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A Case for ForeignA Case for Foreign

Direct Investment intoDirect Investment intoUkraineUkraine

Name

September 2010

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Contents

A Case for Foreign Direct Investment into Ukraine................................................................................................1

Name.............................................................................................................................................................................1

September 2010............................................................................................................................................................1

Contents........................................................................................................................................................................2

Executive Summary.....................................................................................................................................................4

Introduction..................................................................................................................................................................5

General Understanding of FDI..................................................................................................................................7

1.1 Definition of FDI ...................................................................................................................................................7

1.2 Trends in Foreign Direct Investment ...................................................................................................................8

1.3 Foreign Direct Investment plans ..........................................................................................................................9

General Overview of Ukraines Economy...............................................................................................................10

2.1 Historical review of FDI inflow ..........................................................................................................................10

2.2 GDP growth statistics .........................................................................................................................................102.3 Ukrainian Export .................................................................................................................................................13

2.4 Ukraines trade with EU .....................................................................................................................................15

2.5 Ukraines trade with USA ..................................................................................................................................15

2.6 Trade with Russia ................................................................................................................................................16

Direct Foreign Investment In Ukraine....................................................................................................................19

3.1 FDI inflow in Ukraine .........................................................................................................................................19

3.2 The most attractive sectors for FDI inflow into Ukraine .................................................................................21

3.3 Problematic sector for FDI inflows ....................................................................................................................25

Analysis of Current Situation...................................................................................................................................35

4.1 Macroeconomical .................................................................................................................................................35

4.2 SWOT Analysis ....................................................................................................................................................41

4.3 Boston Consulting Group Matrix .......................................................................................................................48

4.4 Approximate analysis of effectiveness of different investment projects .........................................................55

4.5 History of successful investment projects ..........................................................................................................59

Possible Ways of Improving the Effectiveness On FDI Inflow.............................................................................60

5.1 Decrease the level of corruption. .......................................................................................................................60

5.2 Create an attractive law.......................................................................................................................................60

5.3 Protect the right to own property. ......................................................................................................................61

5.4 Measure for preventing inflation process. ........................................................................................................61

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5.5 Create a free economy with less government interruption..............................................................................62

5.6 Establish an attractive taxation system..............................................................................................................63

5.7 Decrease the level of bureaucracy...................................................................................................................... 64

5.8 Provide further political stabilisation................................................................................................................64

5.9 Create international awareness of existing opportunities. ..............................................................................65

Conclusion..................................................................................................................................................................66

References...................................................................................................................................................................67

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Executive Summary

The level of foreign direct investment (FDI) inflow can have a significant effect on a countrys

economy especially during a time of major economic and social transformation.

For the short time of its existence as an independent country, Ukraine has faced major changes in

terms of economical and political transformation which have required a rapid capital inflow from

overseas.

The historical review of Ukraines growth shows, that despite its potential, the countrys GDP has

grown very slowly during the 90s. Only since 2000, has the country started to show positive trends in

term of GDP growth. Analysis of FDI inflow also indicate that compared to other post Soviet countries

such as Poland or Czech Republic, Ukraine hasnt been very successful in the process of attracting FDI

into the countrys economy due to the number of obstacles.

Review of the countrys industries shows that Ukraine already has a number of existing and well

developed sectors which have attracted increasing interest for foreign investors. Also there exist

some industries which have experienced a number of difficulties due to the transformation from

Soviet plan based economy into the free market economy.

After providing the macro economical, SWOT and BCG analysis we are able to observe that while

every single sector in Ukraines economy has its own unique set of problems, the main problem which

prevents foreigners from investing in Ukraine is corruption, inflation, political instability, high

taxation and government intervention.

But despite the problems that exist in Ukraine for foreign investors, we also can see that a number of

successful investment projects have gone ahead. Furthermore, these businesses have plans to

increase the volume of investment in Ukraine in the next period and expect greater dividends in the

future.

At the end of my thesis, I introduce a number of methods which, in my own opinion, could help

Ukraine improve the level of FDI in the near future.

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Introduction

Historically, Ukraine used to be a part of Soviet Union, ruled by the communist party based out of

Moscow, and unable to take its own economic or political decisions. Only in 1991, after the fall of

USSR, has Ukraine emerged as a country with a great potential for fast growing and rapid

development within world economy.

Ukraines territory stretches for 893 kilometers from north to south, and for 1316 kilometers fromwest to east. The total area of Ukraine is 603 700 sq. kilometers that makes 5.7 percent of the

territory of Europe or 0.44 percent of the world. Ukraines territory is larger than that of France,

Spain, Sweden, Germany and Poland. Ukraine consists of the Crimean Autonomous Republic and 24

regions. There are 490 districts, 446 cities, 907 towns and 10196 villages. Total population of the

country on the day of its independence was 52 million and almost 70% of people aged between 18 to

55 were well educated.

Ukraine shares its borders with Poland, Hungary and Slovakia in the west, through which territories

lies the shortest route to the countries of Western and Central Europe. The border of Ukraine with

Russia is in the north and east, while in the southwest the country is contiguous with Moldova and

Romania. In the north, Ukraine adjoins Belarus through which territory it is linked with Baltic

countries. It is with Romania and Russia that in addition to the land border Ukraine has a sea border

too. All these factors make the country a very attractive and profitable trade route which could

connect Eastern Europe within Russia, Turkey and others Asian countries.

In addition, from the beginning of its existence Ukraine has been an industrialised country with very

well developed industries such as coal mining, chemical industry, and metallurgy, machine building,

agricultural and other industries

All of these factors should have been very attractive for foreign investors who could invest capital in

Ukraines economy, which was very important for developing the country in the initial years of its

existence. But, as mentioned before, foreign investors didnt find Ukraine very attractive for

investing money due to some reasons:

1. It was really difficult for Ukraine government to liberalise trade and improve political and

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economical climate which could be more suitable for foreign investors.

2. The legal system in the post Soviet country was very weak and actually wasnt able to protectinvestors in case of losing money, which created another obstacle for investors

3. The level of corruption in the country at that time was very high and it also created difficulties

for attracting foreign investors in the country.

4. Ukraine was much more slow to open its borders than other eastern European countries such

as Poland, Hungary, Estonia etc. As the result the country has suffered economically and its

standard of living are currently bellow those in central Europe, Russia and Kazakhstan

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CHAPTER 1

General Understanding of FDI

1.1 Definition of FDI

Its a well known fact that foreign direct investment (FDI) plays a significantly important and growing

role in world and business in general. It can provide a firm with new markets and marketing channels,

cheaper production facilities, access to new technology, products, skills and financing. For a host

country or the foreign firm which receives the investment, it can provide a source of new

technologies, capital, processes, products, organizational technologies and management skills, and as

such can provide a strong impetus to economic development.

Foreign direct investment, can be identified as a process when a company from one country makes a

physical investment into building a factory in another country. The direct investment in buildings,

machinery and equipment is in contrast with making a portfolio investment, which is considered anindirect investment. In recent years, given rapid growth and change in global investment patterns,

the definition has been broadened to include the acquisition of a lasting management interest in a

company or enterprise outside the investing firms home country. As such, it may take many forms,

such as a direct acquisition of a foreign firm, construction of a facility, or investment in a joint

venture or strategic alliance with a local firm with attendant input of technology, licensing of

intellectual property etc.

In the past decade, FDI has come to play a major role in the internationalization of business. Reacting

to changes in technology, growing liberalization of the national regulatory framework governing

investment in enterprises, and changes in capital markets, profound changes have occurred in the

size, scope and methods of FDI. Also new information technology systems and decline in global

communication costs have made management of foreign investments far easier than in the past. The

sea change in trade and investment policies and the regulatory environment globally in the past

decade, including trade policy and tariff liberalization, easing of restrictions on foreign investment

and acquisition in many nations, and the deregulation and privatisation of many industries, has

probably been the most significant catalyst for FDIs expanded role.

