A Case for Foreign Direct Investment into Ukraine

Name September 2010

Contents
A Case for Foreign Direct Investment into Ukraine................................................................................................1 Name.............................................................................................................................................................................1 September 2010............................................................................................................................................................1 Contents........................................................................................................................................................................2 Executive Summary.....................................................................................................................................................4 Introduction..................................................................................................................................................................5 General Understanding of FDI..................................................................................................................................7 1.1 Definition of FDI...................................................................................................................................................7 1.2 Trends in Foreign Direct Investment...................................................................................................................8 1.3 Foreign Direct Investment plans..........................................................................................................................9 General Overview of Ukraines Economy...............................................................................................................10 2.1 Historical review of FDI inflow..........................................................................................................................10 2.2 GDP growth statistics .........................................................................................................................................10 2.3 Ukrainian Export.................................................................................................................................................13 2.4 Ukraines trade with EU.....................................................................................................................................15 2.5 Ukraines trade with USA ..................................................................................................................................15 2.6 Trade with Russia................................................................................................................................................16 Direct Foreign Investment In Ukraine....................................................................................................................19 3.1 FDI inflow in Ukraine.........................................................................................................................................19 3.2 The most attractive sectors for FDI inflow into Ukraine.................................................................................21 3.3 Problematic sector for FDI inflows....................................................................................................................25 Analysis of Current Situation...................................................................................................................................35 4.1 Macroeconomical.................................................................................................................................................35 4.2 SWOT Analysis....................................................................................................................................................41 4.3 Boston Consulting Group Matrix.......................................................................................................................48 4.4 Approximate analysis of effectiveness of different investment projects.........................................................55 4.5 History of successful investment projects..........................................................................................................59 Possible Ways of Improving the Effectiveness On FDI Inflow.............................................................................60 5.1 Decrease the level of corruption. .......................................................................................................................60 5.2 Create an attractive law.......................................................................................................................................60 5.3 Protect the right to own property. ......................................................................................................................61 5.4 Measure for preventing inflation process. ........................................................................................................61

5.5 Create a free economy with less government interruption..............................................................................62 5.6 Establish an attractive taxation system..............................................................................................................63 5.7 Decrease the level of bureaucracy......................................................................................................................64 5.8 Provide further political stabilisation................................................................................................................64 5.9 Create international awareness of existing opportunities. ..............................................................................65 Conclusion..................................................................................................................................................................66 References...................................................................................................................................................................67

Executive Summary
The level of foreign direct investment (FDI) inflow can have a significant effect on a countrys economy especially during a time of major economic and social transformation. For the short time of its existence as an independent country, Ukraine has faced major changes in terms of economical and political transformation which have required a rapid capital inflow from overseas. The historical review of Ukraines growth shows, that despite its potential, the countrys GDP has grown very slowly during the 90s. Only since 2000, has the country started to show positive trends in term of GDP growth. Analysis of FDI inflow also indicate that compared to other post Soviet countries such as Poland or Czech Republic, Ukraine hasnt been very successful in the process of attracting FDI into the countrys economy due to the number of obstacles. Review of the countrys industries shows that Ukraine already has a number of existing and well developed sectors which have attracted increasing interest for foreign investors. Also there exist some industries which have experienced a number of difficulties due to the transformation from Soviet plan based economy into the free market economy. After providing the macro economical, SWOT and BCG analysis we are able to observe that while every single sector in Ukraines economy has its own unique set of problems, the main problem which prevents foreigners from investing in Ukraine is corruption, inflation, political instability, high taxation and government intervention. But despite the problems that exist in Ukraine for foreign investors, we also can see that a number of successful investment projects have gone ahead. Furthermore, these businesses have plans to increase the volume of investment in Ukraine in the next period and expect greater dividends in the future. At the end of my thesis, I introduce a number of methods which, in my own opinion, could help Ukraine improve the level of FDI in the near future.

Introduction
Historically, Ukraine used to be a part of Soviet Union, ruled by the communist party based out of Moscow, and unable to take its own economic or political decisions. Only in 1991, after the fall of USSR, has Ukraine emerged as a country with a great potential for fast growing and rapid development within world economy. Ukraines territory stretches for 893 kilometers from north to south, and for 1316 kilometers from west to east. The total area of Ukraine is 603 700 sq. kilometers that makes 5.7 percent of the territory of Europe or 0.44 percent of the world. Ukraines territory is larger than that of France, Spain, Sweden, Germany and Poland. Ukraine consists of the Crimean Autonomous Republic and 24 regions. There are 490 districts, 446 cities, 907 towns and 10196 villages. Total population of the country on the day of its independence was 52 million and almost 70% of people aged between 18 to 55 were well educated. Ukraine shares its borders with Poland, Hungary and Slovakia in the west, through which territories lies the shortest route to the countries of Western and Central Europe. The border of Ukraine with Russia is in the north and east, while in the southwest the country is contiguous with Moldova and Romania. In the north, Ukraine adjoins Belarus through which territory it is linked with Baltic countries. It is with Romania and Russia that in addition to the land border Ukraine has a sea border too. All these factors make the country a very attractive and profitable trade route which could connect Eastern Europe within Russia, Turkey and others Asian countries. In addition, from the beginning of its existence Ukraine has been an industrialised country with very well developed industries such as coal mining, chemical industry, and metallurgy, machine building, agricultural and other industries All of these factors should have been very attractive for foreign investors who could invest capital in Ukraines economy, which was very important for developing the country in the initial years of its existence. But, as mentioned before, foreign investors didnt find Ukraine very attractive for investing money due to some reasons: 1. It was really difficult for Ukraine government to liberalise trade and improve political and

economical climate which could be more suitable for foreign investors. 2. The legal system in the post Soviet country was very weak and actually wasnt able to protect investors in case of losing money, which created another obstacle for investors 3. The level of corruption in the country at that time was very high and it also created difficulties for attracting foreign investors in the country. 4. Ukraine was much more slow to open its borders than other eastern European countries such as Poland, Hungary, Estonia etc. As the result the country has suffered economically and its standard of living are currently bellow those in central Europe, Russia and Kazakhstan

CHAPTER 1

General Understanding of FDI

1.1 Definition of FDI Its a well known fact that foreign direct investment (FDI) plays a significantly important and growing role in world and business in general. It can provide a firm with new markets and marketing channels, cheaper production facilities, access to new technology, products, skills and financing. For a host country or the foreign firm which receives the investment, it can provide a source of new technologies, capital, processes, products, organizational technologies and management skills, and as such can provide a strong impetus to economic development. Foreign direct investment, can be identified as a process when a company from one country makes a physical investment into building a factory in another country. The direct investment in buildings, machinery and equipment is in contrast with making a portfolio investment, which is considered an indirect investment. In recent years, given rapid growth and change in global investment patterns, the definition has been broadened to include the acquisition of a lasting management interest in a company or enterprise outside the investing firms home country. As such, it may take many forms, such as a direct acquisition of a foreign firm, construction of a facility, or investment in a joint venture or strategic alliance with a local firm with attendant input of technology, licensing of intellectual property etc. In the past decade, FDI has come to play a major role in the internationalization of business. Reacting to changes in technology, growing liberalization of the national regulatory framework governing investment in enterprises, and changes in capital markets, profound changes have occurred in the size, scope and methods of FDI. Also new information technology systems and decline in global communication costs have made management of foreign investments far easier than in the past. The sea change in trade and investment policies and the regulatory environment globally in the past decade, including trade policy and tariff liberalization, easing of restrictions on foreign investment and acquisition in many nations, and the deregulation and privatisation of many industries, has probably been the most significant catalyst for FDIs expanded role. The most significant effect has been observed in developing and some post Soviet republics, where

annual foreign direct investment flows have increased from an average of less than $10 billion in the 1970s to a annual average of less than $20 billion in the 1980s, to explode in the 1990s from $26.7billion in 1990 to $179 billion in 1998 and $208 billion in 1999 and now comprise a large portion of global FDI.. Driven by mergers and acquisitions and internationalization of production in a range

of industries, FDI into developed countries last year rose to $636 billion, from $481 billion in 1998. Proponents of foreign investment tells that the exchange of investment flows benefits both the home country (the country from which the investment originates) and the host country (the destination of the investment). Opponents of FDI note that multinational conglomerates are able to wield great power over smaller and weaker economies and can drive out much local competition. But in either case, the country needs to identify for itself the importance of foreign investment in the country and the government needs to take measures for attracting foreign investors or protecting domestic business. 1.2 Trends in Foreign Direct Investment The global financial crisis has severely affected capital in-flows to developing and emerging countries, reversing the upward trends observed over the past few years. Yet FDI flows to emerging markets are proving resilient and rebounds are anticipated in 2010. Net capital inflows to developing countries had become almost 40% by the end of 2008. Also it can be true to say that emerging markets in Eastern Europe, including Ukraine have suffered the most from the financial crisis, accounting almost 50% of the decline in capital flows to all developing countries. Net portfolio equity flows plummeted by 90% while private debt flows contracted by 76%. The situation had become even worse in 2009 when another decline of net private capital resulted in a decline of about $363 billion. Flows to emerging markets started to slow during the second half of 2008. In the first quarter of 2009 cross border M&A in the developing world declined to 16 billion compared with more than 30 billion in the previous two years. In 2009 tight credit conditions, weak global demand and low profitability owing to recession were certain to limit the ability and willingness of MNEs to expand in the developing world. The World Bank projected FDI flows into developing countries to decline by 34% to 385$ billion in 2009. Yet FDI flows to developing countries remained more resilient than flows into industrialized countries in 2009, where the World Bank estimated FDI inflows shrank by 50 %

1.3 Foreign Direct Investment plans As discussed above, the global financial crisis brought a great decline in FDI into emerging market in 2009. However this decline appears to be more related to the tightening of financial markets which has made funding scarcer and more expensive than to investors reassessment of the long term business rational for investing in emerging market. The global survey suggests that investors have maintained a positive outlook for FDI in general. Around 40% of them expect their firms to increase foreign investment this year and a further 20% expect investment plans to remain in line with 2008. Around 65% of investors surveyed their foreign investment to increase over the next three years as shown on the graph. The graph indicates that investors do not anticipate that global financial and economic turmoil will affect their investments prospect for long. But investment in the short term will likely continue to be unevenly affected in different sectors. Being faced with decline in the price of commodities, almost half the surveyed investors in primary industries expect their foreign investment to decrease this year in many cases by more than 20% compare to 2008 in contrast more than 60% of investors in other sectors such as financial service and manufacturing are planning to increase or at least maintain foreign investment this year. Also in the next three years a high proportion of investors across all sectors expect to increase their foreign investment.

CHAPTER 2

General Overview of Ukraines Economy

2.1 Historical review of FDI inflow Ukraine opened its market for FDI inflows only in 1991 when the country achieved its independence. This step has made a great improvement in the countrys business environment. At the beginning Ukraine like many other former Soviet countries tried to keep a centrally planned economy which was basic economic base in USSR but also with implementing market principles. In the mid 90s due to the increasing amount of foreign investment in the country, the special law on foreign direct investment, an extensive privatisation program has been started and several new commercial laws came into purpose to regulate foreign trade, taxation and banking system. The largest amount of FDI in Ukraine since its independence has been invested in banking, retail, food processing, machine building, steel, power generation, transport, communication and chemicals. The cities of Kyiv, Lviv, Odessa, Dnipropetrovsk, Donetsk, and Uzhhorod have attracted more than 70% of overall investment and are clearly all geographically strategic for FDI. 2.2 GDP growth statistics Ukraine is one of the former USSR countries which have suffered from the longest economic recession which lasted almost 11 years (since 1989 to 2000). According to the official statistics Ukraines GDP in 1999 was only 38.5% of its level in the year of 1989. But since 1999 the economy began to recover. For over a decade, Ukraine's economy has been growing steadily, with GDP increasing an average of more than 7% per year. This strong growth has been driven by increasing domestic demand, improved productivity in the private sector, low unemployment, and rising wages. In the first six months of 2008, Ukraine's strong and sustained growth rates continued to show dynamic upward momentum - with GDP growing at an annual rate of 7.1%. Ukraine's growth has persisted despite a global economic slowdown, continued political infighting at home, and a high inflation rate, which slowed dramatically over the summer and is projected to end 2008 at around 1820%, far less than the 31% annual rate registered through May. But despite this quite strong economic recovery since 1999, Ukraines GDP in 2008 was only two-third of its potential. The main factor driving recovery in the Ukraines economy was more similar to the reason which began recovery in

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Russia than central European countries. The key factor was rapid growth in output from plants constructed during the Soviet era, primarily in the export industries of ferrous and non-ferrous metals, machine building, and chemicals. Increases in output from the large privately owned

industrial conglomerates that were created from formerly state-owned enterprises have contributed heavily to a doubling of Ukraines industrial output since 1998. In addition Ukraine has achieved its recovery from developing construction, telecommunications (especially cellular telephones), nance, and business and personal services than to manufacturing. Because the service sector was neglected during Soviet times, output in these sectors has soared. Increase in output from small privately owned rms have also been an important driver of economic growth. New plants in the nascent private sector resulted in increased output from the food processing, textiles, and clothing branches. Increases in output from agriculture, government services, and coal mining have lagged the overall $ or 2004 $ at PPP rates (000s) rate of growth in GDP. At one period of time, Ukraines growth record was even better than it appeared to be. The State Statistics Committee of Ukraine reported that GDP rose just 2.7 percent in 2005, down sharply from the increase of 12.1 per cent recorded in 2004. Most of the slowdown in growth stemmed from declines in value added from construction and from wholesale and retail trade. However, retail sales boomed in 2005, up 23 percent in real terms, and yet value added from wholesale and retail trade reportedly fell 8.3 percent. This discrepancy is highly suspect. One respected source has argued that elimination of Special Economic Zones in that year, which had been
Per Capita GDP for Selected skewed statistics on value a source of wide-scale tax evasion on imported goods, Former Soviet Republics, 2006 added in trade for

2005. For instance if value18added in trade had been more accurately measured, Ukrainian GDP growth for 2005 would have 16 been at least 5 percent, and probably substantially more. But despite the rapid economic recovery in the country since 2000, until 2008 Ukraine was still poorer 14 than its neighbors. While East Asia and Central Europe were enjoying growth during the 1990s, 12 Ukraines decline in output drove its 1999 per capita GDP to just 40.3 percent of its 1989 level. The decline in per capita GDP was a little less than the overall decline in output because Ukraines population fell 4.7 percent over this period, as life expectancy remained low and many Ukrainians
6 emigrated to Central and Western Europe and Russia in search of better-paying jobs. 8 10

By 2006, per capita GDP ran4$2,200, putting Ukraine among the middle-income developing countries.
2 Using purchasing power parity (PPP) exchange rates, per capita GDP was still only $7,100 in 2006. Per

Ukraine Armenia Eston Georgia Kazakh

Latvia Lithuania

Russi a

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SOURCE: Eurostat, National Accounts: Gross Domestic Product, 2006; State Statistics Committee of Ukraine, National Accounts, 2006; IMF, International 2007.

