Earlier this year, two of Ukraine’s largest cement manufacturers, the Germany-based Heildelberg-Cement and Dyckerhoff, with a combined market share of more than 45%, released a joint statement claiming they had become “victims to inexplicable and groundless pressure” from the country’s tax authorities.
Retrospective taxation blues
In 2003-2006, the two companies received gas under deals with three minor gas suppliers which are no longer in existence. The companies bought gas from the suppliers, paying the required 20% of value added tax. The State Tax Administration has demanded that the manufacturers now pay taxes for these previous years of co-operation along with an additional tax evasion penalty, totalling UAH 70 million (USD 14 million). “The suppliers had licenses for gas supply. We paid off the state. This is similar to demanding a customer pays taxes for goods that he bought in the supermarket several years ago,” says Stanislav Lysenko, a manager with HeildelbergCement Ukraine.
“For all these years, our companies have worked transparently. We have invested over EUR 100 million into the Ukrainian market. Dyckerhoff planned to invest UAH 1.5 billion more in the two next years. But our management in Germany now doubt whether they should invest more into this country,” echoes Otto Lose, General Director of Dyckerhoff Ukraine.
Dyckerhoff Ukraine’s legal adviser, Serhiy Korniyenko, confirmed that court hearings against the tax administration have lasted for nearly a year. “We have demonstrated the groundlessness of the tax authorities’ demands. But I do believe they will appeal to the Supreme Court,” he said. “The companies also planned to invest into the construction of roads, bridges and hotels in the future: The country wants to host Euro 2012, but the current situation does not favour an improvement of the investment climate,” he adds.
Investors battle corruption, bureaucracy
Many investor complaints over the years have also involved the tax administration’s selective enforcement of tax policy, which stands accused of advancing political or business interests. Delays in VAT reimbursement create opportunities for tax officials to demand kickbacks in return for the prompt processing of rebates. Numerous export companies, both Ukrainian and foreign, claim that tax authorities openly demand bribes of between 10% and 30% of VAT refunds in order to process reimbursement, according to recent report by the US Embassy in Kyiv.
Key problems for the investment climate in Ukraine remain the lack of adequate rule of law, fair and impartial dispute resolution mechanisms and the enforcement of domestic court and international arbitration decisions, which is often a very difficult process in practice. Unsurprisingly, foreign investors continue to express little confidence in the Ukrainian court system, criticising it for “inefficiency, burdensome procedures, unpredictability, corruption, and susceptibility to political interference,” according to the US Embassy’s report.
Endless red tape strangling investment
Regulatory procedures in Ukraine are renowned for bureaucratic complexity. The number of regulations, required certificates, numerous permits and inspection regimes imposes a significant regulatory burden on private enterprise, according to the report.
Corruption continues to affect all levels of Ukrainian society, government and the economy, impacting the daily routine of the Ukrainian citizens and posing a major obstacle to foreign investments. Ukraine moved down to 105th place in 2007 in an international rating of 180 countries and from 99th place out of 163 countries in 2006, according to Transparency International’s Year 2007 Corruption Perception Index published last September. Anti-corruption initiatives by local leaders and the international community have so far failed to make an impact on this thorny issue. The only visible achievement is the recognition of corruption by the country leaders as a major obstacle – until recently, many political leaders refused to concede that major corruption even existed in Ukraine.
Still many reasons to invest in Ukraine
Regardless of the challenges and risks that foreign investors face in Ukraine, the country still remains one of the most attractive direct and portfolio investment destinations in the world with exciting opportunities for business development and expansion. A flurry of recent investment surveys place Ukraine in the top ten global FDI destinations, while the country’s attempts to broaden its Euro-Atlantic integration efforts continue to generate positive media coverage and attract new investors.
