At this week’s Ukraine Recovery conference in London on June 21-22 speaker after speaker called on the world’s biggest companies to invest into Ukraine as the country seeks some €400bn to rebuild its smashed factories, housing and infrastructure.

"We must move from agreement to real projects," Ukrainian President Volodymyr Zelenskiy told the delegates via video link from war-torn Kyiv. "There is a Ukrainian delegation that will present concrete things and we propose to do them together during my tour.”

Zelenskiy went on to say the size of the reconstruction project is so huge that Ukraine will be a source of economic growth “for decades to come.”

But that will be very hard. After three decades of neglect, Ukraine’s failure to make the basic reforms to the capital market, judicial system and corporate governance regime means that most of the infrastructure and laws that underpin this type of direct investment is simply missing. Ukraine had a poor investment climate before the war and its track record of attracting foreign direct investment (FDI) is one of the worst in Europe – far worse than Russia’s. And that was before Russia invaded the country and threatened to annex it or worse.

The scale of the amount of investment needed is staggering. Pre-war the nominal size of the economy was a bit over $100bn, but World Bank estimated the cost of the damage done to Ukraine by Russia to be $411bn in April. Other experts like former Finance Minister Natalie Jaresko told bne IntelliNews that she believes the actual cost is closer to $1 trillion – and since she left Ukraine, she has been working for the US government and oversaw an economic recovery programme for Puerto Rico after it was devastated by Hurricane Maria in 2017 that cost $80bn.

The Western allies have been generous in their support. European Commission President Ursula von der Leyen announced that the EU was earmarking a new €50bn of macroeconomic support in its budget on top of the €25bn it has already allocated. And the other donors added an addition $5bn in fresh commitments. That is enough to keep the government running for several years, although von der Leyen said the EU estimates Ukraine needs a total of €110bn to run the government up until 2027 and the EU is offering 45% of that.

But that is enough to keep the government running, not to pay for the reconstruction of the economy. Where is that money going to come from?

Many have called for Europe to seize the circa €200bn of Central Bank of Russia (CBR) money frozen just days after the conflict started. However, the European Commission legal team repeated this week that it could see “no legal way” of seizing this money. The problem is Europe’s strong property rights make it impossible to for governments to arbitrarily seize other government’s property.

Austrian Foreign Minister Alexander Schallenberg told Bloomberg TV a few days ago: “We are rule-of-law states. We are defending a rules-based international order. So whatever we do in this endeavour has to be absolutely water-tight. It can be challenged, and it might be challenged in front of European or American courts. If any of these actions were to be lifted by a judge, it would be a diplomatic and economic disaster.”

Moreover, just taking the money by fiat could have serious consequences for the global financial system and the trust in the euro in particular, argued Gunter Deuber, the head of research at Raiffeisen Bank International in a column for bne IntelliNews.

Von der Leyen said that the EC is still mulling its options and will propose some sort of plan by the time it breaks up for summer in the middle of July.

Poor investment climate

In his opening remarks at the conference UK Prime Minister Rishi Sunak said that Ukraine was a “great investment opportunity before the war and it still is.” That is to stretch the point a little. Ukraine has always been a potentially great investment opportunity – the last big catch-up story yet to be realised in Europe – but thanks to its poor investment climate it has largely failed to attract much foreign investment cash over the last three decades.

The World Bank data shows that for all of the 1990s Ukraine was attracting less than $1bn a year. It wasn’t until the start of the noughties when the whole region began to recover from the collapse of the Soviet Union that any FDI arrived in notable amounts.

Between 2004 and 2008 FDI inflows soared from $2bn to peak at $10.7bn, according to the World Bank. These numbers have to be taken with a pinch of salt, as a third of Ukraine’s FDI stock is from Cyprus, a favourite offshore haven, and is typically Ukrainian money “round tripping,” so the official FDI numbers overstate the amount of “real” investment going in.

Starting in about 2006 Ukraine became briefly fashionable as “the next big thing.” Foreign investors rushed into the banking sector as the easiest way to get direct exposure to “catch-up” economic growth. Bank valuations soared to crazy eight times price-to-book in some cases, when one or two times is normal. For the big international players moving in, the local banks were small and the multinationals simply wanted quick access to a local bank licence rather than trying to go through the tortuous process of setting up their own bank, so they didn’t mind overpaying.