Financial St

capita GDP is far lower in Ukraine than in Russia, Kazakhstan, and the three Baltic states (Figure 2.2). Ukraines per capita GDP is a fth of Estonias and a third of Russias at market exchange rates. The more favorable comparison, that based on PPP exchange rates, still shows that Ukraines per capita GDP is half that of the Baltic states and two-thirds that of Russia. Wages are substantially lower than in these countries, as well. In May 2007, monthly wages ran $238 in Ukraine compared with $472 in Russia. According to the official European statistics 4.9 percent people in Ukraine were poor. Of the European countries, virtually only Moldova has citizens who live on less than $2 a day. Ukraine scores better in international comparisons using local measures of deprivation: In 2003, 19 percent of its population was classied as poor, which is smaller than the shares classied as poor in Poland, Russia, and Lithuania. Since the beginning of the recovery, poverty has declined more rapidly in Ukraine

than in a number of other transition economies, including Poland and Russia. But the main question is why has Ukraine been so slow to enjoy the benets of transition? In comparison with most of the other transition countries, including Russia, Ukraines new privatesector economic activities were slow to emerge. As late as 2002, Ukraine had only 18.5 incorporated businesses per 1,000 populations, whereas Russias number was more than a third higher. Barriers to entry imposed by corrupt government officials and bureaucrats, the slow pace of privatisation, and the initial absence of dynamic, protable export industries retarded recovery. Because Ukraines investment climate has been perceived as hostile, the country has failed to enjoy the benets from large inows of FDI. Because of low levels of FDI, output from subsidiaries of multinational rms has contributed little to Ukraines recovery, in contrast to the positive impact that FDI has had on economic growth in Central Europe. But in the year 2008, Ukraines economy that had begun to recover only years ago was affected severely by World Economic Crisis. Ukraine's economy shrank 15% in 2009 with inflation being 16.4%. The Ukrainian government predicted GDP growth of 0.4% in 2009 and a slowdown in inflation to 9.5% (also in 2009). The deficit of Ukraine's foreign trade in goods and services January through September 2009 was estimated at $1.08 billion, which was 9.5 times down on the same period in 2008, export of goods over the period decreased by 48.7%, to $27.478 billion, while imports fell by 53.5%, to $31.570 billion; export of services dropped by 23.2%, to $6.841 billion, while imports were down by 19.9%, to $3.829 billion (the deficit of Ukraine's foreign trade over the first nine months of 2008 was estimated at $10.284 billion, which was 2.7 times up on the same period of 2007. According to a forecast by the 12

State Employment Center unemployment in Ukraine would triple to 9% in 2009 (there was 3% unemployment at the end of 2008), which would mean about 3 million people will apply for employment services. In September 2009 the official level of unemployment was 1.9%. 95% of the population of Ukraine felt the influence of the financial crisis. In July 2009 21% of them stated that "the crisis has a catastrophic impact on me and my family", this figure dropped to 17% in October 2009. Most analysts and scientists are inclined to think that the reason for such a huge impact of the recession on Ukraines economy is the decline in steel prices, local banking problems and the cutting of Russian gas supply of January 2009. This made key industries such as metallurgy and machine building lay off workers, and real wages started to fall for the first time in a decade. In 2008 the Hryvnia dropped 38% against the US dollar, eclipsed only by the Icelandic Krona and the Seychelles Rupee. Since many loans and mortgages were issued in dollars and most Ukrainians are paid in Hryvnyas (Ukraine's currency), they had to buy dollars with the weak Hryvnya, and so they were paying back much more on the loans than they had expected. From December 2008 till mid-May 2009 Ukrainian banks were not allowed to grant requests for early withdrawals of bank deposits. As of September 2009 financial analysts predicted a recovery of the Hryvnia. Ukraine's total foreign debt (state and corporate) had reached 93.5% of the 912.563 billion Hryvnya GDP in March 2010; late February 2010 the Ukrainian Finance Ministry had reported that the country's total state debt by early 2010 was to 32.9% of the GDP. Standard & Poor upgraded Ukraine's rating the same day. March 18, 2010 the National Bank of Ukraine stated the total external debt in Ukraine increased 2.3% to $103.973 billion in 2009, and it considered a 4% GDP growth realistic for 2010 the same day 2.3 Ukrainian Export Despite the many problems and obstacles for export at the beginning of its independence Ukraine has begun to export aggressively. As you can observe from the figure, Ukrainian exports grew slowly in the mid-1990s and declined between 1997 and 1999 (as Russian demand fell sharply following the crash of the ruble). But since then, they have surged, more than tripling by 2006.

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In 2000, exports totaled $14.6 billion and imports totaled $15 billion. Ukraine's main export markets are in Russia (24 percent), the European Union (30 percent), and the United States (5 percent). Its main importers are Russia (42 percent), the European Union (29 percent), and the United States (3 percent). Exports have played a very
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important role in the process of economic recovery in the country. Rising heavy productivity industry a and cost
20

reductions have made Ukrainian formidable

10

exporter.

Ukraine has gained

benefits from increases in world market prices. A surge in demand for steel from China, Russia, and other rapidly growing economies boosted this decades demand for
1994 1996 1998 2000 2002 2004 2006 n t s ,

SOURCE: S years shown.

t a S t et a t i C s t o i c m s m of Ui t tak e i r en e N ,

a t iA o cn c a ol u

metals and chemicals, sparking price increases and providing an additional impetus to exports. In addition export also has risen rapidly because Ukrainian exporters have found new markets. The EU is now Ukraines largest export market, having displaced Russia in 1998. But growth in exports to Asia, especially China, has outpaced growth in exports to the EU since 2002. Within the EU, the larger EU economies of Italy and Germany rank among Ukraines top three export markets. But a number of Ukraines former Communist neighbors rank among Ukraines top ten EU markets: Poland, Hungary, Romania, Bulgaria, and Slovakia, in order of importance. of the EU, Russia, Belarus, and China loom large. Ukraines imports are even more concentrated by region than its exports are. Over four-fths of Ukraines imports come from other countries in the Commonwealth of Independent States (CIS) or from Europe, primarily the EU. In 2006, the EU edged out Russia as Ukraines primary source of imports. Russia and Turkmenistan are virtually the sole sources of Ukraines imports of energy. Ukraine imports a number of other commodities from Russia, such as chemicals, metals, and wood. Machinery and consumer goods play a more important role in imports from the EU and Asia Ukraines exports to each of these countries exceed its exports to either France or the United Kingdom. Outside

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2.4 Ukraines trade with EU Since its independence EU has been one of the most important trade partners for Ukraine. During the 1990 Germany, Netherlands and Italy used to be one of the largest trade partners for Ukraine within EU. But economical system of the young country was dependent on its old Soviet network and during that time post Soviet countries such as Russia, Belarus were the largest trade partners of Ukraine. But in the late 90s and at the beginning of the 2000s, due to the countrys economic development and the deeper international trade strategy, the situation started to change. In the 2000s the EU has become a largest trade partner of Ukraine. According to Euro stat, between 2000 and 2007 EU trade in goods with Ukraine more than tripled in value: exports rose from 5.5 bn Euro to 22.4 bn, while imports increased from 4.8 bn Euro to 12.4 bn. But, this increase didn't make Ukraine one of the EU's major trading partners. In 2007, Ukraine accounted for only 2% of EU exports and a mere 1% of European Union imports which is toward the bottom of the EU's top 20 trading partners (16th). According to the European commission paper, manufactured goods dominate trade with Ukraine. Nearly half of the EU exports to Ukraine in 2007 were machinery and vehicles and a further quarter were other manufactured articles. Also it can be possible to observe the similar situation in imports: unspecified manufactured articles accounted for two fifths followed by a crude metal for a further fifth. At the more detailed level, the main EU exports to Ukraine in 2007 were medicine, motor vehicles and mobile phones, while the main imports were iron and steel products, as well as sunflower seed oil, ferro-nickel, iron ores and oil. Among the EU27 Members States, Germany (5.9 bn Euro or 26% of EU exports) was the largest exporter, followed by Poland (4.1 bn or 18%). Italy (2.4 bn or 19%) was the largest importer followed by Bulgaria (1.6 bn or 13%) and Germany (1.3 bn or 11%). The largest surpluses in trade with Ukraine in 2007 were observed in Germany (+ 4.6 bn Euro) and Poland (+2.8 bn Euro) while Bulgaria scored the highest deficit ( -1.4 bn Euro) Even though Ukraine is not yet a member of EU it could be true to say that EU is seeking an increasingly close relationship with Ukraine, going beyond cooperation, to gradual economic integration and deepening of political cooperation. Also Ukraine is a priority partner within the European Neighborhood Policy, which could be helpful for Ukraine to apply for membership of the EU in the future. 2.5 Ukraines trade with USA Ukraine also has a very close trade relationship with the United States. According to the statistics US is the eighth largest export market, just behind Belarus with exports amounting to about 1.2 billion.

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Exports to the United States have uctuated in recent years, although the general trend has been upward. Since 2000, exports to the EU and Russia, Ukraines two largest export markets, have grown more rapidly than exports to the United States, in both relative and absolute terms. Ukraines exports to the United States are heavily concentrated in metals and inorganic chemicals; these two categories accounted for four-fths of the total in 2006. Transport costs, barriers to trade, lack of favorable bilateral trade relations, and limited knowledge of the U.S. market have limited Ukrainian exports of other items to the United States. Ukraines imports from the United States have grown steadily since the year 1998. The items imported are more widely dispersed across commodity categories than are the exports to the United States. The two most important imports, special industrial machinery and motor vehicles, account for just a quarter of imports from the United States, which stands in contrast to the very concentrated nature of Ukraines exports. 2.6 Trade with Russia Even though Russia is not anymore the largest trade partner for Ukraine, it still is a very important trade partner with a long history of trade relationship with each other. The volume of goods turnover between Ukraine and Russia is stable. In 2007, mineral products led exports of Russian goods to Ukraine (47%, although this share is gradually declining). In 2007 mineral goods with the value of USD 7,697.7 million were exported. The volume of deliveries of Russian oil to be treated by NPZ Ukraine the countrys national oil processing company was 9.6 million tons. The rate of export of cars, equipment and transport vehicles is growing, having increased their share in the structure in comparison with 2006 from 16.7% to 20% from total exports (USD 3,216 million). Deliveries of metals and metal products (USD 2,069.3 million) stably maintain their import share at a level of 13%. There has been a considerable increase in the rate of production in the chemical industry (136.5%). Since 2006, mechanical and technical production (for which 36% of all Russian imports from Ukraine are necessary) and also metals and metal products (31%) have increased by 158% in the import structure of goods from Ukraine in terms of the volume of deliveries (USD4, 719 million). Deliveries of food and agricultural raw materials have increased by more than 62.7% and make up about 11% of import. The share of chemical production in Russias import is 10% from Ukraine, and mineral products are 4%. Frequently, intergovernmental agreements and arrangements lead to an increase in supply. 16

Thus, at the end of the first quarter of 2008 the supply of the produce of sixteen meat industry enterprises and twelve dairy industry enterprises of Ukraine to the Russian Federation were permitted upon joint certification (a ban was imposed in January 2006). The sanitary and veterinary services of both countries work towards expanding the list of Ukrainian enterprises, which deliver such products to Russia. In the alcohol production market two trends have emerged during this year. Along with the

relocation of certain Ukrainian alcoholic drinks manufacturers to Russia (spirit is being withdrawn from the free trade regime) their import has grown (by 18.8% for the first 10 months of 2007). Import from Ukraine of alcoholic production makes up 50.3% of all Russian import of alcoholic beverages from CIS countries. The structure of Russian import from Ukraine unlike export is characterised by the big share of production, which has Khmelnitsky, and also in the Lvov and Dnepropetrovsk regions. By 2011 the company plans to open 50 hypermarkets and 24 supermarkets in 35 Ukrainian cities, with a total floor space of 307 thousand sq.m. Ukrainian vodka companies have become more active in the Russian market. Following the lead of the well-known company Nemiroff, the group of companies Soyuz-Viktan (Kyiv), one of the largest Ukrainian manufacturers of strong spirits, opened a factory in Ruze (Moscow region) in March 2005. Investments into it have totaled USD 5 million, which has allowed factory output from 5.5 million units to 8 million units per year. them to increase

In addition it could be true to say that despite the small volume of Ukrainian capital which is present in the Russian economy, it is necessary to note the positive dynamics of its development, which, it is supposed, shall continue for the next few years. It is possible to ascertain that in the presence of considerable divergences construct strong and long-term the between Ukraine and Russia, both states aspire to economic relations, and for these purposes develop new Federations representative office for trade in Ukraine in

programs and create organisations whose work will be directed at attracting investments. Two such organisations are attraction Russian Kyiv and the Russian-Ukrainian investment-commercial centre, whose primary goals are the of Russian investments, and also active development of the Russian-Ukrainian trade and economic relations at inter- regional level.

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CHAPTER 3

Direct Foreign Investment In Ukraine

3.1 FDI inflow in Ukraine As we know, the process of attracting foreign investment in the country hasnt been very successful at the beginning of Ukraines independence due to political and economical reasons which posed significant obstacles for foreign investors. But at the beginning of 2000s, Ukraine has started to be more attractive for foreign investors. Figures presented by Derzhkomstat shows that Ukraine attracted about US $2.87 billion in FDI for at the first half of 2009, bringing the total to US $38.6bn as of October 1, 2009. While small compared to the amount of foreign direct investment inflows detected in neighbouring Central European countries, Ukraine has observed a steady surge of investment inflows since the Orange Revolution of 2004 put the country onto the radar screens of Western investors. Cyprus, and the British Virgin Islands (another place to park cash that is popular with Russian and Ukrainian investors) run a cumulative 23 percent of total FDI in Ukraine. Germany with 17.1%, the Netherlands with 9.9%, Austria with 6.6%, the United Kingdom with 6.1%, and Russia with 5.3%. Because of buying of Krivoryzhstal, the steel industry has attracted more capital than any other sector in Ukraine. However, banking is the most vibrant sector. Since 2006, banking has attracted the most substantial investment. For instance in 2008 $6.1 billion has been invested in Ukrainian finance sector amounting to 18.6% of total FDI which is 25% more than in previous year. Also over a fth of banking capital in Ukraine is now owned by foreign investors. Agriculture - most notably sunower-seed processing, agricultural inputs, and grain trading - has also attracted large sums going back to the 1990s. In addition, foreign investors have put money into the automotive industry, consumer goods, and retailing.

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The United States is currently the sixth largest investor in Ukraine, down from its position as the largest source of FDI in the late 1990s. U.S. investment has encompassed a number of sectors, ranging from agriculture to consumer goods to nancial services. However, as investment in Ukraine began to take o in 2003, U.S. investment grew less rapidly than did a number of other countries, including Cyprus. To some extent, this was the result of European banks showing greater interest in Ukraines banking sector. But U.S. investors were also put off by the difficulties encountered in investing in Ukraine. Given alternative destinations for their investment dollars, they have chosen countries with larger markets (such as China, India, and Russia) or countries with more congenial investment climates (such as the Central European states or countries in
SOURCE: State Statistics Committee of Ukraine

East Asia).