Ukrainian soil is among the richest in the world, which provides good opportunities for agricultural business investments. Ukraine has very a mild and agro-friendly climate with no tornados, tsunamis, deserts, dangerous insects or other natural hazards. Local workers are generally as skilled and lower-paid than their peers in more highly developed economies. The Ukrainian market is large, the country has an extensive transport infrastructure, exports electricity and still enjoys significant discounts on gas from Russia, with prices significantly lower than those paid in the EU. Ukraine’s income tax is among the lowest in Europe and the country’s economy is growing with its crucial WTO membership now a reality.
Last month, Moody’s Investors Service placed Ukraine’s key sovereign ratings on review for a possible upgrade, saying the political system has matured since the Orange Revolution and the current government is adopting reasonable and largely affordable macroeconomic policies despite the populist rhetoric that characterised last year’s parliamentary election campaign.
According to Thompson Financial, the ratings on review include the foreign currency ceilings for bonds and bank deposits, which are Ba3 and B2, respectively, and the B1 foreign- and local-currency government bond ratings. These ratings have carried a positive outlook since November 2006. The Baa1 local currency country ceiling and A3 bank deposit ceiling are affirmed with a stable outlook.
Improving investment climate
When President Yushchenko took office in January 2005, he made improving the investment climate one of his top economic policy goals. This led to a number of new government initiatives, such as the creation a state agency for investment and innovation and a number of investor councils chaired by the President. Over the past few years, Ukraine has liberalised its markets, reduced regulation, eliminated most licensing requirements, eliminated most restrictions on foreign exchange and started the transformation of the agricultural sector from state-run farms to private agriculture.
Listening to big business concerns
One of the most hopeful signs in recent months was the establishment in February by Prime Minister Yulia Tymoshenko of a new Council of Investors (COI) to be headed by First Deputy President Oleksandr Turchynov and Deputy Prime Minister Hryhoriy Nemyria. The Council is to focus on creating favourable conditions for doing business in Ukraine, improving the existing legal framework and tackling corruption.
Five working groups cover the stock market, currency regulation, macroeconomics, agricultural and food markets, and also work drafting laws on concessions and private and public partnership. The groups will evaluate drafts of new laws, identify major hurdles to investment and submit proposals aimed at aiding investment projects in Ukraine’s strategic economic sectors, particularly considering the challenges facing the country as it prepares to host Euro 2012.
“We believe this is a very promising government initiative which opens the door for dynamic interaction between government and business and the chance to make real progress on solving critical issues,” commented Morgan Williams, president of the US-Ukraine Business Council, who is also a COI member.
Tymoshenko pledged on March 26 to guarantee the creation of a favourable investment climate in Ukraine within two months. “In a month or two we will have all the laws in place which have been expected by investors in Ukraine over the last ten years,” she said. “I’m convinced that our collaboration with the Council of Investors will give us answers to all the questions being posed by investors and Ukraine will become the best country to invest in. We will have the best investment climate, at a bare minimum, of all the countries in the post-Soviet space,” she added.
Funds flowing into the country
According to Ukraine’s State Statistics Committee, in 2007 the total volume of foreign direct investment flowing into Ukraine was USD 29.5 billion or USD 636.5 per capita. This was a 36.5% increase from January 2007, when the total volume of FDI stood at USD 21.5 or USD 463.6 per capita. Cyprus tops the list of major investing countries with USD 5.94 billion of investment, followed by Germany (USD 5.92 billion), the Netherlands (USD 2.5 billion), and Austria (USD 2.1 billion). Most FDI went to the financial sector, followed by domestic trade, real estate, the metallurgical sector, food, beverages, and tobacco production, construction, and machine building.
Exploring the IPO market
In February 2005, Ukrproduct, a Ukrainian dairy producer, raised nearly USD 9 million on the Alternative Investment Market (AIM) in London and became the first Ukrainian entity to obtain a foreign listing. This was soon followed by Cardinal Resources, an oil and gas exploration company raising USD 20 million and XXI Century, a real estate developer and property manager, which raised almost USD 140 million by floating 32% of the company. Astarta, a sugar producer, became listed on the Warsaw Stock Exchange in 2006. These successful listings have increased the appetite among both Ukrainian investors and owners to access the IPO market.