The most significant effect has been observed in developing and some post Soviet republics, where

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annual foreign direct investment flows have increased from an average of less than $10 billion in the

1970s to a annual average of less than $20 billion in the 1980s, to explode in the 1990s from

$26.7billion in 1990 to $179 billion in 1998 and $208 billion in 1999 and now comprise a large portion

of global FDI.. Driven by mergers and acquisitions and internationalization of production in a range

of industries, FDI into developed countries last year rose to $636 billion, from $481 billion in 1998.

Proponents of foreign investment tells that the exchange of investment flows benefits both the home

country (the country from which the investment originates) and the host country (the destination of

the investment). Opponents of FDI note that multinational conglomerates are able to wield great

power over smaller and weaker economies and can drive out much local competition. But in either

case, the country needs to identify for itself the importance of foreign investment in the country and

the government needs to take measures for attracting foreign investors or protecting domestic

business.

1.2 Trends in Foreign Direct Investment

The global financial crisis has severely affected capital in-flows to developing and emerging

countries, reversing the upward trends observed over the past few years. Yet FDI flows to emerging

markets are proving resilient and rebounds are anticipated in 2010. Net capital inflows to developing

countries had become almost 40% by the end of 2008. Also it can be true to say that emerging

markets in Eastern Europe, including Ukraine have suffered the most from the financial crisis,accounting almost 50% of the decline in capital flows to all developing countries. Net portfolio equity

flows plummeted by 90% while private debt flows contracted by 76%. The situation had become even

worse in 2009 when another decline of net private capital resulted in a decline of about $363 billion.

Flows to emerging markets started to slow during the second half of 2008. In the first quarter of 2009

cross border M&A in the developing world declined to 16 billion compared with more than 30 billion

in the previous two years. In 2009 tight credit conditions, weak global demand and low profitability

owing to recession were certain to limit the ability and willingness of MNEs to expand in the

developing world. The World Bank projected FDI flows into developing countries to decline by 34% to

385$ billion in 2009. Yet FDI flows to developing countries remained more resilient than flows into

industrialized countries in 2009, where the World Bank estimated FDI inflows shrank by 50 %

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1.3 Foreign Direct Investment plans

As discussed above, the global financial crisis brought a great decline in FDI into emerging market in

2009. However this decline appears to be more related to the tightening of financial markets which

has made funding scarcer and more expensive than to investors reassessment of the long term

business rational for investing in emerging market.

The global survey suggests that investors have maintained a positive outlook for FDI in general.

Around 40% of them expect their firms to increase foreign investment this year and a further 20%

expect investment plans to remain in line with 2008. Around 65% of investors surveyed their foreign

investment to increase over the next three years as shown on the graph. The graph indicates that

investors do not anticipate that global financial and economic turmoil will affect their investments

prospect for long.

But investment in the short term will likely continue to be unevenly affected in different sectors.

Being faced with decline in the price of commodities, almost half the surveyed investors in primary

industries expect their foreign investment to decrease this year in many cases by more than 20%

compare to 2008 in contrast more than 60% of investors in other sectors such as financial service and

manufacturing are planning to increase or at least maintain foreign investment this year. Also in the

next three years a high proportion of investors across all sectors expect to increase their foreign

investment.

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CHAPTER 2

General Overview of Ukraines Economy

2.1 Historical review of FDI inflow

Ukraine opened its market for FDI inflows only in 1991 when the country achieved its independence.

This step has made a great improvement in the countrys business environment. At the beginning

Ukraine like many other former Soviet countries tried to keep a centrally planned economy which was

basic economic base in USSR but also with implementing market principles. In the mid 90s due to the

increasing amount of foreign investment in the country, the special law on foreign direct investment,

an extensive privatisation program has been started and several new commercial laws came into

purpose to regulate foreign trade, taxation and banking system. The largest amount of FDI in Ukraine

since its independence has been invested in banking, retail, food processing, machine building, steel,

power generation, transport, communication and chemicals. The cities of Kyiv, Lviv, Odessa,

Dnipropetrovsk, Donetsk, and Uzhhorod have attracted more than 70% of overall investment and are

clearly all geographically strategic for FDI.

2.2 GDP growth statistics

Ukraine is one of the former USSR countries which have suffered from the longest economic recession

which lasted almost 11 years (since 1989 to 2000). According to the official statistics Ukraines GDP in

1999 was only 38.5% of its level in the year of 1989. But since 1999 the economy began to recover.

For over a decade, Ukraine's economy has been growing steadily, with GDP increasing an average of

more than 7% per year. This strong growth has been driven by increasing domestic demand, improved

productivity in the private sector, low unemployment, and rising wages.

In the first six months of 2008, Ukraine's strong and sustained growth rates continued to showdynamic upward momentum - with GDP growing at an annual rate of 7.1%. Ukraine's growth has

persisted despite a global economic slowdown, continued political infighting at home, and a high

inflation rate, which slowed dramatically over the summer and is projected to end 2008 at around 18-

20%, far less than the 31% annual rate registered through May. But despite this quite strong economic

recovery since 1999, Ukraines GDP in 2008 was only two-third of its potential. The main factor

driving recovery in the Ukraines economy was more similar to the reason which began recovery in

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Russia than central European countries. The key factor was rapid growth in output from plants

constructed during the Soviet era, primarily in the export industries of ferrous and non-ferrous

metals, machine building, and chemicals. Increases in output from the large privately owned

industrial conglomerates that were created from formerly state-owned enterprises have contributed

heavily to a doubling of Ukraines industrial output since 1998. In addition Ukraine has achieved its

recovery from developing construction, telecommunications (especially cellular telephones), finance,

and business and personal services than to manufacturing. Because the service sector was neglected

during Soviet times, output in these sectors has soared. Increase in output from small privately

owned firms have also been an important driver of economic growth. New plants in the nascent

private sector resulted in increased output from the food processing, textiles, and clothing branches.

Increases in output from agriculture, government services, and coal mining have lagged the overall

rate of growth in GDP. At one period of time, Ukraines growth record was even better than it

appeared to be. The State Statistics Committee of Ukraine reported that GDP rose just 2.7 percent in

2005, down sharply from the increase of 12.1 per cent recorded in 2004. Most of the slowdown in

growth stemmed from declines in value added from construction and from wholesale and retail trade.

However, retail sales boomed in 2005, up 23 percent in real terms, and yet value added from

wholesale and retail trade reportedly fell 8.3 percent. This discrepancy is highly suspect. One

respected source has argued that elimination of Special Economic Zones in that year, which had been

a source of wide-scale tax evasion on imported goods, skewed statistics on value added in trade for

2005. For instance if value added in trade had been more accurately measured, Ukrainian GDP

growth for 2005 would have been at least 5 percent, and probably substantially more.

But despite the rapid economic recovery in the country since 2000, until 2008 Ukraine was still poorer

than its neighbors. While East Asia and Central Europe were enjoying growth during the 1990s,

Ukraines decline in output drove its 1999 per capita GDP to just 40.3 percent of its 1989 level. Thedecline in per capita GDP was a little less than the overall decline in output because Ukraines

population fell 4.7 percent over this period, as life expectancy remained low and many Ukrainians

emigrated to Central and Western Europe and Russia in search of better-paying jobs.

By 2006, per capita GDP ran $2,200, putting Ukraine among the middle-income developing countries.

Using purchasing power parity (PPP) exchange rates, per capita GDP was still only $7,100 in 2006. Per

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$

or

2004

$

at

PPP

rates(000s)

Ukraine Armenia Eston Georgia Kazakh Latvia Lithuania Russia

Per Capita GDP for Selected Former Soviet Republics, 2006

2

4

6

8

10

12

14

16

18

SOURCE: Eurostat, National Accounts: Gross Domestic Product, 2006; State Statistics Committee of Ukraine, National Accounts, 2006; IMF, International Financial St2007.