Due to the banking collapse and financial crisis, FDI into Ukraine dropped almost two thirds in the first 9 months of 2009, from US $8bn in the first 9 months of 2008, to US $2.97bn in the same period of 2009. Identified factors: Legal reforms The legal framework for FDI has been improved and finally the original Law on Foreign Direct Investment has been created. This law provided huge tax holidays of up to 10 years for certain industries and for investments over a certain size. But unfortunately this law failed to attract the expected large inflows of foreign direct investment due to the several difficulties in countrys economy and legal system. Attracting FDI has become a governments top policy priority and for this purpose it has set up a National Agency for Reconstruction and Development (NARD). 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 are

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able to finance investment projects and are responsible for the governments investment program. In addition there are other government bodies, such as the Cabinet of Ministers, the Ministry of Finance, and the Ministry of Economy that also handles matters related to FDI. Some areas of Ukraines economy such as banking, insurance, and heavy industry where environmental damage is a risk; require special permission for both domestic and foreign investors. Only the Cabinet of Ministers or other authorised body can grant this. Also Ukraine restricts the production of drugs, weapons, ammunition, and explosives to state-owned companies, which means that there is no direct foreign investment in these areas. Ukrainian law protects foreign direct investments in different 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. In case of nationalisation or expropriation, 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. In addition, the countrys government 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. Trading climate Products which have been 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. It is a clear fact that during the last twenty years Ukraine has been made a great progress in the process of attracting FDI in the country but compared to the other eastern European countries, the level of FDI inflow is quite low and it is important for the country to find the way which can help to improve the level of FDI inflow. 3.2 The most attractive sectors for FDI inflow into Ukraine As discussed, Ukraine is a country with well developed hard industries and due to this factor the most attractive sectors in Ukraines economy for foreign investors still remain in this area. The most important of them is metallurgy, machine building, and chemical industry

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Metallurgy is the key industry of the Ukraines economy. Metallurgy is the most important export product in Ukraine and the production of metal is an important input factor for machine building and metalworking industries and metal is the main source of engineering materials. The metallurgy sector includes 14 integrated steel making plants, 7 pipe plants, 10 plants producing metallic articles, 16 merchant-coke plants, 17 refractory production plants, 3 ferroalloy plants, 20 non-ferrous metallurgical works, 35 factories reprocessing ferrous and non-ferrous scrap metal, and other enterprises. The vast majority of metallurgy enterprises of Ukraine are powerful integrated companies that produce over five million tons of metal per year. The largest of them are Azovstal, Zaporizhstal, and Kryvorizhstal. Three metallurgical regions have developed in Ukraine: Transdnipro, Donetsk, and Transazov. But the main problem in industry is that large parts of machine and equipment in the factories are very old and the cost of maintenance of this equipment is very high. And of course, this factor affects the final cost of production, making it higher than it could be. In this case it could be difficult for Ukraine to compete with China which has installed new modern equipment on most of its factories. But high potential and very good educated labor still make metallurgy one of the most attractive sector for foreign investors. Chemical industry is also well developed and still has a great potential for further growth. The industry accounts for nearly 10% of industrial fixed assets and over 5% of all those employed by Ukrainian industrial sector. About 90% of the capital assets and about 80% employees involved in the industry are concentrated in chemical sector. Petrochemical and chemical-pharmaceutics sub-sectors account for the remaining production potential. Until 1990, Ukraine was producing 16% of the total of mineral fertilizers in the former Soviet Union, 24% plant-protection chemicals, 18% sulfuric acid, 25% soda ash, 16% caustic soda, and 13% chemical fiber. According to the data of the Ministry of Industrial Policy, they manufacture up to 20 thou names of production to the sum of UAH 40-45 bn. In 2007, chemical sector shares amounted for 6.4% in the structure of industrial production (6th place), 2.7% - in the structure of GDP. The base of chemical complex makes up manufacturers of mineral fertilizers (over 60% of the total chemical output in the country). Capacities for production of mineral fertilisers make it possible to produce up to 8 mn tonnes production a year. As of 2008, Ukrainian enterprises decreased manufacture of fertilisers by 5.8% to 2673 thou tonnes (in terms of 100% nitrogen content), as compared to 2007. Key Ukrainian producers of mineral fertilizers and

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nitrogen output are as follows: concern Stirol, Odessa port plant, Azot (Cherkassy), Severodonetskoe Objedinenie Azot, Denprazot, and Rovnoazot; phosphorus Crimea TITAN, Sumykhimprom, Konstantinovsky state plant; potassium Dneprovsky plant of mineral fertilizers. In 2009, according to the data of the Ministry of Agrarian Policy, demand from the agrarian sector for mineral fertilizers totaled 775 thousand tonnes (deliveries 753,6 thousand tonnes). According to the Strategy for the Development of Chemical Complex of Ukraine for 2007-2015, the annual volume of required means to renovate production funds is to be increased from UAH 2,4 bn to UAH 3,3-4,5 bn by 2015. Ukrainian chemical enterprises intend to invest in production some UAH 13 bn by 2015. As we can observe from this situation, the chemical industry is quite well developed and also has a great chance for improvement which makes the industry attractive for investors. Machine building is also very a important industry for the countrys economy. It accounts for over one third of the employed and about a quarter of the total cost of industrial main assets. The largest engineering centers are Novokramatorsk Machine Building Plant, Kramatorsk Plant Energomashspetsstal, Mariupol Heavy Engineering Plant, Kharkiv Turbine Plant, etc. The major electric engineering facilities are concentrated in Kharkiv, Zaporizhzhya, Kyiv, Donetsk, and Dnipropetrovsk. In addition the machine-building complex of Ukraine includes over 20 specialised branches that are practically all branches of machine building (except watch industry). It serves as the basis of heavy industry and plays the decisive role in creating a material and technical base for the economy. Also it could be true to say that in modern conditions, machine building is very important in accelerating scientific and technological growth. This factor makes the industry very attractive for foreign investors. Light and food industry is also well developed and plays a significant role in the countrys economy. Light and food industries relate to the social complex of consumer goods production. Light industry today is a multi-branch sector comprising 25 sub-sectors. It includes over 3,300 enterprises of different forms of ownership and subordination. Light and food industry is well developed in Ukraine and almost completely satisfies the populations need for consumer goods. The light and food industry is foreign dominated, with four of the biggest firms in the sector being foreign owned and three more foreign owned firms featuring in the top 10 of the sector by turnover. The return on capital is on average more than 25%, explaining high interest of foreign investors in this sector. The turnover growth has been very diverse ranging from decline of 70% to increase of 90%. The light industry includes textile, knitting, clothing, leather, footwear, and other sub-industries.

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The key sector of the industry is textile production including cotton, wool and linen sub-units. Cotton industry uses imported raw materials. The largest operations are located in Kherson, Donetsk, Ternopil, Kyiv, Kharkiv, Lviv, Poltava, Chenivtsi, etc. The highest concentration of large wool operations using both domestic and imported raw materials is in Chernihiv, Donetsk, Kryvy Rih, Odessa, Luhansk and Sumy. According to research carried out in previous years, the main problems in the light industry (leather and footwear cluster, home furnishing cluster, textiles and apparel cluster) are poor quality of fabrics and trim; lack of cooperation or collaboration between firms; poor access to export markets; inadequate sales and marketing skills; inadequate access to capital; problems with VAT reimbursements with input. The food industry is traditionally the major supplier of basic foods, such as sugar, salt, oil, alcohol, confectionery, etc. Food industry is the leader of the agro-industrial complex. It will remain strategically important in future, determining the well-being of the people. The sector has considerable production, research and labor potential. At present, its production capacities are not fully utilised. They operate at 42% of capacity in confectionary, 30% in dairy canning and 19% in soft drink production. Thus, reserves of the sector are vast. Economic potential of the countrys food industry strongly depend on the development of agriculture, which is the main element of the agroindustrial sector and the supplier of raw materials to all the sub-sectors of the food industry. Ukraines service sector is one of the fastest growing in the country. Current analysis shows that more than 40% of the population is working in this sector. The industrys share of GDP for services rendered domestically is over 50%. In 2004-2008 this sector has demonstrated an impressive pace of growth and profit margins. Annual turnover is $20bn and growth has been averaging 25% per year, with revenues raising an average of $1.8bn monthly. Growing volumes of services rendered can be seen across all regions in Ukraine, mainly a result of the steady rise in real disposable incomes. The share of services provided to individuals constitutes 31% of all services rendered. One of the most popular services are technical services and repairs (93%), education (89%), air transport (85.0%), photographic services (82.4%), various personal services (76.5%), hotels and lodging (74.1%). Services that are rendered abroad are a major part of Ukraines exports and a source of commercial capital in the country. Today, the export of services is about 10% of GDP. The main consumers of Ukrainian service industry according to the national statistics in 2009 were Russia, the United Kingdom, Cyprus, the US, Germany, Switzerland, Belgium, Turkey, Austria, and Canada.

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Ukraines main competitive advantages in services, especially in international markets, are its inexpensive skilled labor and convenient location. Ukraines geographic advantage is mainly important for transport networks, such as highways, railways, ports, airlines, and oil and gas pipelines. In addition Ukraine has all the fundamentals in place for turnover in the service industry to continue to pick up pace in 2010-2012 It is important to separate tourism from other services because today tourism plays a significantly important role in a countrys economy and has been recognised as one of the most important industry. Daily profit from one foreign tourist in Ukraine equals income from exporting nine tons of Ukrainian coal. The tourism sector of economics serves as a major source of currency for 38% of countries in the world. Its all a matter of priorities. Moreover according to the latest information tourism in Ukraine is rising rapidly. Due to the Ukraine's State Tourism Administration, in 2005, 17.6 million tourists visited Ukraine. This represents a 13% increase from 2004, or an additional 3.1 million visitors. This trend is expected to continue, with a projected 19.6 million visitors expected in 2006. According to industry experts and tourism agencies growth in 2005 was due to Ukraine's abolition of its visa regime with neighboring EU countries, the USA and other countries. The Orange Revolution and Eurovision-2005 were factors for the tourist infrastructure improvements, which support the projections for continued increasing tourism to Ukraine in the future. Also the EURO 2012 scheduled to take place in Poland and Ukraine is a factor, which could increase the flow of tourists in the country on very high level. This factor makes the Ukrainian tourist sector extremely attractive for foreign investors 3.3 Problematic sector for FDI inflows Due to the large transformation in Ukraines economy since its independence and the economic recession which hit the world last year there are a lot industries within the country which are in a difficult situation. The greatest challenge remains privatising the large coal mining industry, energy, telecommunication, developing and creating a market for the agricultural sector. The Ukrainian banking system includes the central bankthe National Bank of Ukraine (NBU)and an assortment of commercial banks. NBU responsibilities consist of monetary circulation, registration and oversight of commercial banks, and intervening in the currency market. As of January, 203 banks were registered in Ukraine, of which 165 banks are in actual operation, including 30 backed by foreign capital, and 9 with 100 percent foreign capital. Ukrainian finance sector is still developing. At the beginning of 2006, the total market capitalisation of the banking sector was only 5% of total GDP.

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But interest of foreign banks in Ukraine is increasing and the countrys banking sector is fast becoming the focal point for foreign investors. Interest income constitutes a major part of income of the Ukrainian banking industry income and it accounted for 69.1% of total banking income in 2005. Current account deposits, time and savings deposits and bank loans are expected to grow at the CAGR of 20.51%, 8.98%, and 24.85% respectively during 2007-2011. As mentioned earlier, since the year 2006 Ukrainian banking sector has attracted the largest amount of FDI inflow. But even though at the moment banking industry is still attractive for foreign investors, due to lack of competitors and other factors the situation within industry remain to be difficult. According to the report of the U.S. Embassy in Kiev, there are a variety of problems in this sector, namely, setting up service projects requires legal endorsement; there is rampant corruption in the licensing and administrative approval process; the payments system is antiquated, with most Ukrainians having neither bank accounts or credit cards; and legal recourse in collecting on unpaid services is almost non-existent. This situation could severely impact FDI inflow into the finance sector in the nearest future. One of the most difficult situations exists within the coal mining Industry. High death rate statistics (Ukraine has the world's second largest fatality rate in coal mining accidents after China), outdated machinery and the depth of mines makes most of them highly inefficient. According to the International Energy Agency (IEA), "The average mine depth is more than 700 meters; in approximately 20 percent of mines it is 1,000-1,400 meters." It is dangerous for miners and has depended for years on large state subsidies. For the past decade, successive Ukrainian governments have provided massive subsidies to the coke-coal industry. This policy has been, in fact, a subsidy to the metallurgical industry by providing it with low-cost coke. These subsidies, in turn, led to accusations of Ukrainian manufacturers dumping steel onto world markets. On her website, U.S. Senator Debbie Stabenow stated that, "from 1997 through 2000, carbon steel slab imports [into the United States] from key producers have risen dramatically: Brazil up 25 percent; Mexico 13 percent; Russia 106 percent, and Ukraine 542 percent." However, the troubles in Ukraine's coal industry far surpass those of its other energy sectors:

Restructuring the coal industry would mean the loss of hundreds of thousands of jobs in a politically sensitive region.

Retraining programs for coal miners are not in place; the prospects for miners performing other jobs are bleak.

