Ukraine sits at a crossroads, one road leading toward democracy and prosperity, with Ukraine taking its place among thriving European economies, and another with its great potential constrained by corruption and government mismanagement. Positive change is underway, hard fought macro-economic stability has led to positive growth as the government continues to grind out difficult reforms. In 2017 the Ukrainian Government will have to navigate a number of significant challenges. These include a possible reshuffle of both the ruling coalition in the parliament (Verkhovna Rada) and the government, negotiation of energy supplies to fuel the economy, and continued economic and military aggression from Russia. The Government of Ukraine has focused on efforts to improve Ukraine’s Ease of Doing Business rating, including by advancing deregulation reforms and by standing up a number of investment promotion agencies. The biggest obstacle to Ukraine’s success is endemic corruption, with reformers facing off against powerful vested interests to bring increased transparency and accountability to Ukraine’s business environment. The task ahead remains daunting, and Ukraine continues to look to the United States and Europe for continued support in many spheres.
Positive and Negative Aspects of Ukraine’s Investment Climate
The Ukrainian economy posted real GDP growth of 1.5 percent in 2016, and the IMF forecasts growth of 2.5 percent in 2017. However the government continues to struggle with structural problems. Ukraine’s currency, the hryvnia, remains largely stable even as the National Bank of Ukraine (NBU) has continued to lift administrative controls that it had levied during the post-Euro-Maidan banking crisis. Ukraine produces sufficient basic foodstuffs domestically (albeit with foreign-sourced inputs like seeds), but relies on imports for most consumer goods, gasoline, automobiles, and clothing. Inflation was 14.2 percent year over year as of March 2017 and is expected to decrease to 9 percent by the year end. Meanwhile, Russia’s ban on Ukrainian dairy, chocolate, fruits, and vegetables announced in 2015 has forced Ukraine to undergo a significant reorientation of its export markets. Russia has since fallen behind the EU as Ukraine’s largest export destination; exports to Russia represented only 9.9 percent of Ukraine's total exports for 2016, down from 24 percent in 2013. On top of an aging infrastructure system already in need of repair, the conflict with Russian led separatists in eastern Ukraine has wrought significant damage to freight rail, mines, and industrial facilities (historically centered in the Donetsk and Luhansk regions). This in turn has severely curtailed Ukraine’s heavy industry exports, a key source of precious foreign currency and middle-class jobs. In March 2017, the Government of Ukraine banned commercial trade with separatist-controlled territories, which have provided coal and industrial inputs to Ukrainian industry and consumers regardless of the conflict in the east. As part of Ukraine’s Association Agreement with the EU, the Deep and Comprehensive Free Trade Area has been in effect since January 1, 2016.
The United States has provided three USD1 billion loan guarantees to the Government of Ukraine since 2014, most recently in September 2016. In March 2015, the International Monetary Fund approved a four-year, USD17.5 billion program for Ukraine. Ukraine’s program envisions difficult but necessary reforms in 2017 including pension and land reform as well as additional anti-corruption measures and privatization of state-owned enterprises. Energy sector reform is ongoing, with key pieces of legislation being passed or drafted by the Rada. In November 2016, the Rada passed the Energy Regulator Law, which finally established an independent energy regulatory commission, but implementation of the law, including rotation of current politically-appointed regulatory commissioners has been behind schedule. The Ministry of Finance launched an electronic VAT refund registry April 1, 2017, a long awaited reform that will bring transparency and efficiency to the VAT returns system. The Rada also passed in its first reading a new Electricity Market Law, which, when finally approved and implemented, will liberalize the power generation sector in Ukraine.
Ukraine’s Key Sectors
Ukraine is an agricultural powerhouse, representing the world’s third-largest grain producer (behind the United States and the European Union) and has been a profitable country for foreign investors. Domestically oriented sectors like construction have traditionally attracted more foreign direct investment than export-oriented manufacturing. Within the manufacturing sector (11th largest steel producer), metallurgy and food processing have attracted investors ahead of machine building and the chemical industry. Even with ongoing reforms to reign in corruption and burdensome regulation, Ukraine is still seen as a difficult place to do business. However, several major U.S. companies are represented here, particularly in the agriculture, consumer goods, and technology sectors.
Ukraine deserves special mention regarding its IT service and software R&D sector – this sector has demonstrated double-digit growth year-over-year. U.S. technology firms conduct R&D activities in Ukraine and an array of local IT outsourcing companies of all types and sizes serve clients worldwide. The export volume of Ukraine’s software development industry increased 15 percent in 2016 (USD2.5 billion in 2015) and is considered the number three export sector. This sector of Ukraine’s economy shows great potential due to the country’s large, skilled workforce.
Key Watch Items: Crimea and Donbas
Investors should note that the situation in both Crimea (unlawfully occupied by Russia in the spring of 2014), and in occupied districts of Donbas remains dire. The investment climate in both of these areas continues to be poor, characterized by a lack of governance, transparency, rule of law, and stability. American companies are prohibited from participating in certain transactions in Crimea, which is subject to sanctions under Executive Order 13685 dated December 19, 2014. Media reports suggest that Crimean “authorities” do not respect property rights and have “nationalized” and/or confiscated a sweeping array of business assets. Crimeans face scheduled blackouts due to a deficit of power generation on the peninsula following the cutoff of Ukrainian electricity in December 2015. Businesses that do operate there report difficult conditions for their personnel as local “authorities” attempt to enforce foreign law and require the adoption of Russian documentation. The situation in the Donbas (portions of Luhansk and Donetsk oblasts) controlled by Russian-backed separatists continues to be volatile. Those businesses remaining in this zone have reported work stoppages, illegal “taxation,” and the kidnapping of company personnel, all at the hands of the Russian-backed separatists. Ukrainian banks have ceased operations in the region, and the Ukrainian Government is unable to provide basic services. The blockade of separatist controlled territory, initially started by volunteers at the end of January but backed by the Ukrainian Government on March 15, bans all trade with separatist-controlled territory. Where previously damaged road and rail systems in the Donbas left businesses with limited or costly means to receive inputs or move product, the government-backed blockade has stopped all movement of goods across the contact line, including coal required for Ukraine’s steel and thermal power plants. In March, separatists seized Ukrainian-registered steel, metallurgical, and energy assets that had been operating on non-government controlled territory, forcing Ukrainian owners to fire staff in order to remain complaint with Ukrainian laws. Ukrainians living in non-government controlled territory report power and water outages due to the conflict, shutoffs because of nonpayment for electricity, and dwindling supplies of coal for power plants.
Table 1: FDI Indicators