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capita GDP is far lower in Ukraine than in Russia, Kazakhstan, and the three Baltic states (Figure 2.2).

Ukraines per capita GDP is a fifth of Estonias and a third of Russias at market exchange rates. The

more favorable comparison, that based on PPP exchange rates, still shows that Ukraines per capita

GDP is half that of the Baltic states and two-thirds that of Russia. Wages are substantially lower than

in these countries, as well. In May 2007, monthly wages ran $238 in Ukraine compared with $472 in

Russia. According to the official European statistics 4.9 percent people in Ukraine were poor. Of the

European countries, virtually only Moldova has citizens who live on less than $2 a day. Ukraine scores

better in international comparisons using local measures of deprivation: In 2003, 19 percent of its

population was classified as poor, which is smaller than the shares classified as poor in Poland, Russia,

and Lithuania. Since the beginning of the recovery, poverty has declined more rapidly in Ukraine

than in a number of other transition economies, including Poland and Russia.

But the main question is why has Ukraine been so slow to enjoy the benefits of transition?

In comparison with most of the other transition countries, including Russia, Ukraines new private-

sector economic activities were slow to emerge. As late as 2002, Ukraine had only 18.5 incorporated

businesses per 1,000 populations, whereas Russias number was more than a third higher. Barriers to

entry imposed by corrupt government officials and bureaucrats, the slow pace of privatisation, and

the initial absence of dynamic, profitable export industries retarded recovery.

Because Ukraines investment climate has been perceived as hostile, the country has failed to enjoythe benefits from large inflows of FDI. Because of low levels of FDI, output from subsidiaries of

multinational firms has contributed little to Ukraines recovery, in contrast to the positive impact

that FDI has had on economic growth in Central Europe.

But in the year 2008, Ukraines economy that had begun to recover only years ago was affected

severely by World Economic Crisis. Ukraine's economy shrank 15% in 2009 with inflation being 16.4%.

The Ukrainian government predicted GDP growth of 0.4% in 2009 and a slowdown in inflation to 9.5%

(also in 2009). The deficit of Ukraine's foreign trade in goods and services January through September

2009 was estimated at $1.08 billion, which was 9.5 times down on the same period in 2008, export of

goods over the period decreased by 48.7%, to $27.478 billion, while imports fell by 53.5%, to $31.570

billion; export of services dropped by 23.2%, to $6.841 billion, while imports were down by 19.9%, to

$3.829 billion (the deficit of Ukraine's foreign trade over the first nine months of 2008 was estimated

at $10.284 billion, which was 2.7 times up on the same period of 2007. According to a forecast by the

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State Employment Center unemployment in Ukraine would triple to 9% in 2009 (there was 3%

unemployment at the end of 2008), which would mean about 3 million people will apply for

employment services. In September 2009 the official level of unemployment was 1.9%. 95% of the

population of Ukraine felt the influence of the financial crisis. In July 2009 21% of them stated that

"the crisis has a catastrophic impact on me and my family", this figure dropped to 17% in October

2009.

Most analysts and scientists are inclined to think that the reason for such a huge impact of the

recession on Ukraines economy is the decline in steel prices, local banking problems and the cuttingof Russian gas supply of January 2009. This made key industries such as metallurgy and machine

building lay off workers, and real wages started to fall for the first time in a decade. In 2008 the

Hryvnia dropped 38% against the US dollar, eclipsed only by the Icelandic Krona and the Seychelles

Rupee. Since many loans and mortgages were issued in dollars and most Ukrainians are paid in

Hryvnyas (Ukraine's currency), they had to buy dollars with the weak Hryvnya, and so they were

paying back much more on the loans than they had expected. From December 2008 till mid-May 2009Ukrainian banks were not allowed to grant requests for early withdrawals of bank deposits. As of

September 2009 financial analysts predicted a recovery of the Hryvnia. Ukraine's total foreign debt

(state and corporate) had reached 93.5% of the 912.563 billion Hryvnya GDP in March 2010; late

February 2010 the Ukrainian Finance Ministry had reported that the country's total state debt by early

2010 was to 32.9% of the GDP. Standard & Poor upgraded Ukraine's rating the same day. March 18,

2010 the National Bank of Ukraine stated the total external debt in Ukraine increased 2.3% to$103.973 billion in 2009, and it considered a 4% GDP growth realistic for 2010 the same day

2.3 Ukrainian Export

Despite the many problems and obstacles for export at the beginning of its independence Ukraine has

begun to export aggressively. As you can observe from the figure, Ukrainian exports grew slowly in

the mid-1990s and declined between 1997 and 1999 (as Russian demand fell sharply following the

crash of the ruble). But since then, they have surged, more than tripling by 2006.

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In 2000, exports totaled $14.6 billion and imports totaled $15 billion. Ukraine's main export markets

are in Russia (24 percent), the European Union (30 percent), and the United States (5 percent). Its

main importers are Russia (42 percent), the European Union (29 percent), and the United States (3

percent).

Exports have played a very

important role in the process of

economic recovery in the country.

Rising productivity and costreductions have made Ukrainian

heavy industry a formidable

exporter. Ukraine has gained

benefits from increases in world

market prices. A surge in demand

for steel from China, Russia, andother rapidly growing economies

boosted this decades demand for

metals and chemicals, sparking price increases and providing an additional impetus to exports.

In addition export also has risen rapidly because Ukrainian exporters have found new markets. The EU

is now Ukraines largest export market, having displaced Russia in 1998. But growth in exports to

Asia, especially China, has outpaced growth in exports to the EU since 2002.

Within the EU, the larger EU economies of Italy and Germany rank among Ukraines top three export

markets. But a number of Ukraines former Communist neighbors rank among Ukraines top ten EU

markets: Poland, Hungary, Romania, Bulgaria, and Slovakia, in order of importance. Ukraines

exports to each of these countries exceed its exports to either France or the United Kingdom. Outside

of the EU, Russia, Belarus, and China loom large.

Ukraines imports are even more concentrated by region than its exports are. Over four-fifths of

Ukraines imports come from other countries in the Commonwealth of Independent States (CIS) or

from Europe, primarily the EU. In 2006, the EU edged out Russia as Ukraines primary source of

imports. Russia and Turkmenistan are virtually the sole sources of Ukraines imports of energy.

Ukraine imports a number of other commodities from Russia, such as chemicals, metals, and wood.

Machinery and consumer goods play a more important role in imports from the EU and Asia

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40

20

10

1994 1996 1998 2000 2002 2004 2006

SOURCE: S t a t eS t a t i s t i c sC o m m i t t e eof U k ra i n e , N a t i o n a lA c c o u

years shown .


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2.4 Ukraines trade with EU

Since its independence EU has been one of the most important trade partners for Ukraine. During the

1990 Germany, Netherlands and Italy used to be one of the largest trade partners for Ukraine within

EU. But economical system of the young country was dependent on its old Soviet network and during

that time post Soviet countries such as Russia, Belarus were the largest trade partners of Ukraine. But

in the late 90s and at the beginning of the 2000s, due to the countrys economic development and

the deeper international trade strategy, the situation started to change.