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Entire municipalities in the Donbas Basin rely on the coal industry to pay for medical care, schools, public transportation, and other vital infrastructure

But despite all negative factors in the industry, the latest figures show that coal accounts for 40 percent of fuels used in Ukrainian power plants, 10 percent in district heating plants and 45 percent in industry. Estimates of Ukrainian coal reserves vary. The World Energy Council estimates total coal reserves in Ukraine at 52 billion tons, the 8th largest in the world. Ukraine's power sector is the twelfth-largest in the world in terms of installed capacity, with 54 gigawatts (GW). But due to the economic recession which occurred in the country in the first year of its independence, generation and consumption fell sharply and only started to increase again in the 2000s. EIA estimates that Ukraine generated 177 billion kilowatt hours (kWh) of electricity. The country is currently in the process of revamping its electricity sector, through privatisation, increased utilisation at existing facilities, and the completion of two new nuclear plants. Ukraine thermal power plants (oil, natural gas, coal) account for nearly 50 percent of generation, with nuclear power generating another 45 percent, and hydroelectric generation accounting for approximately 5%. Ukraine has sufficient generating capacity to supply more than twice its electricity needs. However, the country's transmission and distribution systems are in need of investment and maintenance. Also, several of the country's nuclear facilities are intermittently shut down throughout the year due to technical problems. With the surplus electricity, in 2006 Ukraine increased electricity exports by almost 25 percent or by over 2 billion kWh compared to 2005 according to the Ukrainian Energy. After the completion of two new nuclear reactors, Ukraine signed a deal with RAO UES, Russia's main electricity supplier, to supply 500 million kWh of power per month to Russia at a price of $.014/kWh. The World Bank has been working with Ukraine on energy sector reform and has published a number of different studies on the effect of natural gas price increases on both the rest of the economy and in the electricity sector. Electricity sector reform and infrastructure development is one of the main components of the EU-Ukraine Action Plan, and the World Bank will be spending over $200 million in upcoming months to rehabilitate transmission substations, expand the transmission network, and stablise the Crimea electric power grid, among other institutional and administrative reforms In addition Ukraine signed a contract to supply 2.5 billion kWh to Belarus during 2006 and stands to make $50 million from the contract. Ukraine also exports electricity from the Burshtyn thermoelectric power station to Moldova, Slovakia, Poland, and Hungary. It started exporting electricity to Romania in March 2005. The Burshtyn thermoelectric power station and part of

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Ukraine's western energy system have been connected to UCTE energy system of Europe since July 2002. EU officials met with Ukrainian energy officials in Kiev in early 2006 to discuss plans to fully integrate Ukraines electricity grid into the UCTE by 2008. Also, Ukraine currently has four operating nuclear power plants. These plants have a combined capacity of 12.8 gig watts, accounting for approximately 24 percent of the country's total power-generating capacity. On December 15, 2000, Ukraine permanently shut down the 925-MW, Unit 3 at the Chernobyl power plant, disabling the last remaining working reactor at the ill-fated facility. To replace the power generated by Chernobyl, which Ukrainian officials say accounted for approximately 5 percent of the country's total, Ukraine resumed construction of two 1-GW reactors at the Khmelnitsky and Rivne power plants. The construction of Khmelnitsky Unit #2 and Rivne Unit #4 began under the Soviet Union, and both were more than 80 percent finished when Ukraine received its independence and ran out of money to complete them. After financing from the EBRD was placed on hold, the Ukrainian government completed the reactors on its own and connected them to the electricity grid in August and October 2004, respectively. During President Yushchenkos previous administration in 2000/2001, privatisation of the electricity sector was one of his key objectives and resulted in the sale of six distribution companies. AES, based in the United States, won 2 of the 6 tenders and is now the only foreign investor in the sector. Currently, only six Ukrainian distribution companies have been fully privatised, and 20-45 percent stakes in nine other utilities were sold in 1997-1998. Further privatisation of the sector is not currently planned. Other problems hinder the full development of a deregulated market in Ukraine. First, there is a high level of transmission losses; in recent years, these have increased from 8 percent to 17 percent (compared to around 3 percent in the United States). Again, only six of those companies have begun the process of privatisation, and the Ukrainian government has been reluctant to give new buyers more than a minority stake in the companies. There are also worries that the government will not receive enough compensation for the sale. Also, the industry itself is in debt from a long history of problems which stem from insufficient collection mechanisms during the 1990s. Distribution companies owe $3 billion in debt to the wholesale market. The combination of poor networks, high losses, corruption, and pressure to keep current tariffs low has created inefficiencies in the market and muted the necessary price signals. But despite all obstacles within the Ukrainian energy sector, it still remains to be a well-developed industry with great potential for further development. And this case can be a trigger, which will invite foreign investors into the industry. 28

The key characteristic of Ukraines telecommunication sector is that it has a significant degree of monopoly and governmental control. The monopoly-ridden wire connections area is dominated by two operators, Urktelecom and Utel. However, tough competition exists on the mobile communications market. The trunked, radial, search and satellite communications markets are as yet underdeveloped. Numerous government agencies exercise state regulation of the telecommunications market. As a result of the administrative reform that is currently underway, their names and the scope of their authority change frequently. The telecommunications legal framework comprises several laws governing most general issues and a large number of regulatory acts adopted in pursuance of these laws by specific government agencies. The provision of communications services is subject to license. Where such services require the use of radio frequencies, a separate license for the use of radio frequency resources must be obtained. The procedure for obtaining licenses is complicated and necessitates the prior procurement of consent from several governmental agencies. These factors restrict competition, hinder the entry of new operators into the market and slow down the development of new types of communications. However, a series of measures have been recently brought in, to reduce the degree of monopoly and to make industry more attractive for foreign investment. On July 17 2000 the Law on Peculiarities of the Privatisation of Ukrtelecom OJSC was passed. This law cancelled the 49% cap on foreign ownership of Ukrainian telecommunications services providers, and repealed the state's monopoly to own, maintain and exploit primary networks. At present, networks as well as the means and facilities for public communication may be owned by any entity, either private or state owned. Maintenance and exploitation of public networks may be carried out by any legal entity residing in Ukraine. At the same time, Ukrtelecom is prohibited from transferring the ownership or management of primary networks to other entities. Thus, private owners may receive title to primary networks through the development of new networks only. The Law of Ukraine on Communications, dated May 16 1995, is the basic law that provides a framework for the regulation of the telecommunications sector. It sets forth principal rules on the regulatory authority, customer protection, tariff regulation and terminal equipment. But it could be true to say that the telecommunications legislation is insufficient and contains numerous gaps. To address these problems, several draft laws were developed and passed to the Verkhovna Rada (Parliament). Among them are two alternative draft laws on telecommunications, prepared by the government and by a group of people's deputies and aimed at regulating legal

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relationships in the telecommunications sector. Ukrainian gas industry is almost fully controlled by a National Joint Stock Company Naftogaz of Ukraine (NJSC Naftogaz) which is a vertically integrated company engaged in full cycle of operations in gas and oil field exploration and development, production and exploratory drilling, gas and oil transport and storage, supply of natural gas and LPG to consumers. Currently the company is focusing on creating conditions for gas extraction growth. Also they are planning to increase its extraction volume from the current 14.7 bcm per year up to 17.7 bcm in 2015. This increase is expected to be supported first of all by new wells opening and conversion of investigation holes into commercial production. It is also planned to significantly increase levels of preliminary drilling in order to expand the volume of explored reserves. However primary reserves of major Ukrainian gas fields are currently depleted. Absolute majority of gas fields with large and medium reserves have entered into the phase of falling extraction. Based on the volume of current reserves three quarters of Ukrainian gas fields qualified as small basins with reserves less as 5 bcm including one-third with reserves less than 1 bcm. Moreover the state of domestic enterprises equipment does not meet current requirements and needs modernization. Currently Ukraine does not possess equipment that allows well-drilling deeper than 6000 meters. To solve this problem, for several years, Ukraine has been trying to attract foreign investors The first important step in this field was taken when Chornomornaftogaz signed a contract with American corporation Hunt Overseas Oil Inc. The main idea of project was exploration and development of prospective fields with total area of around 12 thousand square kilometers at the Southern part of the Kerch Strait by using modern American equipment. But unfortunately this project failed due to the absence of a production sharing agreement. Also in this sphere Naftogaz is trying to work with British company SHELL and also with Russian state companies such as GASPROM but unfortunately due to the difficulties in domestic legislation and complication in sharing of product the suitable agreement hasnt been achieved. Agricultural sector of Ukrainian economics is in a period of transformation, accompanied by increase of negative trends in the social sphere: depopulation of significant territories, worsening of living conditions for rural population, increase in mass poverty, growing unemployment, sharp income differentiation. High social losses against a background of development of large-scale commercial production, land concentration and capitalisation of production are leading to increase of social tensions in society thus hampering the country's exit from the crisis.

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Ukrainian economic science and practice of reforms isnt yet ready and social processes in the economics under reform are complicated and inconsistent. Some of them are contributing to economic increase, others are influencing in the opposite way. Currently the urgent task is the development of an efficient social policy promoting structural and institutional rebuilding of economics and stimulating sustainable economic growth. In order to solve this task it is very important to bring economics out of shadow, which is based on humiliatingly low level of wages in Ukraine, prearranged by the inadequate shares of income distribution between the labor and the capital. Processes of land concentration, attraction of industrial capital and creation of large-scale integrated commercial structures in agricultural sector are strengthening shadowing of economics and increasing disproportions in such distribution. With the existence of the shadow economics nominal and real increase of salaries doesn't necessarily mean increase of standards of living for country's population. For example average monthly wage in Ukrainian agriculture grew 4, 5 times from 1999 to 2006, but the share of wages in gross added value (GAV) dropped almost two times. In the industry, wage increase 5, 3 times lead to wage drop by 14, 3% GAV. Only in service and construction the respective ratio grew by 4,3% and 3%. In a country with transitional economics it is impossible to improve standards of living for the population by simple wage increase without simultaneous actions aimed at bringing the economics out of the shadows. The biggest threat of low standards of living of Ukrainians is that there are falling numbers of rural population and large territories are being depopulated. Identification of main trends for development of modern society and social factors of economic growth should promote identification of main direction for social and economic policy of the state during establishment of new rural way of living . Of Ukraine's total land area of 60 million hectares, roughly 42 million is classified as agricultural land, which includes cultivated land (grains, technical crops, forages, potatoes and vegetables, and fallow), gardens, orchards, vineyards, and permanent meadows and pastures. Winter wheat, spring barley, and corn are the country's main grain crops. Sunflowers and sugar beets are the main technical or industrial crops. Agricultural land use has shifted significantly since Ukraine declared independence from the Soviet Union in 1991. Between 1991 and 2000, sown area dropped by about 5 percent, from 32.0 million hectares to 30.4 million, and area decreased for almost every category of crop except for technical crops (specifically sunflowers). Forage-crop area plunged by nearly 40 percent, concurrent with a steep slide in livestock inventories and feed demand. Farms in Ukraine employ a variety of crop-rotation schemes, some including four or more crops, some 31

only two. A six-year crop rotation in the winter grain region will often include two consecutive years of wheat and one season of "clean fallow," during which no crop is sown. The chief reason for including fallow in the rotation is to replenish soil-moisture reserves, and it is more widely used in southern eastern Ukraine where drought is not uncommon. A typical crop sequence might be: fallow, winter wheat, winter wheat, sunflowers, spring barley, and corn. Wheat almost always follows fallow. According to farm directors, this enables the wheat - which is typically the priority crop - to benefit from the reduced weed infestation (fields are cultivated several times during the fallow season). Some crop rotations include several consecutive years of a forage crop. An example of such a rotation would be: fallow, two years of winter wheat, and four years of perennial forage. The perennial forage is usually alfalfa; farmers will get three to four cuttings per year, five if the crop is irrigated. In southern Ukraine, clean fallow is frequently omitted and a crop rotation will likely include sugar beets and/or sunflower, the region's chief industrial crops. A typical seven-year rotation might be: winter wheat, winter barley, sugar beets, winter wheat, winter barley, sunflowers, and corn. The vast majority of field crops, including grains, sunflowers, and sugar beets, are not irrigated. Traditionally, irrigation is used only on forage crops and vegetables. Roughly 5 percent of grains and 10 percent of potatoes, vegetables, and forage crops are irrigated According to official statistics, the fertiliser application rate for wheat plunged from 149 kilograms per hectare in 1990 (when fertilizer was excessively and wastefully applied) to 24 kilograms in 2000. The application rate for corn dropped even more sharply. Fertiliser use has increased modestly since 2000. Rates are still significantly below recommended amounts, but wheat yields have rebounded since 2000 (except for the weather-related crop disaster of 2003) due to a combination of favorable weather and improved crop-management practices on the large agricultural enterprises. There is no shortage of mineral fertilisers or plant-protection chemicals in Ukraine. Any inputs that a farmer needs can be obtained if the farm has money or can get credit. The high price of imported herbicides and fungicides has caused some farmers to cut back on their use, or to use less expensive and less effective domestic products. Farmers still rely to a large degree on mechanical weed control. A chronic lack of modern harvesting equipment remains one of Ukraines main obstacles to increasing grain output and quality. In the late 1980's, the Ukrainian winter wheat harvest could be finished in roughly three weeks. Harvest now takes twice as long to complete, and both yield and grain quality

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suffer as a result of the delays. Farm managers estimate that 10 to 20 percent of the standing crop is typically lost due to outdated, inefficient machinery. Custom combining is available, but operators charge 20 to 25 percent of the crop in exchange for their services. Farmers must weigh customcombining charges against potential harvest losses, and most choose to harvest their own grain. Another consideration for the farm director, in addition to cost, is that the harvest campaign provides work for the farm employees. Many farmers are compelled to sell grain shortly after harvest when prices typically are lowest. One of the main reasons is a shortage of on-farm storage capacity, especially following a good harvest. This is a relic of the Soviet system, which was designed for immediate post-harvest shipment of grain to regional elevators. The need to repay short-term debts or to satisfy "payment-in-kind" arrangements is the second chief factor contributing to the untimely sale of grain (i.e., untimely from the farmers perspective). At harvest time many traders are offering cash for grain. Banks do not accept grain as payment, and for a farm director struggling with a heavy debt burden the lure of immediate cash is difficult to resist. The greatest obstacle to increasing on-farm grain storage and modernising the fleet of agricultural machinery is the difficulty for many farms to obtain large, longterm loans for capital investments. Ukrainian farmers are able to receive credit, but interest rates and collateral demands are high. Since many farms are already heavily in debt to banks or suppliers of fertilizer and plant-protection chemicals and since agricultural loans are not guaranteed by the government, banks are largely unwilling to make long-term loans. Most credit is extended in the form of seasonal loans (six to ten months) used almost exclusively for the purchase of fertiliser and plant protection chemicals. Commercial interest rates typically range from 25 to 30 percent. The State provides assistance to farms by paying 50 percent of the interest on agricultural loans. Banks typically require 200 to 300 percent collateral, depending on the farms credit history and the risk level. Future crop usually serves as collateral, but collateral can also be offered in the form of livestock, farm machinery, or the personal property of the farm director. Under current legislation, land cannot be used as collateral. Farmers difficulty to obtain anything other than short-term, high-interest loans places severe constraints on their ability to invest in long-term capital improvements, such as agricultural machinery or storage facilities. Using land as collateral would enable farms to receive longer-term loans, but many farm directors remain leery of the Ukrainian banking system which is not yet as stable as in Russia and are reluctant to risk losing their land in default. Furthermore, many agricultural enterprises are comprised of hundreds of shareholders, whose permission would need to 33

be obtained before the farm director could use the land as collateral. In many cases, the best option is for a farm to attract an investor who can provide market expertise, operating capital, and collateral to enable the farm to secure loans. The potential down side of investor arrangements, from the farmer's perspective, is that farm directors, to some extent, lose control of farm operations. Often the investment company, or holding company, insists on maintaining control over every aspect of production and essentially takes over the farm, equipment, and land. Farms are forced to enter into extended leases of five to ten years, sometimes longer, because they depend heavily on cash from the holding company. The consensus of most observers is that already-successful farms will continue to expand as shareholders pull out of failing farms and lease their plots to stronger ones. Clearly, many farms will not survive the transition to a market economy, and high-risk farms with few liquid assets, heavy debt, bad credit history, and poor management will collapse. Also the moratorium on buying/selling farmland imposed in 2001 is a major obstacle for attracting foreign investors into Ukraines agriculture sector. The moratorium discourages the farmers from the productive use of land, its improvement and its development. The main condition to achieve sustainable growth in the agrarian sector of the economy is to engage high technologies on big land tracts. A low financial turnaround on the small and medium-size land parcels that were leased to farmers in the early 1990s does not allow for such investments into these technologies and improvement of land quality. Agricultural reform could one of the ways of improving the situation within the industry. It is the opinion of most Ukrainian and foreign experts, that agriculture is one of the areas with the greatest underestimated potential for Ukraine's economic growth. Establishing a fully operational farmland market is the most important element of the agricultural reform, vital for increasing agricultural productivity and maintaining the prosperity of land.