However, the global financial crisis that year nearly brought the sector down as credits went bad and the bubble popped. After a brief recovery rally between 2009 and 2012 FDI slumped again to fall to less than zero by 2015, the year after the Euromaidan revolution that ousted former president Viktor Yanukovych. That caused an economic collapse. At its worst point the GDP contracted by a massive 17% in the second quarter of 2015 – the worst result on record.

Even in the relatively good years between 2009 and 2012 the per capita FDI in Ukraine was just under $100 per person, compared with Russia’s just under $500 per person, according to the World Bank, and Russia has also always failed to attract significant FDI. In their heyday the countries of Central Europe were attracting several thousand dollars of FDI per capita as European investors rushed into these new markets, although the pace has eased off since then as these markets mature.

FDI started to recover again over the next four years, rising to $5.8bn in 2019 but collapsed again to near zero by 2020 as tensions with Russia started to rapidly escalate. FDI was growing once more in 2021, but following the start of the war will have collapsed to zero again, although the government has not produced any new FDI statistics since the outbreak of hostilities.

All these FDI results are disappointingly small by comparison to the rest of emerging Europe. Even the $10.7bn peak of 2008 is only 5.7% of GDP and FDI has never been much above 4% of GDP since then.

The almost total lack of effective reforms and poor business environment due to endemic corruption and an unpredictable legal environment have meant that what FDI that does go the region, almost all goes to Ukraine’s more attractive neighbours, many of them EU members with far more predictable business environments. In 2021, flourishing Poland was the favourite destination for FDI (and still is), taking a fifth of all inbound investment compared to Ukraine’s 3% – the worst in the region. (chart) Even Russia attracted 15% of the total simply thanks to the size of its market, followed by Turkey with 13.4%, according to GlobalData. Between them Poland, Russia and Turkey account for more than half of all FDI into the region in 2020.

And raising money in the current climate will be even harder, as the war means FDI into Europe as a whole stalled in 2022, rising only 1% compared with 2021, and remains 7% lower than in 2019, just before the COVID-19 pandemic hit, according to the annual EY European Attractiveness Survey 2023.

Ukraine does have a lot to offer. It has a huge agricultural and natural resource base. It has a large consumer market – the third-largest in Europe. It has a motivated and well-educated work force. And it has sensible geography and good transport and communications infrastructure. And it sits cheek by jowl with major EU markets. But what investment coming in is still cherry-picking a few opportunities in the local market rather than looking at large scale long-term strategic investments. Current investments are focused on the retail sector, and that is highly focused on just the capital; half of all Ukraine’s FDI in 2019-202 was invested in projects in Kyiv, with less being spent in Odesa and Lviv.

Sweetspots

Ukraine’s poor investment climate has put foreign investors off, but there are three notable exceptions: renewables, IT and logistics.

After the Maidan revolution, in an effort to wean the country off Russian gas, former President Petro Poroshenko introduced extremely attractive green power tariffs that started a new gold rush into solar and wind power farms. Over the next five years, Ukraine attracted about $5bn of investment – both foreign and domestic – into green energy, rapidly bring its share in the energy mix to about a quarter.

However, the green energy boom went sour in 2020 when the state refused to pay the new power companies and tried to retroactively reduce Poroshenko’s generous terms. A crisis was brewing as the foreign investors threatened to sue the government for breaking the terms of its investment guarantees until eventually the state issued a $1bn Eurobond and settled its debts in November 2021. Green power investments accounted for 19% of inbound projects between 2019 and 2020.

Software and IT services are even more important, accounting for 27% of the total in the same period, one of the most vibrant sectors in the economy. Ukraine has become a European hub for software development and services and this is one of the sectors mostly likely to attract real investment as part of Ukraine’s reconstruction.

The advantage of IT is that it doesn’t rely on physical infrastructure, nor does it have much interaction with the state other than the paying of taxes. Companies can be small, although some big tech giants such as the New York-listed EPAM have large teams of developers working in Ukraine too. Another advantage is the key markets for IT are the US, Germany and the UK, so the business is also not really subject to the vagrancies of the local legal environment, as contracts are all governed by the laws of foreign jurisdictions.

