When will Ukraine’s economy reach critical mass and start

the virtuous circle of profits, investment, rising wages and ballooning consumption? Of all the countries in the former socialist block, Ukraine is one of the last to begin its “catch up” growth spurt, but with a new raft of reforms and the first ever push-back against the oligarchs by the government, the take-off may be close.

UkraineInvest, the government investment promotion agency, has just had an injection of fresh blood as the Zelenskiy administration cranks the handle of the foreign investment engine. Sergiy Tsivkach recently took over as CEO of UkraineInvest and talked to bne IntelliNews on the sidelines of the German-Ukraine annual investment conference in Berlin on March 19.

“This forum is about aligning Ukraine and German co-operation strategies. It was opened by German Chancellor Angela Merkel, who called on more German companies to invest into Ukraine, and Ukraine’s Prime Minister Denys Shmyhal, as well as including sessions on specific investments,” Tsivkach told bne IntelliNews in an interview in the locked down German capital.

Germany is an obvious port of call for an Eastern European country looking to raise more foreign direct investment (FDI). It is already fifth-biggest investor in Ukraine in terms of the FDI stock, following the Netherlands, Cyprus, UK and Switzerland.

“But Germany is one of the leaders in terms of “real industrial investment” in Ukraine,” says Tsivkach. “And there are a lot of German companies already operating in Ukraine, including Metro, BASF, KNAUF and others. As of the third quarter of last year the total German FDI stock was €1.9bn.” And as is usual, an early and very large investor has been the European Bank for Reconstruction and Development (EBRD) that has dramatically ramped up its investment activity in the country in the last few years, as part of its work to help develop an attractive investment climate. A pick up in the EBRD’s activity is usually a harbinger for increasing private investment.

To hammer home the point, EBRD President Odile Renaud-Basso was in Kyiv this week and said that state-owned enterprises stand to gain the most from radical reforms.

She told reporters: “The EBRD and Ukraine have been strong partners for almost three decades now. Ukraine is a top-three investment destination for the EBRD. In the past two years alone, the Bank has committed €2bn of investment to the Ukrainian economy. We provide a comprehensive support package for the country to assist its stabilisation, the anchoring of its reforms and sound, inclusive and sustainable growth.”  Among sectors with the highest potential cited by Renaud-Basso are: agriculture, energy, transport, information technology.

“There is a huge potential in Ukraine, especially in its people and its youth. Pursuing the reform agenda is key for the economic development. Structural weaknesses remain and weigh on the pace of economic growth, while labour productivity remains below other countries in the region. Progress in key areas of governance would provide a level playing field for investors and entrepreneurs, which is crucial for unleashing the growth potential of the Ukrainian economy,” said Renaud-Basso.

With a large population, an educated and skilled work force, and situated in the heart of Europe, potentially Ukraine has a lot going for it. But it remains a hard sell. The political instability, the slow progress on reforms and a war in the eastern part of the country all put investors off. The government is trying to do something about that.

In February the government launched a New Economic Strategy 2030 (NES2030) that introduces a number of investment incentives – including the much touted “investment nannies” – with which the government hopes to increase FDI from the zero FDI it received in 2020 to $15bn a year by 2030.

Changing the investment climate

Ukrainian President Volodymyr Zelenskiy was elected on a wave of optimism in April 2019, but the reality of making changes that have been ignored for some three decades is much tougher.

Scandal and war dominate the international headlines, but the country has already made significant progress in some areas. The banking sector has been cleaned up and ended 2020 with its best month-on-month profits in four years, the coronacrisis notwithstanding. The lingering problem of high non-performing loans (NLPs) have now be provisioned for and don't represent a danger to the system anymore.

A crucial new law on the sale of land has also been passed, albeit watered down and delayed from the more radical draft version. And most recently the Cabinet of Ministers has put in place a set of laws to define the conditions and perks for inbound investors.

“For the first time since independence the president signed off on a law to support significant investment for sums over $20mn over five years that will receive significant state support,” says Tsivkach. The support comes in form of things like tax breaks, low rents on land, reduced duties, connection to grids and construction of necessary infrastructure that in total will be equivalent up to 30% of the total amount invested. The law just came into effect in February and now the government is working on the all-important instructions that lay out the details of how the law should be applied.