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CHAPTER 4

Analysis of Current Situation

4.1 Macroeconomical To understand the obstacles and be able to anticipate the situation with FDI in the future, and also to give useful advice, we need to make a careful analysis of the current situation. In order to make our analysis we are going to use already existing tools which can be useful to us. First of all, we need to be aware of the general situation within the country. It can be the current political situation, economical trends and others. In this case we are going to use PESTEL (political, environmental, social, technological, economical, legal) analysis. Political Ukraine is a democratic country with its own constitution, multi-party system and legislative guarantees of civil and political rights for national minorities. The Constitution adopted on June 28 1996, mandates a pluralistic political system with protection of basic human rights and liberties. Freedom of religion is also guaranteed by law, although religious organisations are required to register with local authorities and with the central government. Minority rights are respected in accordance with a 1991 law guaranteeing ethnic minorities the right to schools and cultural facilities and the use of national languages in conducting personal business. The President is elected by popular vote for a five-year term. The President nominates the Prime Minister, who must be confirmed by parliament. The Prime Minister and cabinet are de jure appointed by the Parliament on submission of the President and Prime Minister respectively. However, in our day, Ukraines political environment is not so easy and clear. After the Orange revolution in 2004, the major changes within the countrys political system has resulted in constitutional reform. The idea of implementing unbalanced constitutional reform in the country had become the reason for the political crisis, still at large. The essence of the constitutional reform lay in redistributing powers between president, legislative and executive power branches. The form of government in Ukraine turned from presidentialparliamentary into parliamentary-presidential one. The President lost a significant part of his powers which were transferred to the Verkhovna Rada of Ukraine and to the Government. This coupled with the introduction of proportional elective system which resulted in emergence of a new political reality in Ukraine. After arranging the anticrisis majority the Parliament formed the coalition government, which immediately started a tough competition with the weakened president of 35

Ukraine. In the present situation, the current Constitution doesnt suggest any system of checks and balances for stabilising Ukraines political system. Faults of the existing political system of Ukraine are illustrated by the long-lasting problem with assigning the Minister of Foreign Affairs of Ukraine and the Head of Security Service. This political instability can be responsible for the FDI outflows and also pose obstacles for investors looking for new opportunities to invest. But we can also see that situation while unstable is not critical. Furthermore after the elections, the political situation in the country is getting better which indicates some kind of stabilisation in the country. Economical as we have discussed above, Ukraines economy has been hit severely by world economic crisis which has appeared in the middle of 2008. The recession of the countrys economy has reached 15% at the beginning of 2009, inflation has achieved a point of 16,4% Unemployment rate had become in 9% and total foreign debt has reached 93.5% of the 912.563 billion Hryvnya GDP. But in the middle of 2009 some data has shown that economic decline in some sectors has slowed. Inflation has notably decelerated, the national currency has stabilised and even started to appreciate during April-May, and the current account gap narrowed dramatically in 1Q 2009. The recent riskappetite reversal on global financial markets and the resumption of the IMF stand-by program to Ukraine were reflected in the sharp decline of CDS spreads for Ukraine (from more than 5000 basis points to less than 1800 points at the end of May) and revival of the Ukrainian stock market. By the end of May, the PFTS stock market index had gained 120% since Marchs bottom, although this growth was achieved on relatively low trading volumes and on a very low base. Also with the previous economic growth heavily hinged on external demand, Ukraines exportoriented sectors continued to suffer from the sharp decline in commodity prices and economic woes in the Ukraines main trading partner countries. Thus, production in metallurgy, the chemical industry and machine-building fell by 44%, 36% and 54% respectively over the first four months of 2009. At the same time, the impact of the crisis on domestic demand has strengthened since the beginning of the year. Retail trade turnover and the value of passenger transportation works declined by more than 14% and 10% respectively over January-April. Food processing production fell by almost 9% over the period. On the other hand, farming, which employs about one-fifth of the total workforce, continued to expand. Actually, agriculture was the only sector that demonstrated an increase in output, growing by 2.1% over January-April. Second, sharp Hryvnia depreciation at the end of 2008 gave new impetus to import-substituting

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industries. But it can be true to say that this competitiveness gain is hampered by banking sector weaknesses, depriving the economy of credit resources. The credit dry-out and weak demand have already resulted in a 40% decline in investments in fixed assets. However, assuming a gradual recovery of world commodity and financial markets in the second half of the year, a successful bank recapitalisation program and prudent fiscal policy despite the presidential election, most analytics anticipate the economic growth at least by 8% in the year 2010. This factor can demonstrate that Ukraines economy is going to recover and this factor could be able to attract more foreign investors in the country. Social Ukraine is a country with a well-developed system of social care. Since Soviet era there exists free medical care, free educational system including higher education in state universities etc. Due to this factor Ukrainian citizens have a very strong educational background and huge proportion of countrys population have a diploma of higher education. One of the biggest social issues in the country is that of language. Official language in the country is Ukrainian but in the east and in the south of country there exists a large Russian minority who prefer to speak in Russian. Many people see the choice between Russian and Ukrainian as symbolic of two polar political and cultural allegiances: with Russia, or with Europe and the west promotion of Ukrainian is meant to counteract its historical subjugation to Russian. At the same time, there is state support for minority languages and cultures, including Russian, to help develop a Ukrainian civic identity not restricted to Ukrainian ethnicity. Legislation designates Ukrainian as the sole state language while also supporting education in Russian and other languages, including Romanian, Hungarian, and Crimean Tatar. The previously low status of Ukrainian has risen greatly since the disintegration of the USSR, and this language is much more widely used than before in education, government, and public life in general. However, Russian continues to dominate in many spheres as it did during the Soviet era. Many people feel that the survival of Ukrainian is still threatened by Russian, and that the recent gains of Ukrainian in status and spheres of use are tenuous. In 2008, struggles over language policies persist and the implementation of existing policies continues to be uneven. But despite the language question which has been in the country since its independence, the level of social culture in Ukraine seems to be quite good due to the high level of well educated people in the country. Technological Ukraine is a country with an emerging market which has a lot of well developed industries such as steel, which contain one of the largest steel factories in Europe, Coal mining

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industry, telecommunication, machine building industry, which also contain the largest factories in Europe. All of this industries demand modern technologies and also personnel with strong technological skills. Due to this fact, there exist a lot of technology Universities and schools across the country which helps to groom new specialists who will be able to improve already existing technologies or even create new ones. According to the national statistics in Ukraine the total number of scientific personnel constitutes about 200 thousand, among them there are 4.1 thousand Doctors of Sciences, 18.9 thousand Candidates of Sciences. In addition the priorities of Ukraine in development and implementation of new technologies are to be accomplished within the framework of the state programs and projects in the traditional technological fields, such as metallurgy, power industry, chemical industry, agriculture as well as in new high technology fields, namely, space exploration, aviation, biotechnology, development of information and telecommunication systems, creation of new substances and materials and health protection. It should be pointed out that application of high technology products in the national economy of Ukraine is almost twice more efficient as compared to the traditional developments. But it is also true to say that implementation of the priorities of scientific and technological development is unfortunately, not being accomplished within the framework of the unified national program of advanced technologies development, but is connected with a number of separate state scientific and technical programs (SSTP) for sorting out various problems. Alongside with numerous SSTP for implementation of the priority directions of development in Ukraine the following forms are used:

State orders (contracts) for development of scientific and technical products. Branch scientific and technical programs which have acquired the status of national (the National Space Exploration Program, the National Program of Informatisation, etc.)

Branch scientific and technical programs.

Scattering of state funds and state clients, absence of the unified coordinating center result in:

Insufficient financing of programs; Incomplete implementation of programs; Low rate of the priority innovations implementation into production.

The analysis of the present economic state shows that we can expect a gradual rise of machine building, metallurgy and chemical industry, i.e. the branches where the level of profitability is 38

almost steady, like the level of profit. In addition, the major part of enterprises in these industries are introducing new technological processes and starting manufacture of new products, which is also connected with technologies improvement. Environmental Unfortunately, in the last 50 years Ukraine has suffered a lot due to environmental and ecological problems. Ukraine releases polluted water, heavy metal, organic compounds, and oil-related pollutants into the Black Sea. The water supply in some areas of the country contains toxic industrial chemicals up to 10 times the concentration considered to be within safety limits. Air pollution is also a significant environmental problem in the Ukraine. In 1992, Ukraine had the world's seventh-highest level of industrial carbon dioxide emissions, which totaled 611.3 million metric tons, a per capita level of 11.72. In 1996, the total had dropped significantly to 397 million metric tons. The pollution of the nation's water has resulted in large-scale elimination of the fish population, particularly in the Sea of Azov. As of 2001, only 1.6% of Ukraine's total land area is protected, including 22 Wetlands of International Importance. Fifteen mammal species, 10 bird species, and 20 plant species are threatened, including the European bison, the Russian desman, and the Dalmatian pelican. But the most serious problem which has seriously harmed the countrys population during the last twenty years is Chernobyl. Because of Chernobyl accident One-tenth of Ukraine's land area was affected by the radiation. According to UN reports, approximately one million people were exposed to unsafe levels of radiation through the consumption of food. Approximately 3.5 million ha (8.6 million ac) of agricultural land and 1.5 million ha (3.7 million ac) of forest were also contaminated. Due to this fact its really important for Ukrainian government to create some state program and also promote all nongovernmental organization, which takes care of different environmental problems. In the year 1991 the State Committee of the USSR on Ecology and Rational Use of Natural Resources has been reorganised into Ministry for Environmental Protection of Ukraine. The main purpose of the Ministry of Environment and Natural Resources of Ukraine are:

Implementation of the state policy in the field of nature protection Rational use of natural resources (land, minerals, surface and underground waters, free air, forests and other flora, fauna, marine environment and natural resources of territorial water, continental shelf and exclusive (marine) economic zone of Ukraine)

Ecological, nuclear and radioactive safety, as well as hydro meteorological, topographical,

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geodesic and cartographic activities, arrangement of ecological preconditions for sustainable development of Ukraine;

Arrangement of complex management and regulation in the sphere of environmental protection, rational use and restoration of natural resources, ensuring of ecological, nuclear and radioactive safety as well as hydro meteorological, topographical, geodesic and cartographic activities;

Arrangement of appropriate functioning of the State Geological and Hydro meteorological Services and development of topographical, geodesic and cartographic activities.

Execution of state control over adherence to legislative demands on environmental protection, rational use of natural resources, ecological safety, hydro meteorological, topographical, geodesic and cartographic activities as well as state supervision of the situation of nuclear and radioactive safety.

In addition there also exist many public environmental organisations which are trying to solve the ecological problems in Ukraine. There are some network organisations, based in the capital Kiev and with branches in the regions. From the most renowned organisations we can state the following: organization of the women-ecologists -86, Ukrainian ecological league Ukrainian ecological association "The Green world", Ukrainian ecological movement "Khorticky forum".. Besides, in different cities and even villages of Ukraine there are local public organisations and initiatives focused on solution of the local ecological problems. Some ecological public organisations work also in the Transcarpathian region (Zakarpatska oblast) bordering 4 states of EU (Hungary, Slovakia, Romania and Poland). Legal - Ukraine is a parliamentary democracy with separate executive, judicial, and legislative branches. The president nominates the prime minister, who must be confirmed by the parliament. The 450-member parliament (Supreme Rada) initiates legislation, ratifies international agreements, and approves the budget. The constitution of Ukraine provides for an independent judiciary; but in reality the judiciary is subject to considerable political interference from the executive branch and also suffers from corruption and inefficiency. In addition, the judiciary lacks sufficient staff and funds, which engenders inefficiency and corruption and increases its dependence on the executive, since the court receives all its funding from the Ministry of Justice. It is important to point out that Ukraines legal system has a substantial body of commercial,

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contractual and investment laws. Although most were adopted in the last several years, they very quickly became outdated and can hardly cope with the developing business environment. Moreover, the absence of the new Civil Code remains a major problem. Ukraine has several tax laws which are constantly revised with the latest idea being to codify all tax laws in one comprehensive tax code. At the beginning of its independence foreign investment legislation was extremely favorable and provided for all sorts of privileges and exemptions. Gradually these privileges and exemptions were revoked, with attempts by the Government to revoke even those which were grand-fathered (at present, a combined claim filed by a large number of such investors is pending at the Constitutional Court of Ukraine). Currently, foreign investors are generally subject to a national regime with minor exceptions provided by relevant legislation and international treaties. The positive thing is that Ukraine already is, or plans to become, a member of several major international organisations, as evidenced by its pending application in the WTO. One more membership that would enhance Ukraine's investment climate is participation in the Convention on the Settlement of Investment Disputes between States and Nationals of Other States (the ICSID Convention). Ukraine already signed this Convention, but ratification between Ukraine and the other ex-Soviet republics, both on a multilateral (CIS) and bilateral bisection is still pending in the Supreme Rada. Also closer cooperation has been developed between Ukraine and the other ex-Soviet republics, both on a multilateral (CIS) and bilateral bases Although Ukraine is not a member of the Customs Union, it has bilateral free trade agreements with most CIS counties and participates in a number of multilateral CIS agreements. 4.2 SWOT Analysis In the next stage of our analysis we need to make a deep review of countrys perspective for doing business for foreign investors. In this case we have to analyze the strengths and weaknesses of Ukraine and also estimate the opportunities and possible problems which might arise in the near future. For this reason we are going to use SWOT analysis which can help to identify countrys strength, weakness, opportunities and threats. STRENGTH: Well educated people. According to the national statistics there are about 99.8% literacy people among men and 99.7% among women which shows than almost everyone in the country has at least finished elementary school. More than 80% of countys population in the age group from 18 to 60 has finished primary school. Furthermore higher school in Ukraine includes developed training, scientific

