Last year's Orange Revolution sparked hopes of massive foreign investment inflow and new market reforms. However, the Ukrainian government so far fails to elaborate a policy that would increase foreign direct investments (FDI) in the country. State statistics committee data released in mid August showed a dramatic year-to-year decline of FDI Ukraine received in H1/05.
The indicator dropped 14.4% y/y to USD 491.3mn. Accumulated FDI amounted to USD 9.061bn or USD 192 per capita as per Jul 1, 2005, SSC informs. In Q1 foreign direct investment totaled USD 227.2mn and in Q2 it made up USD 264mn. To compare, FDI in Q1/04 amounted to USD 216mn and in Q2/05 it stood at USD 357.3mn.
Government can improve FDI statistics only by selling large state companies
Nevertheless government has the only chance to improve FDI statistics. If government, as it now plans, manages to sell steel producer Kryvorizhstal and telecommunication monopoly Ukrtelecom till the end of 2005, we will witness record FDI inflow over 2005. Now the record makes up USD 1.69bn, attracted in 2004.
The approximate cost of the two state companies is about USD 4-6bn and there are many foreign companies among the potential bidders. However, risk of
repeat re-privatization looms large for investors, discouraging them from diving in.
Also, except selling large state enterprises, government does not have any other tools to boost FDI volumes. There are no real trends promoting investment in Ukraine. And this is the forming opinion of foreign investors who expressed last week their disappointment toward state economic policy.
Slowdown of economic growth discourages investors
The #1 factor influencing FDI decrease is the slowdown of Ukraine's economic growth. Merrill Lynch expert Ralph Suppel says the economic and political situation did not improve after the presidential elections, as it was expected in the beginning of the year. The continuing political strife limits progress of structural reforms, he said.
Suppel called the growth slowdown the disappointment of the year. Suppel's declaration coincides with the official report on Ukraine's economic development published by experts of International Monetary Fund (IMF). The mission studied the economic situation in the country in Jul-Aug.
According to the report, Ukraine's GDP growth will make up 5.5% in 2005 and 5% in 2006. In Jan-Jul GDP rose by only 3.7% y/y to USD 42.78bn, SSC
informed earlier. In June growth amounted to a mere 1.1% y/y. To remind you, GDP surged 12.1% y/y in 2004 and 9.4% in 2003.
Government can soon lower GDP growth forecast for 2005 from 8% y/y to 6-6.5% y/y. which we still consider too optimistic
IMF estimates are lower than even government's downward revised forecast. In March 2005 government forecasted GDP would grow 8.2% y/y in 2005, reaching USD 87.2bn. In July economy minister Sergey Teryokhin declared that EconMin would revise the target for 2005 from 8.2% y/y to 8%. Government plans to reach 9.5% y/y GDP growth in 2006.
Taking into consideration latest GDP data, we have strong doubts in government's forecasts. We expect another decrease of GDP growth forecasts by authorities in the nearest future. In August, director of EconMin's economic and social department Vadim Pischenko informed the GDP forecast could soon be revised down by the government from 8% y/y to 6-6.5%.
Even that, in our view, is too optimistic. Because in order to reach 6-6.5%, growth in the remainder of the year (Aug-Dec) would have to hit 9.2-10.4%. Slight acceleration can take place off a lower base (GDP growth slowed slightly in anticipation of the presidential vote in late 2004). Also, government can adjust downward 2004 figures or raise Jan-Jul 2005 estimates, to boost growth figures. But still, a miracle would have to happen for growth to resurge.
Government does not agree with IMF forecasts and calculations
IMF considers that the main reason impairing GDP growth is decreasing industrial output and accelerating inflation. This fully confirms our observations. Thus, industrial production shrank 2.4% y/y in July, staying up 3.9% in Jan-Jul.State statistics committee reported that industrial production was decreasing the second month in a row.
In June 2005 it declined 0.1% y/y. As we noted on Aug 9, growth of the indicator is slowing since March 2004 when the figure reached 18.8% y/y.
In July 2004, IP rose 8% y/y. In Jan-Jul 2004 IP was up a robust 14.7% y/y. Earlier this year, government lowered its forecast for IP growth in 2005 from 12% y/y to just 6-7% y/y. Again, do not be surprised if this target is undershot considerably.
Authorities, in their turn, disagree with IMF's projections. Anecdotally, officials from EconMin asked not to believe parliament speaker Volodymir Lytvin's words regarding the inflation rate in Ukraine. Lytvin declared on Aug 12 that inflation made up 15% ytd in Jan-Jul, refuting the 4.4% figure by state statistics committee.
Saying that, Lytvin referred to IMF's estimates. He declares that government should stop hiding real macroeconomic data. Government still forecasts inflation will reach 9.8% y/y in 2005 and 9.3% y/y in 2006. It seems SSC is unable to properly track consumer price changes in the country.
Economic expansion in recent years created big opportunities for foreign investors
In spite of differences in macroeconomic data, it is obvious that slower economic expansion is a barrier for FDI in Ukraine. Over the last 2 years, robust macroeconomic growth figured were the real drivers of FDI in spite of high political risks. In recent years returns on investment were extremely attractive.
For example, corporate bond issuances were regularly placed at 15-17% yield, while some investors reported returns of 18-19%. Foreign portfolio investors
declared lately about 20-30% return on equity investments. That is why the FSTS stock market index (in spite its small size and low liquidity) rose 40% in 2003 and a tremendous 350% in 2004.
Now imports and real estate are most attractive sectors
But by lowering duties, Ukraine worsened its trade balance. The trade surplus declined by USD 1.9bn y/y in H1.According to SSC, Ukrainian exports exceeded Ukrainian imports by USD 381.3mn in the period. But while merchandise exports increased 9.2% y/y to USD 16.93bn, imports soared 26% to USD 16.55bn.
For comparison, in full-2004 the trade surplus increased to USD 3.62bn. The lowering of customs duties, needed for Ukraine to enter WTO, can results in
imports exceeding exports in full-2005.
Government's worst moves regarding investment are: keeping VAT rate at 20% and liquidating free economic zones
We should note that Ukrainian exports largely consist of only 4 kinds of goods: steel products, energy, chemicals and agricultural products. If the country faces a drop in world metal prices (something already taking place now) or deterioration of political relations with Russia (that can influence Ukraine's energy exports) the economy might collapse. Such high risks definitely do not help attract foreign investments to Ukraine.
Besides the difficult economic situation, foreign investors generally suffer from an unfavorable regulative environment. The FIRST factor is 20% VAT rate and problems connected with its reimbursement. If the VAT rate is cut even to 17%, exporters could significantly decrease their transaction costs.
The SECOND factor is cancellation of free economic zones (FEZ) in Ukraine. Abolishment of privileges for entities operating in FEZs was aimed to stop money laundering that was performed by some Ukrainian and Russian companies.
Intellinews - Ukraine This Week
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