine’s economy, like banking, insurance, and heavy industry where environmental damage a risk, require special permission for both domestic and foreign investors. This can only be granted by the Cabinet of Ministers or other authorized body. Like other former soviet republics, Ukraine restricts the production of drugs, weapons, ammunition, and explosives to state-owned companies, which means they see no direct foreign investment. Many other restrictions change on a regular basis, which does not promote liberalization.
Ukrainian law protects foreign direct investments in a variety of ways. Some allow for the full repatriation of profits, invested capital and the wages of expatriate employees in hard currency, once taxes and other debts have been paid. If nationalization or expropriation takes place, Ukrainian law guarantees quick hard currency compensation of the full amount that was invested. It also provides a 10-year guarantee against changes in legislation that could damage foreign investors in any way.
Ukraine has signed many bilateral investment treaties with a variety of countries. Projects from treaty countries may sometimes be allowed to import machinery and other equipment tax free or at concessional rates, with the possible exception of restricted sectors like banking, insurance and heavy industry. There are also provisions for international arbitration in the settlement of disputes between foreign investors and the state.
Products manufactured by a company with ties to a foreign company are exempt from export licensing and quotas, although such benefits do not apply to all products. Key among the latter is electricity, which is a disincentive for potential investors in the power sector.
Ukraine has made great progress over the past few years in making its economy both stronger and more stable. It is clear the country's leaders are committed to reform.
In 2014, private and government investment is expected to be lower than in 2013 because of reductions in government capital expenditures, an important component of fiscal consolidation measures, and lower domestic and foreign private investment associated with current political and economic risks.
As soon as the new government came into power in March 2014, it immediately applied for foreign financial assistance. On March 26, Ukraine reached a provisional arrangement with the IMF on a US $14-18 billion loan for a two-year period. On April 30, the IMF Executive Board approved a two-year Stand-By Arrangement for Ukraine worth US $17.01 billion. On May 21, Ukraine received the first tranche of SDR 2.058bn of its IMF credit, or about US $3.19bn.
The IMF loan is expected to unlock financial aid from the EU, the US and other sources worth up to US $27bn over 2014-2015. Ukraine could receive as much as US $13bn in 2014. Given that the renewal of the IMF program will favorably affect foreign investor sentiment, we expect Ukraine’s balance of payments to stay balanced on a cumulative basis for the rest of 2014.