In the 2000s the EU has become a largest trade partner of Ukraine. According to Euro stat, between2000 and 2007 EU trade in goods with Ukraine more than tripled in value: exports rose from 5.5 bn

Euro to 22.4 bn, while imports increased from 4.8 bn Euro to 12.4 bn. But, this increase didn't make

Ukraine one of the EU's major trading partners. In 2007, Ukraine accounted for only 2% of EU exports

and a mere 1% of European Union imports which is toward the bottom of the EU's top 20 trading

partners (16th). According to the European commission paper, manufactured goods dominate trade

with Ukraine. Nearly half of the EU exports to Ukraine in 2007 were machinery and vehicles and afurther quarter were other manufactured articles. Also it can be possible to observe the similar

situation in imports: unspecified manufactured articles accounted for two fifths followed by a crude

metal for a further fifth. At the more detailed level, the main EU exports to Ukraine in 2007 were

medicine, motor vehicles and mobile phones, while the main imports were iron and steel products, as

well as sunflower seed oil, ferro-nickel, iron ores and oil. Among the EU27 Members States, Germany

(5.9 bn Euro or 26% of EU exports) was the largest exporter, followed by Poland (4.1 bn or 18%). Italy(2.4 bn or 19%) was the largest importer followed by Bulgaria (1.6 bn or 13%) and Germany (1.3 bn or

11%). The largest surpluses in trade with Ukraine in 2007 were observed in Germany (+ 4.6 bn Euro)

and Poland (+2.8 bn Euro) while Bulgaria scored the highest deficit ( -1.4 bn Euro)

Even though Ukraine is not yet a member of EU it could be true to say that EU is seeking an

increasingly close relationship with Ukraine, going beyond cooperation, to gradual economic

integration and deepening of political cooperation. Also Ukraine is a priority partner within the

European Neighborhood Policy, which could be helpful for Ukraine to apply for membership of the EU

in the future.

2.5 Ukraines trade with USA

Ukraine also has a very close trade relationship with the United States. According to the statistics US

is the eighth largest export market, just behind Belarus with exports amounting to about 1.2 billion.

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Exports to the United States have fluctuated in recent years, although the general trend has been

upward. Since 2000, exports to the EU and Russia, Ukraines two largest export markets, have grown

more rapidly than exports to the United States, in both relative and absolute terms. Ukraines

exports to the United States are heavily concentrated in metals and inorganic chemicals; these two

categories accounted for four-fifths of the total in 2006. Transport costs, barriers to trade, lack of

favorable bilateral trade relations, and limited knowledge of the U.S. market have limited Ukrainian

exports of other items to the United States.

Ukraines imports from the United States have grown steadily since the year 1998. The itemsimported are more widely dispersed across commodity categories than are the exports to the United

States. The two most important imports, special industrial machinery and motor vehicles, account for

just a quarter of imports from the United States, which stands in contrast to the very concentrated

nature of Ukraines exports.

2.6 Trade with Russia

Even though Russia is not anymore the largest trade partner for Ukraine, it still is a very important

trade partner with a long history of trade relationship with each other.

The volume of goods turnover between Ukraine and Russia is stable. In 2007, mineral products led

exports of Russian goods to Ukraine (47%, although this share is gradually declining). In 2007 mineral

goods with the value of USD 7,697.7 million were exported. The volume of deliveries of Russian oil to

be treated by NPZ Ukraine the countrys national oil processing company was 9.6 million tons. Therate of export of cars, equipment and transport vehicles is growing, having increased their share in

the structure in comparison with 2006 from 16.7% to 20% from total exports (USD 3,216 million).

Deliveries of metals and metal products (USD 2,069.3 million) stably maintain their import share at

a level of 13%. There has been a considerable increase in the rate of production in the chemical

industry (136.5%). Since 2006, mechanical and technical production (for which 36% of all Russian

imports from Ukraine are necessary) and also metals and metal products (31%) haveincreased by 158% in the import structure of goods from Ukraine in terms of the volume of deliveries

(USD4, 719 million).

Deliveries of food and agricultural raw materials have increased by more than 62.7% and make up

about 11% of import. The share of chemical production in Russias import is 10% from Ukraine, and

mineral products are 4%.

Frequently, intergovernmental agreements and arrangements lead to an increase in supply.

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Thus, at the end of the first quarter of 2008 the supply of the produce of sixteen meat industry

enterprises and twelve dairy industry enterprises of Ukraine to the Russian Federation were

permitted upon joint certification (a ban was imposed in January 2006).

The sanitary and veterinary services of both countries work towards expanding the list of Ukrainian

enterprises, which deliver such products to Russia.

In the alcohol production market two trends have emerged during this year. Along with the

relocation of certain Ukrainian alcoholic drinks manufacturers to Russia (spirit is being withdrawn

from the free trade regime) their import has grown (by 18.8% for the first 10 months of 2007). Import

from Ukraine of alcoholic production makes up 50.3% of all Russian import of alcoholic beverages

from CIS countries.

The structure of Russian import from Ukraine unlike export is characterised by the big share of

production, which has Khmelnitsky, and also in the Lvov and Dnepropetrovsk regions. By 2011 the

company plans to open 50 hypermarkets and 24 supermarkets in 35 Ukrainian cities, with a total floor

space of 307 thousand sq.m.

Ukrainian vodka companies have become more active in the Russian market. Following the lead of

the well-known company Nemiroff, the group of companies Soyuz-Viktan (Kyiv), one of the

largest Ukrainian manufacturers of strong spirits, opened a factory in Ruze (Moscow region) in

March 2005. Investments into it have totaled USD 5 million, which has allowed them to increase

factory output from 5.5 million units to 8 million units per year.

In addition it could be true to say that despite the small volume of Ukrainian capital which is

present in the Russian economy, it is necessary to note the positive dynamics of its development,

which, it is supposed, shall continue for the next few years. It is possible to ascertain that in the

presence of considerable divergences between Ukraine and Russia, both states aspire to

construct strong and long-term economic relations, and for these purposes develop new

programs and create organisations whose work will be directed at attracting investments. Two

such organisations are the Russian Federations representative office for trade in Ukraine in

Kyiv and the Russian-Ukrainian investment-commercial centre, whose primary goals are the

attraction of Russian investments, and also active development of the Russian-Ukrainian trade

and economic relations at inter- regional level.

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CHAPTER 3

Direct Foreign Investment In Ukraine

3.1 FDI inflow in Ukraine

As we know, the process of attracting foreign investment in the country hasnt been very successful

at the beginning of Ukraines independence due to political and economical reasons which posed

significant obstacles for foreign investors. But at the beginning of 2000s, Ukraine has started to be

more attractive for foreign investors.

Figures presented by Derzhkomstat shows that Ukraine attracted about US $2.87 billion in FDI for at

the first half of 2009, bringing the total to US $38.6bn as of October 1, 2009. While small compared

to the amount of foreign direct investment inflows detected in neighbouring Central European

countries, Ukraine has observed a steady surge of investment inflows since the Orange Revolution of

2004 put the country onto the radar screens of Western investors.

Cyprus, and the British Virgin Islands (another place to park cash that is popular with Russian and

Ukrainian investors) run a cumulative 23 percent of total FDI in Ukraine. Germany with 17.1%, the

Netherlands with 9.9%, Austria with 6.6%, the United Kingdom with 6.1%, and Russia with 5.3%.

Because of buying of Krivoryzhstal, the steel industry has attracted more capital than any other

sector in Ukraine. However, banking is the most vibrant sector. Since 2006, banking has attracted

the most substantial investment. For instance in 2008 $6.1 billion has been invested in Ukrainian

finance sector amounting to 18.6% of total FDI which is 25% more than in previous year. Also over a

fifth of banking capital in Ukraine is now owned by foreign investors. Agriculture - most notably

sunflower-seed processing, agricultural inputs, and grain trading - has also attracted large sums going

back to the 1990s. In addition, foreign investors have put money into the automotive industry,

consumer goods, and retailing.