The support comes in the form of things like tax breaks, low rents on land, reduced duties and attractive leasing rates on property that in total will be equivalent to 30% of the total amount invested. The law just came into effect and now the government is working on the all-important instructions that lay out the details of how the law should be applied.

The new investment law is designed to attract international investors but the same law applies to domestic investors, as the government wants to encourage investment across the board and believes creating strong local players, who can become partners with international investors, will pull in more FDI in the long run.

Indeed, Tomas Fiala, the CEO and founder of Ukraine’s biggest investment bank, Dragon Capital, already said in the middle of March that he was looking at the new rules and considering investing into two industrial parks, making use of the benefits on offer.

Privatisation redux

Another big plank of the Zelenskiy shake-up is to re-launch the privatisation programme, which has already seen some old disused prison buildings sold off and an iconic hotel in the heart of Kyiv. Bigger assets are in the pipeline to go under the gavel later this year, which will also be supported by the new investment law.

There are several big companies that have been on the list for years that were temporarily removed from the list while the coronavirus (COVID-19) ravished the country in 2020, but these restrictions are expected to be removed soon and those companies put back under the gavel.

On February 4, the Verkhovna Rada supported the draft law 4543 on unlocking transparent large-scale privatisation auctions in the first reading. The adoption of this bill in the second reading eliminates the last barrier to attracting sustainable investment through large-scale privatisation in Ukraine’s economy.

And the state has a lot of sell. The former president of Georgia and now a Ukrainian politician, Mikheil Saakashvili, said in a Kyiv Post opinion piece recently that the state-owned enterprises (SOEs) cost the Treasury $6.1bn a year and that Ukraine has 63 times more state companies than Poland and 76 times more than Sweden.

In 2021, the State Property Fund plans transparent tenders for the sale of the United Mining and Chemical Company (UMCC), JSC "First Kyiv Machine-Building Plant" ("Bolshevik" plant) and the President Hotel, among other assets.

Several new classes of state property have been added to the list. Online auctions for oil and gas deposits have already happened and more recently the country's significant reserves of non-ferrous and rare-earth metals, including unique deposits of beryllium, zirconium, tantalum and rare-earth metals, have come into focus.

“Ukraine’s estimated reserves of lithium are [some] of the largest in Europe. The country also has a real opportunity to enter the global market with pure and ultra-pure metals and other natural resources such as hafnium, cobalt, gold, zirconium, as well as gas and crude oil… Ukraine just needs to harness its mineral resources to thrive. For this to happen, new technologies and large investments are needed,” says Tsivkach.

With China accounting for 80% of rare earth imports into the US, Ukraine could benefit from Washington’s growing nervousness about supplies, mining experts say. Rare earths are essential for production of goods ranging from smart phones to fighter jets, Bloomberg argued in a recent editorial.

Some deals have already been done. With a population of around 35mn people (there is a dispute over the exact size of the population due to labour migration and the fact a full census has not been carried out for years), Ukraine is third largest retail market in Eastern Europe. German cash-and-carry firm Metro has already moved in and Swedish furniture store IKEA just opened its first branch in Kyiv.

Maybe more significant is that last year Ukraine signed off on the largest concession deal in its history: Qatar-based terminal operating company QTerminals won a UAH3.4bn ($138mn) concession to operate the Port of Olvia, as part of the state’s goal to develop its transport infrastructure. Tsivkach says there are another 16 similar concession projects in the pipeline that should generate around $2.4bn of deals in the coming years.

But the privatisation process is going slowly. A modest total of UAH3bn ($111mn) worth of state property was sold in 2020 but the plan for 2021 is to quadruple that to UAH12bn.

The main fly in the ointment to selling off the biggest and most valuable assets is the oligarchs that have stuffed many of these assets with poison pills such as large debts or threats of legal action if anyone else takes control of the asset.

Encouraging, the head of Ukraine’s State Property Fund (SPF) Dmytro Sennychenko said out loud that the oligarch groups are actively trying to derail Ukraine’s privatisation programme by using law enforcement agencies to illegally raid objects slated for sale in comments in January, in a rare public admission of the main obstacle to privatisation.

