Improving Ukraine

1
Improving Ukraines Investment Climate
Dr. Edilberto Segura SigmaBleyzer, The Bleyzer
Foundation January 2008
v2
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Economic Performance

• Between 2001 and 2006, few countries showed
  the following combination of economic
  achievements 
• High average rate of economic growth
• Low fiscal deficits
• Moderate inflation rates of about 10-12 pa
• Good external fundamentals (with large surpluses
  in the current account)
• Fairly stable foreign exchange rate
• High international reserves in excess of three
  months of imports
• Very low ratio of external public debt to GDP
• However, 2007 already showed some signals of
  economic, disequilibrium both external (with a
  3.0 CA deficit) and internal (with inflation at
  16.6).

  2001 2002 2003 2004 2005 2006 2007(e) 2008(f)
Real GDP Growth 9.2 5.2 9.6 12.1 2.7 7.3 7.3 5.5
Fiscal Balance ( GDP) -0.3 0.7 -0.2 -3.2 -1.8 -0.7 -1.8 -2.0
Consumer Inflation (eop) 6.1 -0.6 8.2 12.3 10.3 11.6 16.6 13-15
Exchange Rate (Hr/, eop) 5.30 5.33 5.33 5.31 5.05 5.05 5.05 5.05
Current Account (bn) 1.4 3.2 2.9 6.8 2.5 -1.6 -4.0 -10.0
(as of GDP) 3.7 7.5 5.8 10.6 2.9 -1.5 -3.0 -5.5
International Reserves (bn) 3.1 4.4 6.9 9.5 19.4 22.3 32.5 34.0
Foreign Public Debt ( GDP) 26.3 24.1 21.3 18.7 13.4 11.9 10.0 9.0
Source State Statistics Committee of Ukraine,
National Bank of Ukraine, Ministry of Finance of
Ukraine, The Bleyzer Foundation
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Medium Term Outlook

• Past economic growth was supported by increases
  in private consumption (which grew in 2004-2007
  by around 16), fixed investments (surging on
  average by around 17 in 2004-2007) and export
  growth in 2004, 2007.
• The increases in private consumption were
  associated with major increases in pension
  payments and public wages approved by the
  government, as well as continuing credit boom
  (surging in 2004-2007 by almost 60 p.a.).
• Exports benefited from high metal and chemical
  prices and reasonable external conditions for
  other commodities (i.e., machinery and transport
  equipment).
• Unfortunately, consumption and export as a
  sources of growth are unlikely to be maintained
  in the future
• Consumption increases are already been reflected
  in high inflation.
• Export prices for metals are unlikely to increase
  in the future.
• Therefore, over the medium term the country will
  not be able to rely on increased private
  consumption and exports as the main engines of
  growth.
• In order to achieve strong and sustainable
  economic growth in the long-run the country will
  require new investments and technology.
• This will require major improvements in the
  investment climate.

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Break-through to knowledge based economy

• To ensure sustainability of the economic growth,
  Ukraines top priorities for 2008-2009 should
  include comprehensive efforts to improve
  countrys investment climate, stimulate
  investments in knowledge and innovations, other
  structural changes in order to boost productivity
  growth
• Based on extensive theoretical and empirical
  research, there is a broad recognition among
  economists and policy-makers of the positive
  impact of human capital, RD, technological
  progress and innovation on productivity and
  economic growth
• In order to advance towards the knowledge-based
  economy, Ukraine needs to invest in high
  technology sectors and promote knowledge
  diffusion across economy. Investments in the
  knowledge-based economy must be channelled into
  (i) highly-skilled human capital (ii) capacity
  and quality of education systems (education
  spending and life-long learning), (iii) purchase
  of new capital equipment that spread innovative
  technologies and managerial know-how.

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Ukraine in Global Competitiveness Index 2007-2008
Source World Competitiveness Report 2007-2008
According to the latest World Competitiveness
Report, weak technological readiness of Ukraine
continues to exact a visible toll on countrys
competitive position. Hence, encouraging foreign
investments into the high technology sectors is
key to maintain and advance countrys global
competitive advantages.
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Improving the Countrys Business Environment

• The governments program should include measures
  in the following areas
• Public and Corporate Governance
• Macroeconomic Stability
• Stable and Predictable Legal Environment
• Liberalization and Deregulation of Business
  Activities
• Removal of International Capital Foreign Trade
  Restrictions
• Facilitation of Business Financing by the
  Financial Sector
• Reduce Corruption
• Country image
• Political risks

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Future Reform Agenda for Ukraine