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The United States is currently the sixth largest

investor in Ukraine, down from its position as the

largest source of FDI in the late 1990s. U.S.

investment has encompassed a number of sectors,

ranging from agriculture to consumer goods to

financial services. However, as investment in Ukraine

began to take off in 2003, U.S. investment grew less

rapidly than did a number of other countries,

including Cyprus. To some extent, this was the result

of European banks showing greater interest in

Ukraines banking sector. But U.S. investors were also

put off by the difficulties encountered in investing in

Ukraine. Given alternative destinations for their

investment dollars, they have chosen countries with

larger markets (such as China, India, and Russia) or

countries with more congenial investment climates

(such as the Central European states or countries in

East Asia).

Due to the banking collapse and financial crisis, FDI into Ukraine dropped almost two thirds in the

first 9 months of 2009, from US $8bn in the first 9 months of 2008, to US $2.97bn in the same periodof 2009.

Identified factors:

Legal reforms

The legal framework for FDI has been improved and finally the original Law on Foreign Direct

Investment has been created. This law provided huge tax holidays of up to 10 years for certainindustries and for investments over a certain size. But unfortunately this law failed to attract the

expected large inflows of foreign direct investment due to the several difficulties in countrys

economy and legal system. Attracting FDI has become a governments top policy priority and for this

purpose it has set up a National Agency for Reconstruction and Development (NARD).

NARD is responsible for attracting increased investment and improving the legal environment by

streamlining existing rules and regulations. The Ukrainian State Credit and Investment Company are

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able to finance investment projects and are responsible for the governments investment program. In

addition there are other government bodies, such as the Cabinet of Ministers, the Ministry of Finance,

and the Ministry of Economy that also handles matters related to FDI. Some areas of Ukraines

economy such as banking, insurance, and heavy industry where environmental damage is a risk;

require special permission for both domestic and foreign investors. Only the Cabinet of Ministers or

other authorised body can grant this. Also Ukraine restricts the production of drugs, weapons,

ammunition, and explosives to state-owned companies, which means that there is no direct foreign

investment in these areas.

Ukrainian law protects foreign direct investments in different ways. Some allow for the full

repatriation of profits, invested capital and the wages of expatriate employees in hard currency,

once taxes and other debts have been paid. In case of nationalisation or expropriation, Ukrainian law

guarantees quick hard currency compensation of the full amount that was invested. It also provides a

10-year guarantee against changes in legislation that could damage foreign investors in any way.

In addition, the countrys government has signed many bilateral investment treaties with a variety of

countries. Projects from treaty countries may sometimes be allowed to import machinery and other

equipment tax free or at concessional rates, with the possible exception of restricted sectors like

banking, insurance and heavy industry. There are also provisions for international arbitration in the

settlement of disputes between foreign investors and the state.

Trading climate

Products which have been manufactured by a company with ties to a foreign company are exempt

from export licensing and quotas, although such benefits do not apply to all products. Key among the

latter is electricity, which is a disincentive for potential investors in the power sector.

It is a clear fact that during the last twenty years Ukraine has been made a great progress in the

process of attracting FDI in the country but compared to the other eastern European countries, the

level of FDI inflow is quite low and it is important for the country to find the way which can help to

improve the level of FDI inflow.

3.2 The most attractive sectors for FDI inflow into Ukraine

As discussed, Ukraine is a country with well developed hard industries and due to this factor the most

attractive sectors in Ukraines economy for foreign investors still remain in this area. The most

important of them is metallurgy, machine building, and chemical industry

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Metallurgy is the key industry of the Ukraines economy. Metallurgy is the most important export

product in Ukraine and the production of metal is an important input factor for machine building and

metalworking industries and metal is the main source of engineering materials. The metallurgy sector

includes 14 integrated steel making plants, 7 pipe plants, 10 plants producing metallic articles, 16

merchant-coke plants, 17 refractory production plants, 3 ferroalloy plants, 20 non-ferrous

metallurgical works, 35 factories reprocessing ferrous and non-ferrous scrap metal, and other

enterprises.

The vast majority of metallurgy enterprises of Ukraine are powerful integrated companies thatproduce over five million tons of metal per year. The largest of them are Azovstal, Zaporizhstal, and

Kryvorizhstal. Three metallurgical regions have developed in Ukraine: Transdnipro, Donetsk, and

Transazov. But the main problem in industry is that large parts of machine and equipment in the

factories are very old and the cost of maintenance of this equipment is very high. And of course, this

factor affects the final cost of production, making it higher than it could be. In this case it could be

difficult for Ukraine to compete with China which has installed new modern equipment on most of itsfactories. But high potential and very good educated labor still make metallurgy one of the most

attractive sector for foreign investors.

Chemical industry is also well developed and still has a great potential for further growth. The

industry accounts for nearly 10% of industrial fixed assets and over 5% of all those employed by

Ukrainian industrial sector. About 90% of the capital assets and about 80% employees involved in the

industry are concentrated in chemical sector. Petrochemical and chemical-pharmaceutics sub-sectors

account for the remaining production potential.

Until 1990, Ukraine was producing 16% of the total of mineral fertilizers in the former Soviet Union,

24% plant-protection chemicals, 18% sulfuric acid, 25% soda ash, 16% caustic soda, and 13% chemical

fiber. According to the data of the Ministry of Industrial Policy, they manufacture up to 20 thou

names of production to the sum of UAH 40-45 bn.

In 2007, chemical sector shares amounted for 6.4% in the structure of industrial production (6th

place), 2.7% - in the structure of GDP. The base of chemical complex makes up manufacturers of

mineral fertilizers (over 60% of the total chemical output in the country). Capacities for production of

mineral fertilisers make it possible to produce up to 8 mn tonnes production a year. As of 2008,

Ukrainian enterprises decreased manufacture of fertilisers by 5.8% to 2673 thou tonnes (in terms of

100% nitrogen content), as compared to 2007. Key Ukrainian producers of mineral fertilizers and

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nitrogen output are as follows: concern Stirol, Odessa port plant, Azot (Cherkassy), Severodonetskoe

Objedinenie Azot, Denprazot, and Rovnoazot; phosphorus Crimea TITAN, Sumykhimprom,

Konstantinovsky state plant; potassium Dneprovsky plant of mineral fertilizers.

In 2009, according to the data of the Ministry of Agrarian Policy, demand from the agrarian sector for

mineral fertilizers totaled 775 thousand tonnes (deliveries 753,6 thousand tonnes). According to the

Strategy for the Development of Chemical Complex of Ukraine for 2007-2015, the annual volume of

required means to renovate production funds is to be increased from UAH 2,4 bn to UAH 3,3-4,5 bn by

2015. Ukrainian chemical enterprises intend to invest in production some UAH 13 bn by 2015. As wecan observe from this situation, the chemical industry is quite well developed and also has a great

chance for improvement which makes the industry attractive for investors.

Machine building is also very a important industry for the countrys economy. It accounts for over

one third of the employed and about a quarter of the total cost of industrial main assets. The largest

engineering centers are Novokramatorsk Machine Building Plant, Kramatorsk Plant

Energomashspetsstal, Mariupol Heavy Engineering Plant, Kharkiv Turbine Plant, etc. The major

electric engineering facilities are concentrated in Kharkiv, Zaporizhzhya, Kyiv, Donetsk, and

Dnipropetrovsk. In addition the machine-building complex of Ukraine includes over 20 specialised

branches that are practically all branches of machine building (except watch industry). It serves as

the basis of heavy industry and plays the decisive role in creating a material and technical base for

the economy. Also it could be true to say that in modern conditions, machine building is very

important in accelerating scientific and technological growth. This factor makes the industry very

attractive for foreign investors.

Light and food industry is also well developed and plays a significant role in the countrys economy.

Light and food industries relate to the social complex of consumer goods production. Light industry

today is a multi-branch sector comprising 25 sub-sectors. It includes over 3,300 enterprises of

different forms of ownership and subordination. Light and food industry is well developed in Ukraine

and almost completely satisfies the populations need for consumer goods.