“Large-scale privatisation is on the way and is very important for Ukraine, as many large SOEs still have vested interests and privatisation is needed to clean the system and root out corruption,” says Tsivkach.

“If all these changes are made then the privatisation revenues could go up ten-fold to UAH100bn,” says Tsivkach. “President Zelenskiy takes this very seriously. This was one of his initial promises.”

Decentralisation and judicial reforms

Another unsung reform success has been the efforts to decentralise government and make local government more accountable to its community. The reforms to decentralise government are now in their final phase and it has led to local government being more responsive to the local population’s needs and wants.

“Decentralisation has introduced regional competition as the local leaders all want to attract investment,” says Tsivkach.

The improvements in local government have been welcomed by regular Ukrainians but a general overhaul of the judiciary remains on the to-do list and is another major concern for foreign investors.

“The National Security Council has signalled that it wants to change the system to provide all legal means to protect the Ukrainian people. This is the first time that the change has come from the top,” says Tsivkach. “We have never seen this before – a top-down approach to tackle corruption and vested interests. Also, going after the big fish has never been seen before. The president is willing to change the country.” Fighting corruption remains at the heart of improving Ukraine’s investment climate and it seems that the Zelenskiy administration has finally grasped the nettle after the president make an “oligarch speech” in the middle of March, calling for Ukraine’s top business to get out of politics and concentrate on doing business.

Zelenskiy speech was unprecedented and echoes Russian President Vladimir Putin’s famous oligarch meeting shortly after he took office where he told Russia’s oligarch they can keep what they have, but to stop the stealing. In Ukraine the jury remains out as to how sincere the new efforts to curb the oligarchs influence is, but Zelenskiy's call to action has already been met with another unprecedented decision by the US government to impose sanctions on oligarch Ihor Kolomoisky, who has been actively working against the government and the reform programme.

Kolomoisky is a controversial figure. A personal friend of Zelenskiy, Kolomoisky bankrolled his presidential bid and is credited with putting him into office after Kolomoisky threw his considerable media assets behind Zelenskiy's campaign. However, more recently the president has been forced into a choice between doing a deal with the IMF and supporting his friend, and increasingly it seems Zelenskiy is coming down on the side of the Ukrainian people. Zelenskiy openly supported the US sanctions on his friend and mentor on March 13.

The Kolomoisky saga was supplemented by a radically departure from the past after three senior former managers of PrivatBank were named in a fraud investigation in February. The bank that used to belong to Kolomoisky but was nationalised in 2016 after a $5.5bn hole was found in its balance sheet. As bne IntelliNews reported at the time, the management had been making billions of dollars in related party loans and sending the money offshore. Yet no one at the bank has been investigated or charged with looting the bank since then.

The state was forced to pump in $5bn of fresh capital – by far the biggest bank bailout in Ukraine’s history and one of the biggest bailouts in the whole Former Soviet Union (FSU) – to rescue the bank, which is now under state management and once again in profit.

After four years of total inactivity, an investigation has been launched and the former CEO Oleksandr Dubilet along with first deputy of the bank Volodymyr Yatsenko named as suspects. Yatsenko tried to flee the country just before the announcement but had his plane ordered to the ground and was then taken into custody. Dubilet is reportedly in exile in Israel.

If all this adds up to a sustained and successful attempt to curb the influence and avarice of the oligarchs then it could set the stage for Ukraine’s take-off.

It’s still too early to say if that virtuous circle will start turning, but many of the necessary pieces are falling into the place. The effort will be helped by the general economic bounce-back following the shocks of 2020 that should prime the pump. After an unexpected mild 4% economic contraction in 2020 the economy is anticipated to grow by between 4.6% and 5.1% this year, according to various predictions, which could start the virtuous investment-consumption wheel turning.

UkraineInvest is committed to making this happen. Tsivkach says the focus is to attract industrial investment, what he calls the “New Asia” in Europe where among other goals UkraineInvest is hoping to attract Asian companies selling in Europe to re-locate production to Ukraine to shorten their supply chain and increase their profits.