The inflow of foreign investors brings several additional benefits as investors demand greater transparency, a greater degree of financial and business ethics, consistent application of taxation laws and protection of property rights. Foreign listings are often accompanied by foreign management, which also brings new business practices and innovative ideas and technologies.
Many companies have publicly announced their intention to access foreign markets including Viktor Pinchuk’s East One (formerly InterPipe), the Industrial Union of Donbass, Poltava GOK, Galnaftogas, Soyuz Victan, and Hortytsya. During a meeting with the New York Stock Exchange CEO Duncan Niederauer in Davos Economic Forum in January, President Yushchenko announced that in 2008 Ukraine will for the first time introduce approximately ten national enterprises to the NYSE’s listings.
A continuing lack of transparency
However, some experts warn that many Ukrainian companies are not yet ready to enter the IPO market. Yaroslav Khobta, head of the PRT Communication Group, states that most companies have only a vague idea of what the IPO market is and of the consequences of listing abroad. Among their main problems, he says, is their lack of readiness to conduct business in an open and transparent manner in line with global practice.
“Ukrainian companies still tend to unveil information about their assets and ownership structures with great reluctance, which suggests a continuing lack for transparency on the home financial market,” Khobta states. “However, this needs to change in the near future, because companies have to become more transparent if they really want to attract foreign investments – this is exactly what the IPO market demands,” he adds.
Last December, Standard & Poor’s Governance Services first Ukrainian corporate transparency and disclosure survey said that less than a fourth of crucial investor information is publicly disclosed by Ukrainian companies. The survey covered the country’s 36 largest companies.
The level of transparency among these corporations is generally low (23.9%). This indicator significantly lags far behind the foremost global practices in this area and compares unfavourably even with Standard & Poor’s Transparency Index for 30 of the largest Ukrainian banks, which stands at 41.0%.
“In our opinion, the main reason for such a low Transparency Index value is the lack of sufficient market motivation for such disclosure,” says Standard & Poor’s governance analyst Elena Pastoukhova. “At the moment, the companies we studied don’t have a critical need to attract capital on the world markets. As our previous T&D studies have shown, issuers tend to raise the level of their transparency in an effort to decrease the cost of borrowing on the global capital markets,” she adds.
Still a global FDI magnet
Despite concerns over transparency and the burden of outdated regulations, the market remains attractive, especially during the recent global turndown. Brian Best, an Investment Banking analyst with Dragon Capital in Kyiv says: “As strange as it may sound, Ukraine fundamentally appears to be a much less risky place to invest than in the West, where markets are suffering from the global credit crisis. Fundamentally, Ukraine looks very attractive with solid macroeconomic indicators and strong growth in equity markets over the past several years.”
These strong growth prospects, with lower levels or risk than seen in the past, are helping to drive investors to Ukraine. “Moreover, Ukrainian companies are finally starting to bring their finances out of the shadows and are reporting a truer picture of their performance,” Best says.
In other words, once investors started to see the true profitability of Ukrainian companies, they realised they were undervalued and serious interest was aroused.
Best argues that a critical factor lies in improving the laws and institutions that form the foundations for a strong capital market. For example, the current law on joint stock companies, he says, is outdated and needs to be replaced with a law that gives better protection to minority shareholders and improves corporate governance as a whole for Ukrainian companies. “This is a fundamental step in helping build capital markets. Moreover, there need to be more self-regulated institutions that govern the work being done by financial intermediaries such as stock exchanges, brokerages, insurance companies and pension funds.”
Once the rules of the game are clearly defined, more investors will feel comfortable investing, Best concludes. “Thus far, only the higher risk investors are coming to Ukraine and there are vast pools of capital that would come if the market here were easier to operate in.”