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and social infrastructure and is geared to provide every citizen of Ukraine or citizen of any other country opportunity to obtain education of different levels, to study at proficiency improvement or advanced courses, to study at post-graduate courses or to write doctorate dissertation, to take part in fundamental and applied researches. Every year almost 200 thousand Ukrainians and citizens of other countries become students of higher educational institutions in Ukraine after passing entrance examinations based on secondary education. Almost 900 thousand undergraduates study at the universities, academies and institutes, about 600 thousand of them are full-time students. About 40% of school leavers have the opportunity to get higher education. Scientific and teaching staff accounts about 80,000 persons; including among them, 4,506 doctors of science, 32,825 candidates of science, 5,228 professors and 26,665 assistant professors. This factor can give a great capability for foreign investors to obtain high quality personnel in the country without invitation specialists from abroad. Already existing and well developed industries. As mentioned before, Ukraine is a post Soviet country which already has a lot of very powerful industries such as metallurgy, chemical and petrochemical and gas, machine-building, coal mining, food and light industry and other. As we know some of them are quite well developed and also a source for countrys GDP growth. Industries such as steel are considered being the most important in the country because the largest part of government income is obtained from steel trading. Chemical industry which employs about 5% of country population is also very important and a source of national income. It is also important to point out that Ukraine has five nuclear power stations with fifteen reactors with a total power output of 13.6 thousand MW (13 reactors of WWR type and 2 reactors of RBMK type in the Chernobyl NPS). In addition there are 47 thermal power stations with a total power output of 32.4 thousand MW, 6 large hydraulic power stations on the Dnieper and 55 small stations on other rivers. The coal mining industry consists of more than 300 mines operated in three coal-mining regions. Ukraine produces only 5.5 million tons of its own oil, but the ramified network of oil pipelines supports the operation of 10 petroleum plants. It shows that there is no need for foreign investors to set up industry from scratch, because there is an opportunity to join already existing and quite well developed industries. High population density. According to the national statistics Ukraine has 45,905,341 million inhabitants from which 52% is female and 48% male. In 2007, for the first time since 1990, five Ukrainian regions (Zakarpattia Oblast, Rivne Oblast, Volyn Oblast, Lviv Oblast, and Kiev Oblast) experienced more births than deaths. This demonstrates a positive trend of increasing birthrates in 42

the last couple of years throughout Ukraine. The ratio of births to deaths in those regions in 2007 was 119%, 117%, 110%, 100.7%, and 108%, respectively. The large population in the country and also positive trend in birth statistics can demonstrate for investors that exists a large base of potential consumers or employees which companies can avail of. Relatively cheap labor and cost of material. It can be important to point out that salary in Ukraine is much lower than in the EU for the same job. According to governmental statistics, the average salary in Ukraine about 200-300 euro compares to 1500-2000 euro in the EU countries. But due to the high level of education in the country the quality of work for lower price than in EU can be the same or very similar to European standards. In addition due to the low cost of labor the cost of materials is cheaper than in Europe. This can be a very attractive factor for investors to set up their business in Ukraine. WEAKNESS: Unstable political situation. Following the Orange revolution in 2004, there were major changes in the countrys political system and this gave rise to controversial issues which has created a political crisis. In fact, the countrys government is divided by two major groups of political elite. One of them mainly represents the interests of people from the south and east of the country which historically inclined to have closer relationship with Russia. Another one represent the interest of people from the west where people are more likely to support pro-western parties and candidates. This political conflict also raises issues for other questions such as WTO, gas supplying, border regime and other. The worst thing in this situation is that politicians cannot find a suitable compromise and intervention of politics from abroad further aggravates the situation. Weak economic. As we know in the last two years the world has suffered from the global economic crisis and Ukraine is one of the countries worst impacted from the crisis. Economists are inclined to think that Ukraine has had a severe impact due to the fact that a large percent of the countrys income is derived from selling steel. But in 2008 China produced a huge amount of cheap steel and a lot of consumers who used to buy Ukrainian steel switched to Chinese producers. Furthermore the global crisis made the economic situation worse. Now some positive trends in the countrys economy have appeared and it seems that Ukraines economy is going to recover, although still in difficult conditions. Corruption. It can be true to say that corruption is one of the biggest problems in Ukraine and also might be the key obstacle for improving the inflow of foreign investment in the country. In a report

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by international civil rights organisation in Brussels, Ukraine was placed last among the new independent states with an index of 4.3 index compare to Armenia 3.1, Azerbaijan 3.3, Belarus 3.4, Georgia 3.1. Corruption pervades all levels of society and government and all spheres of economic activity and is a major obstacle to foreign investment. Low public-sector salaries fuel corruption in local administrative bodies such as the highway police and tax administration, as well as in the education system. Some foreign investors argued that in many cases government administration prefer to give the right of work or to purchase property not to the company which presents better investment plans, but to the individual or company who gives a bribe. This is one of the most threatening factors for foreign investors which can prevent them from doing business in Ukraine. Ukraine ranks 134th out of 179 countries in Transparency Internationals Corruption Perceptions Index for 2008 Weak legal system. Ukraine obtained its legal system after gaining independence in 1991. But even though the Ukrainian legal system follows all modern democratic rules and standards and is dedicated to protecting human rights, it still seems to be underdeveloped. The laws provide equal treatment for foreign investors, but certain sectors are restricted or barred. Burdensome bureaucracy and regulations are the primary deterrents to investment. Contracts are not always upheld by the legal system, and privatisation has slowed. Resident and non-resident foreign exchange accounts may be subject to restrictions and government approval. Payments and transfers are subject to various requirements and quantitative limits. Some capital transactions are subject to controls and licenses. Foreign investors are not able to own land. Some export restrictions, services market access barriers, import taxes and fees, import licensing requirements, non-transparent government procurement, complex standards and certification regulations, burdensome customs procedures, and weak enforcement of intellectual property rights tend to prevent the inflow of foreign investment. Some industries need to be rebuilt. As mentioned before, Ukraine has many well developed industries but its important to note that some of them havent been rebuilt since the Soviet time and technologies within the industries have become obsolete. Furthermore some of them have survived only due to the government subsidies. The most difficult situation seems to be in the coal mining industry - where a lot of coal mines are unprofitable and the death rate statistics are very high, the power sector which has very old equipment that needs to be replaced, the agricultural sector which is still in the period of transformation from Soviet standards and also a very weak legal background. To rebuild these industries to make them work, needs a huge capital investment for a long term which seems to be very risky venture for investors. 44

Weak financial system. Rebuilding of the banking system has proceeded slowly, and the more than 150 small banks often suffer from insufficient capital. Two banks are state-owned, and the 10 largest banks account for over half of net assets. Due to the lack of efficiency and depth in the financial system, the development of a domestic capital market is still at a rudimentary stage. A liquidity crisis and an increase in non-performing loans related to the global financial crisis have led to a large bailout package from the International Monetary Fund. The government has also taken controlling stakes in three of five banks in financial trouble and has been considering nationalisation of the others. OPPORTUNITIES: Further economic growth. The latest research shows that some positive trends have appeared in Ukraines economy. The research shows that before the crisis Ukraines economy was doing quite well. Ukraines GDP growth reached a point at about 7% in 2006-2007. European economists are inclined to think that the main reason of this growth was increase of steel price in the market. Also in the first half of 2008 year, FDI in Ukraine was $6.9 billion, up 170% from the same period in 2007. The unemployment rate in the years 2006-2007 was less than 4%. Then, as we know, Ukraine suffered from the crisis severely, but in this year some data shows that economy has started to recover. Real sector data for the first three months of 2010 shows that the economic recovery in Ukraine has been gaining strength. Moreover, stronger-than-expected growth in the global economy, driven primarily by emerging Asia and Latin America, larger social transfers to the population approved in the 2010 budget law and a lower price for imported natural gas (renegotiated with Russia in mid-April) led to upgrade the 2010 macroeconomic forecast for Ukraine. As we know the economic growth is an important indicator of stabilizing the situation within the country and it could be the trigger for foreign investors which can influence their decision to make an investment into Ukraines economy. Improvement in legal system. As we know Ukraines legal system is relatively young and still underdeveloped. The lack of legislation attractive for foreign investors and also the absence of good laws against corruption is a great obstacle for implementing FDI in the country. Further improvement in legislation can increase the level of FDI. For instance, a positive factor can be that the parliament of Ukraine has approved a foreign investment law allowing Westerners to purchase businesses and property, to repatriate revenue and profits, and to receive compensation if the property is nationalised by a future government. However, complex laws and regulations, poor corporate governance, weak enforcement of contract law by courts, and corruption all continue to stymie direct large-scale foreign investment in Ukraine. While there is a functioning stock market, the lack 45

of protection for shareholders' rights severely restricts portfolio investment activities. Improvement in these sectors can be a factor that increases the level of FDI rapidly. Political stabilisation. After the last election in February 2010 the new president Victor Yanukovych has been elected. After that a new ruling coalition was formed in the Ukrainian parliament and a new government headed by Prime Minister Mykola Azarov was approved. the unstable political situation which lasted in the country since 2005 has been a negative factor for improving the level of FDI in the country. If the new Ukrainian government can help stablise the political situation in the country, it will help increase the level of FDI inflows. Decrease in corruption and bureaucracy level. As mentioned earlier, corruption in Ukraine is very high and widespread. It has infiltrated Ukraines political, legal and economical sector. In addition the level of bureaucracy is very high. For instance, it takes more than the world average of 18 procedures and 218 days to obtain a business license and costs are high. This is really destructive to attracting FDI. But some major changes in this situation are about to happen. The new president is going to sign new anti-corruption laws which are quite well developed and has a more strict legislation base. According to the opinion of analysts, this new law can really decrease the level of corruption in the country EURO 2012. It can be really important to point out that in 2007 FIFA has taken a decision to make Ukraine and Poland, a host country of the final part of the European Football Championship. Due to the global popularity of football this kind of tournament is one of the most popular in the world. The preparation process requires a huge capital investment in purpose of building stadiums, roads, hotels etc. But, a huge number of potential tourists are expected for this event. Millions of TV viewers across the world, can generate the income which can be able not only to cover the spending on preparation but also will bring a great profit. Economists indicate that the EURO 2008 in Austria generated a value added impact of 641 million EUR in total, a sum which includes the effects from public screen viewing events, but excluding the effects of second-round investments. The associated employment effect is around 13,400 (in person years) or about 11,800 (in full-time equivalent personyears). The ability for foreign investors to gain a great profit during the period of this event a great profit can generate a new FDI inflow in the country. THREATS: Further financial crisis in the world especially in Europe. The world has started to recover from the global economic crisis which has lasted since the middle of 2008. But some countries especially in

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Europe have been hit by another serious economic problem. One of the most difficult economic crises has appeared in Greece this year. National debt in Greece reached 300 billion ($413.6 billion), and is bigger than the country's economy, with some estimates predicting it will reach 120 percent of gross domestic product in 2010. Greece's budget deficit is mushrooming, at 12.7 percent of its national economy and it was growing despite of all measures which government has taken. Finally the Greek government announced its inability to pay the debt and asked the European Bank for a loan. The similar situation now is happening in other European countries such as Portugal, Ireland and Italy where national debt is also very high. All these countries hold EU currency and any economic or financial stagnation in these countries can negatively influence the stability of the EURO which could cause economic and financial problems for another EU countries. As I mentioned before, the biggest inflow of FDI in Ukraine is going from EU countries such as Germany, Cyprus and Netherlands. Financial problems in these countries can push them to take away money from abroad which will be the reason of FDI outflow. Economic recession in Ukraine. Even though Ukraines economic situation has started to recover from crisis and some positive trends in its economic process have happened, it would be true to say than Ukrainian economy is still weak and undependable. Budgetary deficit is 12% of GDP; pension funds deficit is almost 22 billion. In the private sector external debt of about $18-$20 billion has been announced for the year 2010. According to analysts, the positive trends have been noticed due to the increase in steel pricing, because steel export is the source of the government income. Since the countrys economy is dependent on its export, any negative changes in steel pricing will be a cause of economic problems. And its a clear fact that economic instability will lead investors to take their money back and seek safer source for their investment. Political instability. As mentioned earlier, in February 2010 a new president has been elected and a majority in parliament by the ruling party has been formed. According to the new presidents speech, the government is willing to work closer with opposition to find a compromise which will bring a stability to the country. But despite this a lot of problems between the opposition and ruling party still exist. Moreover new disputes have appeared in 2010. The signing of a document which continues the stay of the Russian navy in Sevastopol only aggravates the situation and has widened the gap between the ruling coalition and opposition. Rising political conflict wont be an attractive factor for foreign investors and even can be the reason of FDI outflow.

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New competitors. Ukraine is a country with an emerging market which can be very attractive for foreign investors due to its already existent and quite well developed industries. But it is important to point out that there are many countries in the world in a similar situation, such as Ghana in African region where the economy is growing really fast or central Asian countries such as Uzbekistan which is also ex-Soviet country with well developed industry. These countries can be strong competitors for Ukraine in the process of attracting FDI especially in the light of political and economical problems which might appear in the near future in Ukraine. 4.3 Boston Consulting Group Matrix In the next stage of our research it will be important to analyse the countrys industries for the purpose of identifying which could be most attractive for foreign investors and also to identify the economic effectiveness of these industries. In this stage, I will first use the Boston consulting matrix which can help find out which industries are already attractive and economically effective and which are going to be attractive and profitable in the near future. STARS: In first place here, without any doubt, I need to put Steel Industry. This industry is one of the most profitable in the country. Also steel is one of the most important product for exporting and as I mentioned before the economic situation in the country strongly depends on its steel export. The acquisition of Krivorozstal by Lakshmi Mittal and other similar processes with less amount of capital shows that steel industry one of the most popular sours of FDI in Ukraine. The next industry in this group can be Chemical. Because its also a well developed industry since the Soviet time and a source of GDP growth. Before the economic crisis hit the country, the chemical sector produced 6.4% of all industrial production (6 place), 2.7% - in the structure of GDP. The Ukrainian chemical industry manufactures up to 20 thousand tones of production to the sum of UAH 40-45 bn. According to State Committee of Statistics, in 2008 the share of chemical products in the structure of exports amounted to 8.2%. The growth in production and export of chemical products, observed over the past eight years, indicates that at least for the next few years the chemical industry will play a key role in the Ukrainian economy. All these positive trends indicate attractiveness of Ukraines chemical industry for the foreign investors. Another industry which is also attractive for investors is machine building. There exists one of largest machine building factories in Europe such as Novokramatorsk Machine Building Plant, Kramatorsk Plant Energomashspetsstal, Mariupol Heavy Engineering Plant, Kharkiv Turbine Plant. As I have 48

already mentioned, it accounts for over one third of the employed and about a quarter of the total cost of industrial main assets. In addition it will be important to point out that Ukrainian machine building industry was very successful last year. Production capacity of machine building enterprises raised by 12% and total value of sold products amounted around $ 12 billion. Almost half of production ($6 billion) related to manufacture of transport; ($ 3,9 billion) to machine and equipment production; more than $ 2,1 billion production of electric and electronic equipment. The Ministry of Industrial Policy of Ukraine estimates that in the near future the annual volume of machine-building production in Ukraine will exceed $ 100 billion which also can be an indicator of attractiveness for FDI Service sector is another important branch of Ukraine economy. Previously Ive mentioned that this sector employs about 40% of countrys population and shares about 50% of GDP. The most popular services exported from Ukraine are transport (71.3%) and various business, professional and technical services (11.3%). The most attractive areas for foreign investors are wholesale trade and brokering, and property services. The share of foreign capital in these segments is the highest among services. Exports of air transport services grew by 33.9 % in 2008 and reached $1.23 billion and pipeline transit grew to $2.56 billion or by 6.2%. The export of financial services increased by 50.9%, computer services by 71.1%, royalty by 115.8%, architectural services by 45.9%. Also there was increase both in import and export of insurance services in 2008. It also important to note that Ukraine has every chance to continue growing processes in industry in 2010-2012 due to the European Football Championships which is going to take place in Ukraine. The main segments that are expected to grow in this period include banking, retail, healthcare, and tourism. Other promising segments include business-to-business (B2B) services such as consulting and auditing and IT services and communications, which constitute nearly a third of all services in developed countries. It shows that service sector in the nearest future is going to be one of the most attractive sector for FDI inflows. The Ukrainian banking sector is also a well developed industry which at the current situation represents the largest amount of interest amongst foreign investors. Among the 165 banks registered in Ukraine, 30 represent banks with 100% foreign capital. Since 2006 Ukrainian finance sector has been targeted as the most attractive sector for foreign investors. In addition due to the rapid transformation which has happened in industry during the last ten years and lack of competitors the interest of foreign banks in the Ukrainian banking sector continues to grow. Due to this situation it still remains one of the most important industry for FDI inflow. As mentioned before, a lot of problem 49

exist such as weak legal system, corruption, complication in the process of payment and others. This situation in the future can have a serious effect on the FDI inflow in the industry. In order to prevent it, the Ukrainian government needs to take all measures to implement its legal system and decrease the level of corruption in the industry. CASH COWS: Ukraine also has a large and well developed light and food industry. Light industry includes textile, knitting, clothing, leather, footwear, and other sub-industries. The key sector of the industry is textile production including cotton, wool and linen sub-units, knitting industry manufacturing clothes, underwear and other products. It can be important to note than currently this sector is going through substantial structural transformation. Small enterprise has grown considerably, and most companies have changed their ownership pattern which indicates that potentially this industry could be able to work better. The countrys food industry is a traditional supplier of basic food such as sugar, salt, oil for the Ukraines population. Food and alcohol is one of the key products of Ukrainian export. In addition the sector has huge production and labor potential which provides potential investors the ability to increase the level of profitability. Furthermore it could be important to note that the food industry depends on the agricultural sector which is the main supplier of raw materials and any successful transformation in the agricultural sector will influence on the food industry in a positive way. From this research we can see that the light and food industry is still developing and there exists a great potential for investors to gain dividends in the future. Next industry which we can put in this group is tourism. From our previous research we know that tourism is very important branch of Ukrainian economy. As I mentioned before, the daily profit the countrys economy gains from one foreign tourist equals income from exporting nine tons of coal. A tourist sector of economics serves as a major source of currency for 38% of countries in the world. Also the turnover of foreign tourists visiting Ukraine is increasing rapidly every year. Furthermore a major change in Ukraines tourism industry has happened. The Cabinet of Ministers and the President adopted several important decrees on tourism. "The Program of Development of Tourism up to the year 2010" has already been launched. In addition Ukraine is a host country for the European football championship which is going to be in 2012. Due to the popularity of this tournament, relatively cheap prices, geographical destination a huge number of tourists are expected to visit Ukraine in this year which makes a great opportunity to invest money in Ukraine.