The light and food industry is foreign dominated, with four of the biggest firms in the sector being

foreign owned and three more foreign owned firms featuring in the top 10 of the sector by turnover.

The return on capital is on average more than 25%, explaining high interest of foreign investors in this

sector. The turnover growth has been very diverse ranging from decline of 70% to increase of 90%.

The light industry includes textile, knitting, clothing, leather, footwear, and other sub-industries.

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The key sector of the industry is textile production including cotton, wool and linen sub-units. Cotton

industry uses imported raw materials. The largest operations are located in Kherson, Donetsk,

Ternopil, Kyiv, Kharkiv, Lviv, Poltava, Chenivtsi, etc. The highest concentration of large wool

operations using both domestic and imported raw materials is in Chernihiv, Donetsk, Kryvy Rih,

Odessa, Luhansk and Sumy. According to research carried out in previous years, the main problems in

the light industry (leather and footwear cluster, home furnishing cluster, textiles and apparel cluster)

are poor quality of fabrics and trim; lack of cooperation or collaboration between firms; poor access

to export markets; inadequate sales and marketing skills; inadequate access to capital; problems

with VAT reimbursements with input.

The food industry is traditionally the major supplier of basic foods, such as sugar, salt, oil, alcohol,

confectionery, etc. Food industry is the leader of the agro-industrial complex. It will remain

strategically important in future, determining the well-being of the people. The sector has

considerable production, research and labor potential. At present, its production capacities are not

fully utilised. They operate at 42% of capacity in confectionary, 30% in dairy canning and 19% in softdrink production. Thus, reserves of the sector are vast. Economic potential of the countrys food

industry strongly depend on the development of agriculture, which is the main element of the agro-

industrial sector and the supplier of raw materials to all the sub-sectors of the food industry.

Ukraines service sector is one of the fastest growing in the country. Current analysis shows that more

than 40% of the population is working in this sector. The industrys share of GDP for services rendered

domestically is over 50%. In 2004-2008 this sector has demonstrated an impressive pace of growth and

profit margins. Annual turnover is $20bn and growth has been averaging 25% per year, with revenues

raising an average of $1.8bn monthly. Growing volumes of services rendered can be seen across all

regions in Ukraine, mainly a result of the steady rise in real disposable incomes. The share of services

provided to individuals constitutes 31% of all services rendered. One of the most popular services are

technical services and repairs (93%), education (89%), air transport (85.0%), photographic services

(82.4%), various personal services (76.5%), hotels and lodging (74.1%). Services that are rendered

abroad are a major part of Ukraines exports and a source of commercial capital in the country.

Today, the export of services is about 10% of GDP.

The main consumers of Ukrainian service industry according to the national statistics in 2009 were

Russia, the United Kingdom, Cyprus, the US, Germany, Switzerland, Belgium, Turkey, Austria, and

Canada.

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Ukraines main competitive advantages in services, especially in international markets, are its

inexpensive skilled labor and convenient location. Ukraines geographic advantage is mainly

important for transport networks, such as highways, railways, ports, airlines, and oil and gas

pipelines. In addition Ukraine has all the fundamentals in place for turnover in the service industry to

continue to pick up pace in 2010-2012

It is important to separate tourism from other services because today tourism plays a significantly

important role in a countrys economy and has been recognised as one of the most important

industry. Daily profit from one foreign tourist in Ukraine equals income from exporting nine tons of

Ukrainian coal. The tourism sector of economics serves as a major source of currency for 38% of

countries in the world. Its all a matter of priorities. Moreover according to the latest information

tourism in Ukraine is rising rapidly. Due to the Ukraine's State Tourism Administration, in 2005, 17.6

million tourists visited Ukraine. This represents a 13% increase from 2004, or an additional 3.1

million visitors. This trend is expected to continue, with a projected 19.6 million visitors expected in

2006. According to industry experts and tourism agencies growth in 2005 was due to Ukraine'sabolition of its visa regime with neighboring EU countries, the USA and other countries. The Orange

Revolution and Eurovision-2005 were factors for the tourist infrastructure improvements, which

support the projections for continued increasing tourism to Ukraine in the future. Also the EURO 2012

scheduled to take place in Poland and Ukraine is a factor, which could increase the flow of tourists in

the country on very high level. This factor makes the Ukrainian tourist sector extremely attractive for

foreign investors

3.3 Problematic sector for FDI inflows

Due to the large transformation in Ukraines economy since its independence and the economic

recession which hit the world last year there are a lot industries within the country which are in a

difficult situation. The greatest challenge remains privatising the large coal mining industry, energy,

telecommunication, developing and creating a market for the agricultural sector.

The Ukrainian banking system includes the central bankthe National Bank of Ukraine (NBU)and an

assortment of commercial banks. NBU responsibilities consist of monetary circulation, registration

and oversight of commercial banks, and intervening in the currency market. As of January, 203 banks

were registered in Ukraine, of which 165 banks are in actual operation, including 30 backed by

foreign capital, and 9 with 100 percent foreign capital. Ukrainian finance sector is still developing. At

the beginning of 2006, the total market capitalisation of the banking sector was only 5% of total GDP.

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But interest of foreign banks in Ukraine is increasing and the countrys banking sector is fast

becoming the focal point for foreign investors. Interest income constitutes a major part of income of

the Ukrainian banking industry income and it accounted for 69.1% of total banking income in 2005.

Current account deposits, time and savings deposits and bank loans are expected to grow at the

CAGR of 20.51%, 8.98%, and 24.85% respectively during 2007-2011. As mentioned earlier, since the

year 2006 Ukrainian banking sector has attracted the largest amount of FDI inflow. But even though

at the moment banking industry is still attractive for foreign investors, due to lack of competitors and

other factors the situation within industry remain to be difficult.

According to the report of the U.S. Embassy in Kiev, there are a variety of problems in this sector,

namely, setting up service projects requires legal endorsement; there is rampant corruption in the

licensing and administrative approval process; the payments system is antiquated, with most

Ukrainians having neither bank accounts or credit cards; and legal recourse in collecting on unpaid

services is almost non-existent. This situation could severely impact FDI inflow into the finance

sector in the nearest future.One of the most difficult situations exists within the coal mining Industry. High death rate

statistics (Ukraine has the world's second largest fatality rate in coal mining accidents after China),

outdated machinery and the depth of mines makes most of them highly inefficient. According to the

International Energy Agency (IEA), "The average mine depth is more than 700 meters; in

approximately 20 percent of mines it is 1,000-1,400 meters." It is dangerous for miners and has

depended for years on large state subsidies. For the past decade, successive Ukrainian governments

have provided massive subsidies to the coke-coal industry. This policy has been, in fact, a subsidy to

the metallurgical industry by providing it with low-cost coke. These subsidies, in turn, led to

accusations of Ukrainian manufacturers dumping steel onto world markets. On her website, U.S.

Senator Debbie Stabenow stated that, "from 1997 through 2000, carbon steel slab imports [into the

United States] from key producers have risen dramatically: Brazil up 25 percent; Mexico 13 percent;

Russia 106 percent, and Ukraine 542 percent."

However, the troubles in Ukraine's coal industry far surpass those of its other energy sectors:

Restructuring the coal industry would mean the loss of hundreds of thousands of jobs in a

politically sensitive region.

Retraining programs for coal miners are not in place; the prospects for miners performing other

jobs are bleak.

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Entire municipalities in the Donbas Basin rely on the coal industry to pay for medical care,

schools, public transportation, and other vital infrastructure

But despite all negative factors in the industry, the latest figures show that coal accounts for 40

percent of fuels used in Ukrainian power plants, 10 percent in district heating plants and 45 percent

in industry. Estimates of Ukrainian coal reserves vary. The World Energy Council estimates total coal

reserves in Ukraine at 52 billion tons, the 8th largest in the world.