• 1. Implement a fundamental public administration
  reform
• The weaknesses of Ukraines public administration
  including cumbersome decision-making,
  bureaucracy, unclear and overlapping
  responsibilities -- are major constraints in the
  implementation of economic reforms. The country
  can design policies, but fails in implementation.
  Without public administration reform, it is
  likely that needed economic reforms will be
  implemented very slowly or will be reversed
  quickly.
• A reform of public administration should include
  the following
• clearly define the Objectives/Role of the
  Government limiting it to public goods and
  support - not substitution of the private
  sector
• Undertake a comprehensive audit of all
  government programs, with a view to transfer some
  of them to local governments, sub-contract others
  to the private sector and eliminate
  unnecessary/overlapping activities.
• develop the concept of well-defined Programs and
  Projects for all government activities (this
  will help to improve administrative efficiency,
  deal with corruption and also bring equilibrium
  to the fiscal budget)
• Improve the efficiency in retained core
  government activities and local governments,
  increasing public transparency and access to
  government information.
• Carry out a civil service reform introducing
  effective "Incentives" and "Control Systems

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.Future Reform Agenda for Ukraine

• 2. Improve macroeconomic Stability by
  strengthening fiscal policies (improving tax
  administration, reforming the pension system,
  decentralizing financing), monetary policies
  (developing techniques for inflation targeting
  open market operations, forecasting models) and
  foreign exchange rate policies (abandoning the
  exchange rate anchor)
• 3. Improve the legal environment by
• Improving the practice of public consideration
  of any legislative act to be adopted, including
  their correspondence with existing legislation.
• Ensure the independence of the Judiciary by
  further improvement of the financing of courts.
• Improve court administration and enforcement
  procedures.
• Deal expeditiously with issues of illegal
  corporate raidering.
• 4. Accelerate further quick deregulation and
  liberalization of business activities (permits,
  licenses).

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.Future Reform Agenda for Ukraine

• 5. Develop sound Corporate Governance practices
  by enacting key pending legislation (e.g., the
  Joint Stock Companies law), abolishing the
  Commercial Code while amending the Civil Code,
  developing corporate governance codes, and
  accelerating the adjustment of Ukrainian
  accounting standards to international accounting
  standards.
• 6. Liberalize trade, join the WTO, sign free
  trade agreements with the EU, CIS, and other
  countries, and simplify trade clearance
  procedures.
• 7. Strengthen the Financial Sector, particularly
  by enforcing banking regulations and supervision.
  
• 8. Implement a prevention program to deal with
  Corruption
• 9. Improve the countrys image by strengthening
  an Investment Promotion Agency and implement
  specific activities for large investors (identify
  major projects, carry out targeted promotional
  campaigns, identify niches/sectors) and for
  small/medium firms (access to bank credit, better
  information on laws, etc).

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Ukraine is an Attractive Country for Investment

• Highly educated labor force (almost 60
  university enrolment)
• Low wages
• Border on the EU, with increasing trade potential
• Large domestic market (large population with
  growing purchasing power)
• Great agricultural potential
• Industrial and high-tech potential
• Likely prolonged period of significant economic
  growth
• Inefficiently run companies provide significant
  opportunity for value creation through improved
  operations, marketing, finance, customer and
  quality focus bottom line growth
• Growing interest in the country by multinationals
  and other investors
• Ukraine is the only post-Soviet country (in
  addition to the Baltic states) that is rated by
  Freedom House as a free country
• But there is strong competition to attract FDIs
  and Ukraine has a below average investment
  climate, as shown in the following country
  ratings of investment climates.

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1. Public and Corporate Governance

• CORPORATE GOVERNANCE
• Accelerate the adoption of the Joint Stock
  Company Law
• Speed up the adjustment of Ukrainian accounting
  standards to international accounting standards.
• Remove inconsistencies between the Civil and the
  Commercial Codes by eliminating the Commercial
  Code and passing some of its provisions to the
  Civil Code.
• Develop corporate governance codes.

• PUBLIC GOVERNANCE
• Redefine the Government's Role towards Supporting
  Private Sector Activities
• Undertake a comprehensive audit of all
  government programs, with a view to transfer some
  of them to local governments, sub-contract others
  and eliminate unnecessary/overlapping activities.
• Improve efficiency in retained core government
  activities and local governments, increasing
  public transparency and access to government
  information.
• Carry out civil service reform introducing
  effective "Incentives" and "Control systems

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2. Macroeconomic Stability

• Pursue sustainable fiscal budget policies,
  including improvements in tax administration and
  expenditure controls, reform of the pension
  system, and decentralization of
  financing/execution of some government
  activities.
• Pave the way for adopting monetary policy based
  on inflation targeting.
• Strike a reasonable balance between social,
  political and economic dimensions of policy
  decisions.

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3. Stability and Predictability of the Legal
Environment

• Improve the practice of thorough consideration of
  any legislative act to be adopted, including
  their correspondence with existing legislation.
• Ensure the independence of the Judiciary by
  further improvement of the financing of courts.
• Improve court administration and enforcement
  procedures.
• Drastically enhance enforcement of rights and
  contracts.

