AFTER CENTURIES SUBSUMED within the borders of the Soviet Union and recent years confined to the economic doghouse, Ukraine is emerging as the latest favourite destination on the global investment map.
Strong performance from nearly every industry in 2003 gave Ukraine a fourth successive year of GDP growth. At over 6%, that made the country one of the top performers in the world despite the worst harvest for 50 years.
The strong performance came as a surprise to some policymakers. After posting 4.8% growth in 2002 – down from 5.9% in 2000 and 9.1% in 2001– they predicted that the slowdown would continue in 2003. Such strong growth caught some unawares. Deputy prime minister and energy minister Vitaly Haiduk was fired early in December for the failure of the dilapidated power system to provide for the needs of the economy; he blamed it all on the unforeseen and inexplicable rise in industrial production.
Economic reform was already attracting inward investment. "The economy is expected to grow by 21% in the course of 2001 to 2003, while inflation is subdued at 12% to 13% in three years," Valeriy Khoroshovskiy, minister of economy and European integration, had told the IMF meeting in Dubai in September 2003. "Since 2001 exports and imports increased by 38% and 41% respectively, while the level of foreign debt declined in relative and absolute terms. We managed to diversify our trade significantly, while the demand for our major exports has recently been good. Investment activity is picking up, household incomes are growing steadily, and we are aiming at a better balanced growth."
These sturdy macroeconomic achievements provided the platform for Ukraine to make a triumphant return to the international capital markets for the first time since 1998. Its $800 million 10-year bond issue in June 2003 was six times oversubscribed – proof that foreign investors have regained their appetite for Ukraine as a sovereign credit.
With the EU accession prospects of other central and eastern European countries reducing the possibilities of lucrative returns, Ukraine is becoming one of the key holdings for emerging-market investors. But the word is: get in now while assets are still cheap.
There is a caveat of course. The biggest cloud on the horizon is short-term uncertainty in the run-up to the October 2004 presidential elections. No-one knows what will happen. After eight years in power, Leonid Kuchma, Ukraine's autocratic leader, will stand down. It is unclear whether he will be able to preserve his power base. In any case, foreign investors are wary – they know that doing deals before these issues are clarified is a decidedly risky strategy.
Ukraine still has a bad press abroad – headlines highlight murdered journalists, parliamentary squabbling among oligarch blocs, widespread corruption, and the breaching of sanctions by selling weapons to Iraq.
But in economic and financial terms Ukraine is over the dark days that followed the 1998 Russian financial crisis, when it humiliatingly defaulted on its foreign debt and briefly became an international pariah.
Starting in 2000, Ukraine slowly eased out of its slump with a number of tough macroeconomic reforms under the government of Victor Yushchenko, now the leading opposition candidate for the presidency. Foremost among these was the abandonment of barter and the introduction of transparency into settlements by allowing only cash. Money previously siphoned offshore could now be used for investment in Ukraine.
The new virtuous circle
Since then, the economy has stabilized, says Kamen Zahariev, Ukraine director of the European Bank for Reconstruction & Development in Kiev. "Little inflation, no devaluation of the currency – without that no-one can run a business; it has created the fertile ground for businesses to stabilize and start exporting and think a little bit more long term," he says. "That has led to a virtuous circle because exports have grown, there's a foreign account surplus – which is almost amazing – and foreign reserves have rocketed to $6 billion."
Others agree. "The last few years since the restructuring of its external debt have seen a number of favourable developments in Ukraine – economic management, the reform effort and stability domestically – that have boosted its external position and debt servicing prospects across the board," says Caren Gaboutchian, senior economist at ING Financial Markets in London.
Industrial output and services sector growth has been particularly impressive this year, and manufacturing industries are now the fastest-growing sectors of the economy. The country also boasts abundant natural resources and a well educated population – 20% go to university. Ukraine has also made efforts to join the World Trade Organization, as well as sometimes contradictory moves to integrate with the EU and with other CIS states.
Capital market investors looking only at the credit risk of the government are the vanguard of investment flows into Ukraine, says Zahariev of the EBRD, which is by the far the biggest and most diversified investor in the country.
That will force analysts to cover Ukraine more closely, which in turn will encourage investors to come in. But Zahariev warns that there is a big difference between buying sovereign bonds and investing in the country's business economy.
Foreign direct investment figures are feeble – total investment since independence in 1991 is about the same as Poland gets each year – and stock market investment is negligible. But there are signs of improvement.
"This year we have seen $760 million in foreign direct investment – higher than last year," says Mykola Azorov, first deputy prime minister and minister of finance. "It is not a big size but it still represents 132% growth – which means investors see less risk about investing capital in Ukraine. There are no restrictions on the flow of capital; the tax regime is favourable and the financial system is stable. In the coming year, more investors will come to Ukraine."
Up until 2003 it was only hedge funds that showed an interest in Ukraine, says Igor Mazepa, managing director of MFK, a Kiev-based investment bank. Now a lot more international investors have noted fundamental changes. "The economy is no longer ruled by command of the government," says Mazepa. "Around 70% to 80% of GDP is created by the private sector."