And following Zelenskiy's election in 2019 the mood was beginning to change and incomes started to close the gap with Russia. As bne IntelliNews reported in May 2021, Russia and Ukraine were both emerging from the coronacrisis and had had very similar experiences, but as the recovery got under way Ukraine started to rapidly close the gap with Russia.

Things were looking up. Ikea opened its first store in Kyiv, move than 20 years after it opened its iconic flagship story in Moscow, which is a sure sign of an emerging middle class. And both Phillip Morris and Carlsberg announced this week that they were investing into their Ukraine factories that will re-open soon, as that consumer story remains intact, albeit reduced.

Disputes

Despite the headline-grabbing arrival of a few multinational retailers and the leading FMCG investors who are always quick into new emerging markets, there are few notable FDI projects in the country. Austria’s Fischer makes skis in Ukraine, but that quirky investment goes back to the Soviet-era. German investors set up the Eurocar factory to assemble Skoda cars about ten years ago as the first serious investment into Ukraine automotive industry, but as bne IntelliNews reported, the plant was almost idle by 2018 and never fulfilled its potential of catering to Ukraine’s large population.

Foreign investments into Ukraine have occasional got themselves caught up in some nasty corporate disputes that are difficult to resolve thanks to the poor state of the judicial system.

A long-running shareholder dispute between Norway’s telecom giant Telenor and Russia’s Altimo, owned by oligarch Mikhail Fridman, for control of Ukraine’s leading mobile phone operator Kyivstar finally came to an end in 2009 when the partners agreed to a divorce.

Telenor was the majority shareholder in Ukraine's Kyivstar, with Altimo as the junior partner. However, the problem in Russia was that the roles are reversed, where Altimo was the majority shareholder in Russia's most successful mobile operator VimpelCom, and Telenor was the minority shareholder. Fridman was trying to merge the companies to build a “Vodafone of the East”, but when Telenor refused to play ball Altimo blocked the board of Kyivstar from functioning.

The dispute went to court in Ukraine, but a representative of Telenor told bne IntelliNews at the time: “It’s a nightmare, as every time you win a court decision, another small regional court pops up and overturns it. We have ended up running all over the country in a never-ending process.”

The failings of the judicial system were thrown into stark relief after oligarch Ihor Kolomoisky launched a legal campaign to force the NBU to return his PrivatBank, which was nationalised in 2016 after he had allegedly stolen some $5.5bn using fake loan scams. Kolomoisky launched over 200 legal suits and what the NBU called a “campaign of terror” against the central bank, including physically threatening its staff. At the time, Ukrainian President Volodymyr Zelenskiy seemed powerless to prevent Kolomoisky from blatantly abusing the judicial system, although he eventually acted, introducing the so-called Anti-Kolomoisky banking law and then stripping him of citizenship.

The case of the seizure of the assets of Smart Holding in April, including two of Ukraine’s largest gas fields, ran in the opposite direction. This time the state seized the assets of billionaire businessman Vadym Novynskyi in a matter of a few days. He was accused of abetting the Russian state, but there was no court decision and the company was given no legal recourse to contest the allegations against it. Novynskyi, a priest in the Ukrainian Orthodox Church, has since fled into exile.

Zelenskiy’s speech and appeal to the international business elite made it clear he is well aware of all these problems – and was aware of them before the war started. His administration has continued with the reform agenda despite the distraction of fighting a war against Russia. There have been the first cases of high-level officials being arrest and convicted of corruption.

Ukraine's Security Service (SBU) reported on June 2 that it was bringing charges against Mykhailo Kiperman, one of Kolomoisky's business partners, for embezzling nearly UAH600mn ($16mn) from the oil refining company Ukrtatnafta.

And the Ukrainian Corruption Court sentenced former judge Chaus to ten years in prison for accepting a $150,000 bribe back in 2016, making an extremely rare precedent.

Zelenskiy has been pushing reforms of the legal system hard and apparently to good effect. At the Ukraine Recovery conference von der Leyen announced that Ukraine had completed two out of seven of the tasks that the EU had set ahead of accession negotiations to join the EU –  including improvements to the judiciary. But will it be enough to convince the world strategic companies and hedge funds to invest hundreds of millions of dollars into Ukraine?