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4. Liberalization and Deregulation of Business
Activities

• Secure effective implementation of the second
  phase of the quick deregulation strategy.
• Increase stability of existing regulations by
  avoiding frequent changes in legislation
  concerning business activity.
• Improve coordination between central and local
  government bodies on regulatory policy issues by
  avoiding conflict of interests between different
  levels of executive power and making clear
  distinctions in the area of their
  responsibilities.

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5. Liberalization of Foreign Trade Capital

• Ensure entry into the WTO as soon as possible.
• Promote signing free trade agreements with the
  EU, CIS and other countries.
• Continue streamlining customs procedures and
  formalities to ensure prompt consideration and to
  avoid opportunities for rent seeking behavior.
• Soften export restrictions and eliminate import
  nontariff restrictions.
• Ease the system of certification and
  standardization to acknowledge international
  standards.

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6. Financial Sector Development

• Better enforce banking regulations and
  supervision
• Ensure equal "playing conditions" for domestic
  and foreign banks.
• Provide mechanisms to deal with risky unsecured
  debts issued by commercial banks
• Encourage stock market transactions to be made on
  the organized market.
• Stimulate development of nonbanking financial
  sector by introducing a framework law on
  nonbanking financial institutions.

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7. Corruption Level

• Implement a corruption prevention program,
  including public administration reform to improve
  transparency of decision making process and
  procurement procedures.
• Reduce the ambiguity and discretion of government
  regulations and raise accountability of the
  public servants for their decisions by
  introduction of e-governance resources.
• Strengthen the capacities of the internal audit
  and make it fully accountable for public.
• Accelerate the creation of independent
  anticorruption agency.

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8. Country Image

• Strengthening an Investment Promotion Agency and
  implement specific activities for large investors
  (identify major projects, carry out targeted
  promotional campaigns, identify niches/sectors)
  and for small firms (access to bank credit,
  better information on laws, etc).
• Resolve outstanding investment disputes with
  foreign investors ensure fair treatment of
  foreign investors in courts.
• Engage the country's embassies and other missions
  to disseminate up to date information on Ukraine
  and its business opportunities.

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9. Political Risks

• Take measures to eliminate power abuses at
  different levels of government.
• Accelerate Public Administration Reform.
• Ensure predictability and public consensus on
  political reforms in the country.
• Ensure political stability by developing a long
  term strategy on establishing the effective
  balance of powers and sustainable civil society.
• Achieve balanced distribution of gains from
  economic and structural reforms. Avoid
  disproportionate allocation of economic and
  social hardships to selected groups of
  population.

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Overall Investment Drivers Country Ratings
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The Role of Techno Parks

• Poorly designed Industrial and Technology Parks
  have failed in many countries, including the Free
  Economic Zones of Ukraine.
• The weaknesses in Ukraine included
• Patchy legal framework, with contradictory
  regulations, which frequently resulted in tax
  evasion and abuses of tax and customs privileges.
• Ad hoc incentives and tax privileges led to
  distortions and rent-seeking behavior.
• Week infrastructure and technology support.
• Lack of seed capital for start-up companies.
• Poor management and administration of the parks,
  with overlapping responsibilities and many cases
  of corruption.
• As a result, these initiatives were abandoned in
  Ukraine.
• Nevertheless, required improvements in Ukraines
  overall countrys investment climate will take
  time, even if pursued energetically.
• International experience shows that prudent
  administration of Industrial and Techno Parks
  helps to trigger country-wide liberalization of
  business environment and promote technological
  development.
• Therefore, in the meantime, the government could
  use well-designed Industrial and Technology Parks
  as pilots to accelerate investments and
  technology innovation.

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High Potential For Knowledge Economy in Ukraine
Ukraine Selected Technology Indicators
percentage of surveyed countries performing
worse than Ukraine

• Despite obvious technological bottlenecks,
  Ukraine possesses key resources that, under
  adequate management, can trigger successful
  development of technology and innovations
• Highly educated and low cost labor force
• High enrollment rates in universities and
  exceptionally strong educational and research
  potential in engineering, cybernetics,
  programming and mathematics
• Established tradition of scientific and applied
  industrial research
• Developed network of research and educational
  facilities.

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Policies to Develop Technology Parks in Ukraine

• By Law, the government established 16 Technology
  Parks in various Oblasts.
• But not all are operative, and most face
  weaknesses that undermine their growth, including
  poor infrastructure, poor property rights and
  lack of investments and financing.
• To seriously developed Technology Parks, the
  Government should
• Cooperate with the private sector to develop a
  national vision and strategy on science and
  technology.
• Entrust the management of these parks to a
  partnership between private companies and the
  government
• Develop stable regulations and tax treatments.
• Limit Government support to the needed initial
  infrastructure.
• Strengthen and simplify customs procedures
• Encourage knowledge transfers through industrial
  clusters
• Facilitate start ups of innovation companies
• Heavily invest into the human capital
• Liberalize the telecommunications industry