Ukraine's power sector is the twelfth-largest in the world in terms of installed capacity, with 54

gigawatts (GW). But due to the economic recession which occurred in the country in the first year ofits independence, generation and consumption fell sharply and only started to increase again in the

2000s. EIA estimates that Ukraine generated 177 billion kilowatt hours (kWh) of electricity. The

country is currently in the process of revamping its electricity sector, through privatisation, increased

utilisation at existing facilities, and the completion of two new nuclear plants. Ukraine thermal

power plants (oil, natural gas, coal) account for nearly 50 percent of generation, with nuclear power

generating another 45 percent, and hydroelectric generation accounting for approximately 5%.Ukraine has sufficient generating capacity to supply more than twice its electricity needs. However,

the country's transmission and distribution systems are in need of investment and maintenance. Also,

several of the country's nuclear facilities are intermittently shut down throughout the year due to

technical problems. With the surplus electricity, in 2006 Ukraine increased electricity exports by

almost 25 percent or by over 2 billion kWh compared to 2005 according to the Ukrainian Energy. After

the completion of two new nuclear reactors, Ukraine signed a deal with RAO UES, Russia's main

electricity supplier, to supply 500 million kWh of power per month to Russia at a price of $.014/kWh.

The World Bank has been working with Ukraine on energy sector reform and has published a number

of different studies on the effect of natural gas price increases on both the rest of the economy and

in the electricity sector. Electricity sector reform and infrastructure development is one of the main

components of the EU-Ukraine Action Plan, and the World Bank will be spending over $200 million in

upcoming months to rehabilitate transmission substations, expand the transmission network, and

stablise the Crimea electric power grid, among other institutional and administrative reforms

In addition Ukraine signed a contract to supply 2.5 billion kWh to Belarus during 2006 and stands to

make $50 million from the contract. Ukraine also exports electricity from the Burshtyn

thermoelectric power station to Moldova, Slovakia, Poland, and Hungary. It started exporting

electricity to Romania in March 2005. The Burshtyn thermoelectric power station and part of

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Ukraine's western energy system have been connected to UCTE energy system of Europe since July

2002. EU officials met with Ukrainian energy officials in Kiev in early 2006 to discuss plans to fully

integrate Ukraines electricity grid into the UCTE by 2008. Also, Ukraine currently has four operating

nuclear power plants. These plants have a combined capacity of 12.8 gig watts, accounting for

approximately 24 percent of the country's total power-generating capacity.

On December 15, 2000, Ukraine permanently shut down the 925-MW, Unit 3 at the Chernobyl power

plant, disabling the last remaining working reactor at the ill-fated facility. To replace the power

generated by Chernobyl, which Ukrainian officials say accounted for approximately 5 percent of the

country's total, Ukraine resumed construction of two 1-GW reactors at the Khmelnitsky and Rivne

power plants. The construction of Khmelnitsky Unit #2 and Rivne Unit #4 began under the Soviet

Union, and both were more than 80 percent finished when Ukraine received its independence and ran

out of money to complete them. After financing from the EBRD was placed on hold, the Ukrainian

government completed the reactors on its own and connected them to the electricity grid in August

and October 2004, respectively.

During President Yushchenkos previous administration in 2000/2001, privatisation of the electricity

sector was one of his key objectives and resulted in the sale of six distribution companies. AES, based

in the United States, won 2 of the 6 tenders and is now the only foreign investor in the sector.

Currently, only six Ukrainian distribution companies have been fully privatised, and 20-45 percent

stakes in nine other utilities were sold in 1997-1998. Further privatisation of the sector is not

currently planned. Other problems hinder the full development of a deregulated market in Ukraine.First, there is a high level of transmission losses; in recent years, these have increased from 8

percent to 17 percent (compared to around 3 percent in the United States). Again, only six of those

companies have begun the process of privatisation, and the Ukrainian government has been reluctant

to give new buyers more than a minority stake in the companies. There are also worries that the

government will not receive enough compensation for the sale. Also, the industry itself is in debt

from a long history of problems which stem from insufficient collection mechanisms during the 1990s.

Distribution companies owe $3 billion in debt to the wholesale market. The combination of poor

networks, high losses, corruption, and pressure to keep current tariffs low has created inefficiencies

in the market and muted the necessary price signals.

But despite all obstacles within the Ukrainian energy sector, it still remains to be a well-developed

industry with great potential for further development. And this case can be a trigger, which will

invite foreign investors into the industry.

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The key characteristic of Ukraines telecommunication sector is that it has a significant degree of

monopoly and governmental control. The monopoly-ridden wire connections area is dominated by

two operators, Urktelecom and Utel. However, tough competition exists on the mobile

communications market. The trunked, radial, search and satellite communications markets are as yet

underdeveloped. Numerous government agencies exercise state regulation of the telecommunications

market. As a result of the administrative reform that is currently underway, their names and the

scope of their authority change frequently. The telecommunications legal framework comprises

several laws governing most general issues and a large number of regulatory acts adopted in

pursuance of these laws by specific government agencies. The provision of communications services is

subject to license. Where such services require the use of radio frequencies, a separate license for

the use of radio frequency resources must be obtained. The procedure for obtaining licenses is

complicated and necessitates the prior procurement of consent from several governmental agencies.

These factors restrict competition, hinder the entry of new operators into the market and slow down

the development of new types of communications.

However, a series of measures have been recently brought in, to reduce the degree of monopoly and

to make industry more attractive for foreign investment. On July 17 2000 the Law on Peculiarities of

the Privatisation of Ukrtelecom OJSC was passed. This law cancelled the 49% cap on foreign

ownership of Ukrainian telecommunications services providers, and repealed the state's monopoly to

own, maintain and exploit primary networks.

At present, networks as well as the means and facilities for public communication may be owned byany entity, either private or state owned. Maintenance and exploitation of public networks may be

carried out by any legal entity residing in Ukraine. At the same time, Ukrtelecom is prohibited from

transferring the ownership or management of primary networks to other entities. Thus, private

owners may receive title to primary networks through the development of new networks only.

The Law of Ukraine on Communications, dated May 16 1995, is the basic law that provides a

framework for the regulation of the telecommunications sector. It sets forth principal rules on the

regulatory authority, customer protection, tariff regulation and terminal equipment.

But it could be true to say that the telecommunications legislation is insufficient and contains

numerous gaps. To address these problems, several draft laws were developed and passed to the

Verkhovna Rada (Parliament). Among them are two alternative draft laws on telecommunications,

prepared by the government and by a group of people's deputies and aimed at regulating legal

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relationships in the telecommunications sector.

Ukrainian gas industry is almost fully controlled by a National Joint Stock Company Naftogaz of

Ukraine (NJSC Naftogaz) which is a vertically integrated company engaged in full cycle of operations

in gas and oil field exploration and development, production and exploratory drilling, gas and oil

transport and storage, supply of natural gas and LPG to consumers. Currently the company is focusing

on creating conditions for gas extraction growth. Also they are planning to increase its extraction

volume from the current 14.7 bcm per year up to 17.7 bcm in 2015. This increase is expected to be

supported first of all by new wells opening and conversion of investigation holes into commercial

production. It is also planned to significantly increase levels of preliminary drilling in order to expand

the volume of explored reserves.

However primary reserves of major Ukrainian gas fields are currently depleted. Absolute majority of

gas fields with large and medium reserves have entered into the phase of falling extraction. Based on

the volume of current reserves three quarters of Ukrainian gas fields qualified as small basins with

reserves less as 5 bcm including one-third with reserves less than 1 bcm. Moreover the state ofdomestic enterprises equipment does not meet current requirements and needs modernization.