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Another industry which could be suitable for this group is the agricultural sector. Agriculture in Ukraine has been developing since its independence in 1991. State and collective farms were officially dismantled in 2000. Farm property owned by the state has been divided among the farm workers in the form of land shares and most new shareholders leased their land back to newly-formed private agricultural associations. It can be true to say that Ukrainian agricultural sector is still under developed and a lot of problems for potential foreign investors exist. One of the most challenging is weak legislation and inability to own land by foreigners. But despite this fact, the rich farm land, cheap labor and educated labor give an opportunity for investors to get a great income. Furthermore according to the latest research shows than agricultural industry is only one in the country which shows positive trends during the crisis. Even though Ukraines telecommunication industry has a number of difficulties such as monopolisation and strict government control, from the latest research we are able to see the positive trends in industry in the last years. During 2004-2008 years Ukraines IT market grew more than 60%. Furthermore this segment is expected to remain the most dynamic and have the most investment appeal in Ukraines service industry, as it is the best integrated into international markets. Annual turnover in the telecoms sector shows that it continues to lead this branch. The highest growth was in mobile communications, radio and television broadcasting and radio communication, and computer communication. The mobile sector remains the most interesting segment in Ukraines telecommunications market. The total number of mobile subscribers by the end of 2008 was 55 million. Internet access has risen dramatically in Ukraine in less than a decade. Today, nearly 11 million Ukrainians use internet services during the course of a day. The number of third-level domain names (name.domain.ua) registered under Ukraines .ua internet domain was up by 24% or 93,400, to 483,601 in 2009 compared 2008.According to some analytics opinion the telecoms sector is growing because of considerable injections of capital. Operators took in over $ 2.5 billion (20 bln UAH) in capital investment, about 15% of total investment. Also a lot of international telecommunications companies are already represented in Ukraine. A number of strong domestic companies are also operating, such as Miratech, SoftLine, SoftServe, Infopulse, TelesensKSCL Ukraine, and TESSART. In addition Ukraine has unique human resources suitable for the development of telecoms services. Every year, Ukraines colleges, institutes and universities graduate 50,000 IT specialists, including mathematicians. The country is fourth in the world after the US with 194,000, India with 145,000,

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and Russia with 68,000 certified programmers. More than 300 IT companies operate in Ukraine today, mostly in offshore software development. 30% have been doing business in this market for more than 10 years. All this confirms that Ukraine has the necessary conditions for an optimistic assessment of the telecoms sectors future and also telecommunication sector will be able to attract FDI inflows in the country QUESTION MARKS: In this group I am going to put industries which have not been realised and it is quite difficult to identify if it is going to be profitable industries for foreign investors. First in this group would be Ukrainian power. Its a well- known fact that Ukraines power sector is the twelfth-largest in the world and has a great potential for growing and producing huge amount of energy. During the Soviet time countrys energy sector has produced 54 gig watts of electricity and the country has supplied not only itself but also another Soviet republics. But since independence, the consumption and generation of energy has fallen sharply. At the moment Ukraines energy sector is in the process of rebuilding through privatisation, utilisation of old equipment and installing new ones and completion of two new nuclear plants. This process is going very slowly and many obstacle along the way of the industrys rebuilding still exist. One of the most challenging problems is finance. These processes require capital investment, but the Ukrainian government, especially during the time of recovery from economic crisis doesnt have such large amounts of free capital that can be used in this purpose. Most of foreign investors find it difficult to invest money in such risky campaigns due to the still unstable economic situation in the country and level of corruption. In addition there is a problem in the process of privatisation and also in the fact that there is a high levels of transmission losses. But despite all problems which exist in the industry, there is still a great opportunity. For instance the new Ukraine Power Report from BMI forecasts that the country will account for 9.43% of Central and Eastern Europe (CEE)'s regional power generation by 2013, and remain a modest net exporter of electricity to neighboring states. Furthermore there is a great possibility for rising in regional generation. Between 2007 and 2018, we are forecasting an increase in Ukrainian electricity generation of 31.5%, which is towards the bottom of the range for the CEE region. This situation shows that there exists ability which could be attractive for foreign investors but also a lot of difficult obstacles and the countrys government need to take measures for solving it. Its obvious that situation in Ukrainian Gas industry is quite complicated. At first of all as I mentioned

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above the reserves of major gas field in the country is almost depleted. Nowadays around 80% of gas extraction in Ukraine is carried out under terms of falling extraction and pace of residual reserves recovery. Also we know that domestic equipment is almost obsolete and needs to be modernizing because Ukraine does not have equipment which allows to drill deeper than 6000 meters. For installation the new equipments a huge amount of capital needs to be invested in this industry and it also can be important to note that it wont be able to get dividends from this project it short term. This situation could be really serious obstacle for attracting FDI in this industry. But despite of problems which already existed in industry its important to point out that there is a lot of opportunities exist. At first of huge portion of natural gas reserves can be found at Black and Azov seas shelf. Potential resources there are estimated to be at least 1500 bcm, while the most optimistic assessments provide figure of 1800 bcm. Out of these resources only 4% have been extracted so far, while 67% of continent basins have been exhausted. But according to the Ukrainian law the only Ukrainian enterprise that can carry out exploration works and Commercial drilling at the sea is SJSC Chornomornaftogaz. Its mean that any foreign company which want to work in this sphere needs to cooperate with Chornomornaftogaz. In addition due to its geographical position, Ukraine plays a key role in the transit of natural gas From Russia and Central Asia as an intermediary connecting Russia, the world's largest natural Gas producer, with growing European markets. More than 80% of Russian gas destined for European consumers travel through Ukrainian pipelines. At 01.01.2008 Ukraine operated 38,200 km of pipelines, 71 compressor stations (110 compressor shops) providing a total capacity of 5,405 MW, and 13 underground gas storage facilities. Currently Ukraine has large reserves of transmission capacities, the input capacity of the system is 288 billion, and the output stands at 178.5 bcm a year, including 142.5 bcm to Western Europe. While the EU is expecting to increase its import of natural gas resources, Ukraine will gain the benefit of its geographical position and previously built infrastructure. Major issues in the future will be pipeline disrepair and gas storage capacity utilization. This picture shows that a lot of opportunities in Ukrainian gas industry still exist but also a lot of difficulties exist and it can be really difficult to estimate the futures benefits from the investment due to industrys specific. DOGS: It could be true to say that the industry which represents the lowest interest for foreign investors in current situation is coal mining industry.

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Currently almost 40% of all Ukrainian mines have been functioning for more than 50 years, and 15% for more than 70 years and the equipment on some mines hasnt been modernized for decades. This means, that due to the old and outdated equipment and the depth of mines, the industry itself is highly inefficient. In addition a high rate of death statistics makes the industry even more expensive. According to analysts, outdated equipment and widespread disregard for safety rules have been the case for the accidents which took at least 318 lives in 2008 and 140 in 2009. Even though the export of Ukrainian coal has grown by 40% in 2008 and reached 0.57mln tones or USD166.56mln, it is still difficult to cover production costs and more than 60% of Ukrainian mines are subsidised by the government. Furthermore despite the high demand of coal from Ukrainian power plants, 50 % of it is exported from Russia and Poland because of different feature of Ukrainian coal. The situation within the Ukrainian coal industry is similar to the period in Britains history when Prime Minister Margaret Thatcher decided to close down the UK coal industry due to the high level of inefficiency and death rate statistics. Of course this step was very controversial and a lot of economists maintain that it was great mistake because the economy of cities in the north of England was based on coal mining and following this reform cities faced major crisis which lasted for a decade. Which means that to close down all unprofitable mines can be a great mistake for Ukrainian government and in this period it should be better to keep them working because such transformation in Ukraines coal industry would mean: 1. The loss of hundreds of thousands of jobs in a politically sensitive region. 2. Retraining programs for coal miners are not in place; the prospects for miners performing other jobs are bleak. 3. Entire municipalities in coal mining regions such as Donbass rely on the coal industry to pay for medical care, schools, public transportation, and other vital infrastructure Its obvious that coal mining sector needs FDI inflow even more than any other industry in the country but the amount of capital which needs to be invested in the new equipment to make coal mines efficient is very high and it takes very long time before the first dividends will come out. In addition the safety rules are badly regulated which provoke miners to break it. As a result there is are large number of injuries and death in the workplace which wouldnt happen if they followed the safety rules. All these factors indicate that even though the Ukraine coal mining industry has potential for further development and a great reserve of coal, in the current situation due to numbers of obstacles this industry could attract the lowest number of foreign investors.

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In order to change this situation the Ukrainian government needs to find a source for subsidies in coal mining sector or provide special programs which could be attractive for foreign investors such as free tax period or special economic zone. Also its important to develop new safety regulations which will help decrease death rate statistics. 4.4 Approximate analysis of effectiveness of different investment projects To get a more accurate view about investment processes in Ukraine and to be aware of what kind of profitability potential investors could have, I am going to estimate two investment projects in terms of five years in different sectors of countrys economy service and metallurgy. By using different kinds of investment appraisal we are going to estimate the profitability of this projects and which one could be more suitable for foreign investors The first project is acquisition of the Krivoroz Steel plant. Presently, Kriviroz Steel plant is one of the most profitable and fast growing facility in Ukraine. Its employ more than 1000 workers and is increasing its productivity at about 10-15% every year. Even during the recession Krivoroz steel plant had shown positive trends in terms of its profitability. Currently the factory is 100% owned by government but due to the process of privatisation in the country the factory will be sold to private investors. 100% of stock will cost investors about 210 million $ but according to the specialists this price could grow rapidly in the next years. The total profit in the year 2010 has been estimated about 36, 3 million$. During the next five years due to the re-initialisation, which has been done and also increasing demand of steel the profitability will increase at 10% every year. In addition if the economic situation in the country and in the world improves the positive trend in the factory will continue to increase at 10% every year approximately until 2020 year. The next project is buying the five star Opera Hotel in Kiev. The luxury hotel built several years ago is situated in the central part of the city addresses all modern European needs and standards. It includes business centre, casino, parking, fitness centre and a lot of other facilities. The approximate profit in the end of 2010 year has been estimated as 10 million$. In the next year due to the further economic stabilisation, awareness and activities connected with EURO 2012 the profitability will be about 12 million. In the year 2012 due to the European Football championship the level of profitability is anticipated to grow rapidly and it is very possible to get a point about 20 million$. In the next year the profit will decline and get the usual level at about 12 million. This figure will be the hotels profit during the next five years. The total cost of the hotel in current situation has been calculated as 50 million $

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There exist many different ways which give us possibility to calculate the effectiveness of investment projects. In this case I am going to use three of them which, I am inclined it think, can show the situation more accurately. The first method is Accounting Rate of Return (ARR). This method focuses on the accounting profit rather than the cash flow. The main advantage of the method is its simplicity. ARR for Krivoroz Steel Plant: (36,3+39,3+45,195+51,975+59,771)210/5 / 210 = 0,02 or 2% ARR for Opera Hotel: (10+12+20+12+12) 50/5 /50 = 0,06 or 6% But it could be true to say that this method is too simple and general. Furthermore it ignores timing differences in cash flows, which can be really important. Another method recognizes the time value of money is Net Present Value (NPV). This method based on evaluation of the cash flow arising during the year. NPV for Krivoroz Steel plant: 36, 6x0, 909 = 32,996 39, 3x0, 826 = 32,461 45,195x0, 751 = 33,941 51,975x0,683 = 35,49 59,771x0,621 = 37,11 TOTAL: 171,998 171,998 210 = -38,002 From this method we able to see that during the next five years the plant will generate negative figure in terms of cash flow. NPV for Opera Hotel: (Internal rate of return 10%) 10x0,909 = 9,09 12x0,826 = 9,912 20x0,751 = 15,02 12x0,683 = 8,196 12x0,621 = 7,452 TOTAL: 49,664 49,664 50 = -0.336 Here we also able to observe the negative trend but the number is much lower than in previous

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situation. In some cases for potential investors, it can be more important to know the period of time when it will be possible to recover the capital invested rather than cash flow or profitability during the years. In this situation it could be useful to calculate payback period for both projects. PBP for Krivoroz Steel Plant: Input 210 Year Generated profit: 2010 36, 3 2011 39,3 2012 45,195 2013 51,975 payback period between 2013-2014 years 2014 59,771

PBP for Opera Hotel Input 50 Year generated profit: 2010 10 2011 12 2012 20 payback period between 2012-2013 years 2013 12 2014 12

From this brief analysis of this project we can see that at the first glance that the hotel could be more attractive for potential investors because it shows better result it all three types of analysis. But its important to note that these investment projects are completely different. Steel plants require much larger capital to be invested and during the first years of implementing the project investor wouldnt get dividends. But it definitely brings large dividends for investors in time. If we continue our calculations for the next five years the result will be different. The calculation for the same projects in the next five years will demonstrate different results. According to the economists, the global economic situation is going to change rapidly. Also due to the transformation in some countrys industries and growth in construction sector in the world, in general the demand for steel is going to grow in the next ten years. In addition the Krivoroz Steel Plant has a great capability to grow its productivity. Due to this fact the factorys economists and managers 57

anticipate the increase of profitability at about 15% during the 2015-2020 years. From this information it can be possible to calculate the effectiveness of the investment project for ten years. NPV for Krivoroz Steel Plant (2014-2019) (Internal Rate of return 10%) 67.536x0,412 = 27,604 77,666x0,344 = 26,69 89,315x0,276 = 24,65 102,71x0,208 = 21,36 118,11x0,141 = 16,65 TOTAL: 116,95 Total for ten years: 171,998+116,95 = 288,94 288,94-210 = 78 ARR for Krivoroz Steel Plant (2010-2019): (36,3+39,3+45,195+51,975+59,771+67,536+77,666+89,315+102,71+118,11)-210/10/ 210 = 0,22 or 22% According to research been done by managers of Opera Hotel and some independent structure the average level of profitability during 2013-2020 years will be approximately 12 million. Following this number the approximate effectiveness of investment project for the ten years will be:

NPV for Opera Hotel (2014-2019): (Internal rate of return 10%) 12x0,412 = 4,94 12x0,344 = 4,128 12x0,276 = 3,312 12x0,208 = 2,496 12x0,141 = 1,169 TOTAL: 16,045 Total for ten years: 49,664+16,045 = 65,709 65,709-50 = 15,7 ARR for Opera Hotel ( 2010-2019) (10+12+20+12+12+(12x5))-50/10/50 = 0,14 or 14%

From further analysis of these two projects we are able to observe that Krivoroz Steel Plant has shown the higher numbers during the longer period of time, which mean that the long term investment acquisition of Krivoroz Steel plant will be more profitable than the acquisition of Opera Hotel Of course its not easy to judge which project is more effective because they are very different in 58

terms of industry, amount of capital which need to be invested and dividends which could be gained in the future. Which project is more effective will be depend on investors needs and capability. 4.5 History of successful investment projects Despite the many problems which remain to be obstacles for FDI inflow in the country, some foreign investors have been extremely successful in their investment into Ukraine. One of the most successful foreign companies to have been invested into Ukraines economy for 10 years is Cargill. Cargill is a multinational corporation based in suburban Minneapolis, Minnesota in the United States, which is focusing on producing and trading of different kind of agricultural commodities. Currently the largest privately owned company in the United States, at the end of 2009 Cargill declared revenues of $116.6 billion $, and earnings of $3.33 billion$ Cargill has set up its investment activities in Ukraine in 1991, with the establishment of a Corn Research Institute, in Dnepropetrovsk. In 1994, Cargill opened a permanent representative office in Kyiv. In 1995 Cargill built a modern seed production plant and opened a fertilizer warehousing and blending facility in 1997. In 1999, the company bought its first grain elevator from the State and recently started buying shares in a second elevator. But the largest investment project by Cargill Corporation has been in 2000 with the establishment of the world class Greenfield sunflower seed processing and extraction plant in Donetsk. It was the first edible oil factory on the post Soviet area at that time. The initial cost of the project was $ 50million. The plant's projected production capacity is 1,000 t of processed sun seed oil per day. Annual output is 156,000 t of sun seed oil and 135,000 t of oilseed meal per year but the companys managers is anticipating to reach 300 000 per year. At the current situation Cargill has already invested more than 85 million$ into Ukraines agricultural sector and it employs 370 people. The companys profitability in Ukraine has reached 3 billion$ at the end of the year 2009 and the companys managers are anticipating further growth in terms of profitability at about 10-15 %. In addition the company is planning to continue its investment process in Ukraine because according to the opinion of some scientists Ukraine is one of the few countries capable of increasing the level of its agricultural production rapidly to feed the worlds fast growing population.

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CHAPTER 5

Possible Ways of Improving the Effectiveness On FDI Inflow

5.1 Decrease the level of corruption. From the previous research we able to observe that corruption is one of the greatest obstacles for FDI inflow into Ukraine. Due to the high level of corruption there is unfairness in the privatisation process, tendering, and in the business environment in the country in general. Furthermore the agencies whose main purpose is to fight against corruption such as police, tax police, and government representatives are rated to be the most corrupt in the country, which makes the situation even worse. Also Ukraines anti-corruption strategy in Ukraine is still in a reactive mode. Which means, that they are fighting against the consequences of corruption rather than investigating the roots of the problem. To change this situation the Ukrainian government needs to start fighting against corruption really aggressively. To this end, a number of actions can be taken by government, which in my opinion could decrease the level of corruption:

1. Set up legal, institutional and economic conditions within which anti-corruption programs will
thrive. In terms of economic condition introduce fair appraisal systems for people who work in institutions dedicated to fight against corruption, because the low salary is one of the reasons that push them to take a bribe.

2. Providing co-working between key government institutions, the civil service, and the judiciary
to together find a better way to stop corruption.

3. Work closely with civil society and business to prepare them for change and oversee
government including activities at local levels and transparency initiatives

4. Create the possibility for anti-corruption law to attack the problem at many levels, but also
concentrate efforts in major sectors and promote high level of diplomatic dialogue. The implementation of this recommendation could help the country to decrease the level of corruption rapidly which definitely will improve the level of FDI inflow. 5.2 Create an attractive law. The Law of Ukraine On Foreign Investment Treatment provides national treatment to foreign investors which means that foreign investors has the same right as national investors do, and no 60

additional benefits are granted to them. In some cases, a preferential treatment can be obtained for particular legal entities if they are carrying out investment projects with attracting foreign investment under the state priority industries development programs. Before the Law On Foreign Investment Treatment was launched there was a five-year profit tax holiday for the enterprises with foreign investments. From this case we can see that status of foreign investor in Ukraine has worsened which could be a case of FDI outflow from the country. Furthermore the situation is aggravated by excessively broad powers held by tax police and other governmental institutions in the country. In order to change the situation it is significantly important for the Ukrainian government to create a number of regulations which could give a right for foreign investors at least to have a kind of a preferential treatment at the first stage of doing business in Ukraine. It can be a tax holiday for the first years of doing business, special insurance program in case of bankruptcy, inflation or other problems, which may appear in the country. 5.3 Protect the right to own property. The privatisation in the country is still under development, which means that buying business property in Ukraine especially by foreigners is very complicated. Firstly, it takes a long time to sign all documents by government due to the high level of bureaucracy. The process of money refunding in case of re-privatisation also works badly. Furthermore the situation is aggravated by corruption in all government institutions. In addition according to the Ukrainian law, foreign investors are not able to own land. In order to change this situation Ukrainian government needs to adopt the law which can clarify all the aspects of buying business property in Ukraine and could help prevent bureaucratic tendencies. Owning farmland is a controversial issue for Ukrainian politics but it is clear that for improving the level of FDI inflow its important to develop a program by which foreign investors at least could have a right to rent a land for the long term period. 5.4 Measure for preventing inflation process. Its clear fact that inflation is a great factor which leads foreign investors to take their capital out of the country. In case of inflation the risk of losing capital increases rapidly and investors try to observe very careful all inflation processes in the country. Ukrainian currency Hryvna has been introduced in 1996. At the beginning of its existence Hryvna showed quite a stable position in marketplace and its rate to the US dollar was approximately 2:1. The first inflation process hit Ukrainian currency in 1997 when the Asian crisis started to spread around the world. Hryvnas

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currency exchange rate to USD felt to the point at 5:1. During the next seven years the situation stablised and the National Bank of Ukraine was able to manage the already existing rate. But political instability, financial crisis and decrease in demand for Ukrainian currency were a case for another inflation which hit the Hryvna in the end of 2008. At that time exchange rate to the US dollar has fallen to the point at 9:1. Later the Ukrainian Central Bank was able to stabilise the currency and set up the exchange rate approximately 7:1 (UAH:USD). But, it could be true to say that in current situation the Hryvnas position is still unstable and according to the opinion of western economists due to the still existing political and economic problems the possibility for further inflation still exists. In order to solve this problem the National Bank of Ukraine together with Ukraines government will have to implement programs which could prevent the national currency from further inflation. One of the good measures could be fixing Ukrainian currency with one of the worlds strongest currency such as EURO or US Dollar. This step could prevent further inflation but on the other hand it could make the currency dependable and national bank will lose its autonomy. Another measure is increasing the countrys gold reserve. It also can help to keep the currency rate stable but this operation require huge capital investment from the government budget and in current situation it could be difficult. One of the effective measures which could be suitable to the current situation could be cooperating in further political and economic stabilisation which will lead to making Ukraines currency more stable. 5.5 Create a free economy with less government interruption. As we know Ukraine is the post Soviet country where all economic processes were controlled by government institutions. Even now after the huge privatisation process which has taken place since 90s many companies in huge industries such as gas or power sector still belong to the government. In addition, the process of re-privatisation of the Krivorozstal which has happened in 2005 shows that level of government intervention in the business process is still very high. A country with a high level of government intervention into economic processes has never been very attractive for FDI inflow because of the threat of losing huge amounts of capital in case of re-privatisation or unfair tendering. In addition the Ukrainian tax police and other governmental institutions have a very wide range of authority by which they are able to intervene in the companys business which aggravates the situation even more.

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Further liberalisation of domestic law connected with international business and privatisation could increase the level of FDI inflow rapidly. A good example in this situation could be the privatisation processes in Great Britain which took place during the 80s when all the hard industries such as transport, coal mining, steel sector, ship building and others were privatised. During this process some domestic laws became more favorable for private investors and also a lower tax regime was introduced. This situation had become really attractive for the foreign investors and the level of FDI inflow increased rapidly which also helped to stabilise the economic situation in the country. Privatisation was fundamental to improving Britains economic performance. Just as nationalisation was at the heart of the collectivist program by which Labor Governments sought to remodel British society, so privatisation is at the centre of any program of reclaiming territory for freedom (Thatcher, 1993) 5.6 Establish an attractive taxation system. Even though the Ukrainian taxation system follows a principle of non-discrimination and equal terms of taxation for any business entity in the country, it could be true to say that taxes in Ukraine are high and the taxation system is overloaded with great number of different taxes, with more and more being introduced all the time. At the current moment there is 20 state taxes and duties, the most significant being corporate profits tax, VAT, personal income tax, payroll taxes. In addition, there are 16 different local taxes and duties. It means that foreign investors in Ukraine face great financial burden which can significantly increase their business cost. A situation like this cannot be an attractive factor for foreign investors and also can be a case of FDI outflow for the country. In order to improve the level of FDI inflow its significantly important to make the countrys taxation system more favorable for foreign investors. In this case the countrys government can implement options that could improve the situation: 1. Re-establish Special Economic Zones. Before March 2005 there were Special Economic Zones. They had been established for an extended period (20-30 years) to create a stable investment environment. SEZ provided a lot of advantages for foreign investors such as a five-year profit tax holiday and reduced taxation for up to eight years. The country has benefited greatly from SEZ. For instance the growth rate for investments from 1999 to 2001 throughout Ukraine was only 10.3 per cent annually, the SEZs averaged 27.8 %. During this period, entities operating in Ukraines SEZs produced goods and services at about 1,42 billion. In March 2005 the Ukrainian government canceled the existing of SEZ in the country. By canceling the SEZ the government expected to decrease the deficit in budget which had appeared in 2005-2006 but according to 63

some countrys economists this step didnt get desirable targets and even was a trigger for some companies to stop their business in Ukraine which in a long term will bring the outflow in budget. In purpose to set up new special economic zones government should develop a system of deduced taxes which can be suitable enough for investors and also could bring an income into countrys budget. 2. Improving double taxation treaties. It will be true to say that Double Tax Treaty network plays an important role in encouraging foreign investment. Currently Ukraine is working on widening its treaty network and today it concludes double taxation treaties with 43 countries. For improving the level of FDI into Ukraine its important to increase the number of countries which has double taxation treaties with Ukraine. 5.7 Decrease the level of bureaucracy. As I mentioned before the level of bureaucracy in Ukraine like in other post Soviet countries is extremely high which makes the way of doing business difficult and very stressful for foreigners. For instance, instead of simply entering your taxpayer code into forms as you do in the U.S. and EU countries, in Ukraine you will need to constantly present copies (sometimes notarised, sometimes not, and sometimes the original only) of the original taxpayer code certificate. . In order to take a business license more than 18 procedures need to be done and it takes about 218 days. In addition due to the low level of motivation the staff in governmental institutions are usually unfriendly and unable to understand basic question in any foreign language. Its obvious that for attracting foreign capital into Ukraine it is significantly important to change this situation. To decrease the level of corruption in the country the government has to provide the following changes:
1. Simplify the way of obtaining the business license by changing the hierarchy into governmental

institutions which can allow cutting down the number of procedures which need to be done and time.
2. Providing special testing and training programs for personnel which could ensure their

politeness and qualification.

3. Set up adequate salaries for the employees in governmental institutions, which will motivate

them do their work with dedication. 5.8 Provide further political stabilisation. As we know political stability is one of the most attractive factors for FDI inflow. Since the Orange

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Revolution which happened in 2004 the political situation in the country has become quite unstable. A lot of political alliances have been rearranged, the prime minister has been changed couple times during the short period in 2005-2006 and even a number of parliament elections have happened within a year. The countrys parliament is divided by major blocks which represent opposition and ruling parties. In order to stabilise the political situation in the country it is significantly important to provide co-working between opposition and ruling parties which can assure the world that Ukraine is trying to achieve political stability. 5.9 Create international awareness of existing opportunities. Ukraine as an independent country appeared on the worlds political map only in 1991 and a lot of companies especially in Asian countries know little about the Ukrainian market and opportunities which they can gain from by investing into Ukraines economy. Also as I mentioned before the Ukraines major trade partners is USA, Russia and EU countries and there are few trade connections with countries with emerging markets such as India, China, Brazil which mean that there is a lack of awareness between Ukraine and the worlds emerging markets. In order to change this situation it is important for the Ukrainian government to create an awareness about Ukraine as an attractive destination for investment which can bring dividends. It can be done by signing international trade agreement such as WTO which Ukraine has already joined in the last year. Co-operation with European Union, United Nations and other international organisations in questions connected with free trading, human rights and peace-keeping will increase the awareness about Ukraine as a country with big opportunities for potential investors.

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Conclusion
In conclusion I would like to say that Ukraine is one of the largest European countries which has appeared on the worlds political map in 1991 and still remains to be a young country with rapid developing market economy. We have realized that Ukraines economy has a great potential for rapid growth in the future which can be an attractive factor for foreign investors to set up their business in Ukraine. Ukraine already has existing well developed industries such as the steel sector which remains one of the largest in Europe, machine-building industry, food and light industry, agricultural sector which according to European scientists is able to produce food for the worlds increasing population, fast growing tourism industry and other industries which can be really attractive for foreign investors. But unfortunately Ukraine hasnt been able to meet its potential in the process of attracting foreign investors into the country due to the high level of obstacles which investors come across during the process of doing business in Ukraine. Improving the level of FDI in the country can be significantly important for Ukraines economy because it will bring capital into the countrys which is very important especially for the emerging market. Furthermore, inflow of foreign capital can create new jobs for Ukrainian citizens, which in a post crisis period is significantly important. For improving the level of FDI inflow in the country it is significantly important for the Ukrainian government to co-operate with business and public organisations to find ways for minimising the level of threats and obstacles which prevent the inflow of foreign capital into Ukraines economy. If Ukraine can resolve some of the existing problems which I have listed in my work by using the ways and methods which I mention above, I am inclined to think than the country will increase the level of FDI rapidly which will also help to improve the economic situation and can be the next stage in the process of joining the European Union

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