Currently Ukraine does not possess equipment that allows well-drilling deeper than 6000 meters. To

solve this problem, for several years, Ukraine has been trying to attract foreign investors The first

important step in this field was taken when Chornomornaftogaz signed a contract with American

corporation Hunt Overseas Oil Inc. The main idea of project was exploration and development of

prospective fields with total area of around 12 thousand square kilometers at the Southern part ofthe Kerch Strait by using modern American equipment. But unfortunately this project failed due to

the absence of a production sharing agreement. Also in this sphere Naftogaz is trying to work with

British company SHELL and also with Russian state companies such as GASPROM but unfortunately due

to the difficulties in domestic legislation and complication in sharing of product the suitable

agreement hasnt been achieved.

Agricultural sector of Ukrainian economics is in a period of transformation, accompanied by increase

of negative trends in the social sphere: depopulation of significant territories, worsening of living

conditions for rural population, increase in mass poverty, growing unemployment, sharp income

differentiation. High social losses against a background of development of large-scale commercial

production, land concentration and capitalisation of production are leading to increase of social

tensions in society thus hampering the country's exit from the crisis.

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Ukrainian economic science and practice of reforms isnt yet ready and social processes in the

economics under reform are complicated and inconsistent. Some of them are contributing to

economic increase, others are influencing in the opposite way. Currently the urgent task is the

development of an efficient social policy promoting structural and institutional rebuilding of

economics and stimulating sustainable economic growth. In order to solve this task it is very

important to bring economics out of shadow, which is based on humiliatingly low level of wages in

Ukraine, prearranged by the inadequate shares of income distribution between the labor and the

capital. Processes of land concentration, attraction of industrial capital and creation of large-scale

integrated commercial structures in agricultural sector are strengthening shadowing of economics and

increasing disproportions in such distribution. With the existence of the shadow economics nominal

and real increase of salaries doesn't necessarily mean increase of standards of living for country's

population. For example average monthly wage in Ukrainian agriculture grew 4, 5 times from 1999 to

2006, but the share of wages in gross added value (GAV) dropped almost two times. In the industry,

wage increase 5, 3 times lead to wage drop by 14, 3% GAV. Only in service and construction the

respective ratio grew by 4,3% and 3%.

In a country with transitional economics it is impossible to improve standards of living for the

population by simple wage increase without simultaneous actions aimed at bringing the economics

out of the shadows. The biggest threat of low standards of living of Ukrainians is that there are falling

numbers of rural population and large territories are being depopulated. Identification of main trends

for development of modern society and social factors of economic growth should promote

identification of main direction for social and economic policy of the state during establishment of

new rural way of living .

Of Ukraine's total land area of 60 million hectares, roughly 42 million is classified as agricultural land,

which includes cultivated land (grains, technical crops, forages, potatoes and vegetables, and

fallow), gardens, orchards, vineyards, and permanent meadows and pastures. Winter wheat, spring

barley, and corn are the country's main grain crops. Sunflowers and sugar beets are the maintechnical or industrial crops. Agricultural land use has shifted significantly since Ukraine declared

independence from the Soviet Union in 1991. Between 1991 and 2000, sown area dropped by about 5

percent, from 32.0 million hectares to 30.4 million, and area decreased for almost every category of

crop except for technical crops (specifically sunflowers). Forage-crop area plunged by nearly 40

percent, concurrent with a steep slide in livestock inventories and feed demand.

Farms in Ukraine employ a variety of crop-rotation schemes, some including four or more crops, some

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only two. A six-year crop rotation in the winter grain region will often include two consecutive years

of wheat and one season of "clean fallow," during which no crop is sown. The chief reason for

including fallow in the rotation is to replenish soil-moisture reserves, and it is more widely used in

southern eastern Ukraine where drought is not uncommon. A typical crop sequence might be: fallow,

winter wheat, winter wheat, sunflowers, spring barley, and corn. Wheat almost always follows

fallow. According to farm directors, this enables the wheat - which is typically the priority crop - to

benefit from the reduced weed infestation (fields are cultivated several times during the fallow

season).

Some crop rotations include several consecutive years of a forage crop. An example of such a rotation

would be: fallow, two years of winter wheat, and four years of perennial forage. The perennial

forage is usually alfalfa; farmers will get three to four cuttings per year, five if the crop is irrigated.

In southern Ukraine, clean fallow is frequently omitted and a crop rotation will likely include sugar

beets and/or sunflower, the region's chief industrial crops. A typical seven-year rotation might be:

winter wheat, winter barley, sugar beets, winter wheat, winter barley, sunflowers, and corn.

The vast majority of field crops, including grains, sunflowers, and sugar beets, are not irrigated.

Traditionally, irrigation is used only on forage crops and vegetables. Roughly 5 percent of grains and

10 percent of potatoes, vegetables, and forage crops are irrigated

According to official statistics, the fertiliser application rate for wheat plunged from 149 kilograms

per hectare in 1990 (when fertilizer was excessively and wastefully applied) to 24 kilograms in 2000.

The application rate for corn dropped even more sharply. Fertiliser use has increased modestly since

2000. Rates are still significantly below recommended amounts, but wheat yields have rebounded

since 2000 (except for the weather-related crop disaster of 2003) due to a combination of favorable

weather and improved crop-management practices on the large agricultural enterprises.

There is no shortage of mineral fertilisers or plant-protection chemicals in Ukraine. Any inputs that a

farmer needs can be obtained if the farm has money or can get credit. The high price of imported

herbicides and fungicides has caused some farmers to cut back on their use, or to use less expensive

and less effective domestic products. Farmers still rely to a large degree on mechanical weed

control.

A chronic lack of modern harvesting equipment remains one of Ukraines main obstacles to increasing

grain output and quality. In the late 1980's, the Ukrainian winter wheat harvest could be finished in

roughly three weeks. Harvest now takes twice as long to complete, and both yield and grain quality

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suffer as a result of the delays. Farm managers estimate that 10 to 20 percent of the standing crop is

typically lost due to outdated, inefficient machinery. Custom combining is available, but operators

charge 20 to 25 percent of the crop in exchange for their services. Farmers must weigh custom-

combining charges against potential harvest losses, and most choose to harvest their own grain.

Another consideration for the farm director, in addition to cost, is that the harvest campaign provides

work for the farm employees.

Many farmers are compelled to sell grain shortly after harvest when prices typically are lowest. One

of the main reasons is a shortage of on-farm storage capacity, especially following a good harvest.

This is a relic of the Soviet system, which was designed for immediate post-harvest shipment of grain

to regional elevators. The need to repay short-term debts or to satisfy "payment-in-kind"

arrangements is the second chief factor contributing to the untimely sale of grain (i.e., untimely from

the farmers perspective). At harvest time many traders are offering cash for grain. Banks do not

accept grain as payment, and for a farm director struggling with a heavy debt burden the lure of

immediate cash is difficult to resist. The greatest obstacle to increasing on-farm grain storage and

modernising the fleet of agricultural machinery is the difficulty for many farms to obtain large, long-

term loans for capital investments.

Ukrainian farmers are able to receive credit, but interest rates and collateral demands are high.

Since many farms are already heavily in debt to banks or suppliers of fertilizer and plant-protection

chemicals and since agricultural loans are not guaranteed by the government, banks are largely

unwilling to make long-term loans. Most credit is extended in the form of seasonal loans (six to tenmonths) used almost exclusively for the purchase of fertiliser and plant protection chemicals.

Commercial interest rates typically range from 25 to 30 percent. The State provides assistance to

farms by paying 50 percent of the interest on agricultural loans. Banks typically require 200 to 300

percent collateral, depending on the farms credit history and the risk level. Future crop usually

serves as collateral, but collateral can also be offered in the form of livestock, farm machinery, or

the personal property of the farm director. Under current legislation, land cannot be used ascollateral. Farmers difficulty to obtain anything othe

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