Fund managers seldom react positively when political infighting gets in the way of market reform. But the dismissal of Yulia Tymoshenko as Ukraine's prime minister and the collapse of the government coalition has received an uncharacteristic thumbs up.

"Tymoshenko was widely seen as a populist with one agenda, which was to collect votes, rather than work for the long-term benefit of the country," said Aivaras Abromavicius, manager of a Ukraine equity fund for East Capital in Sweden. By removing her from office this month, President Viktor Yushchenko "has strengthened his hand before parliamentary elections in March and paved the way for speedier reforms," Abromavicius said.

Matthias Siller, manager of an emerging markets fund for Raiffeisen Capital Management in Vienna, said he also viewed the removal of Tymoshenko in a positive light.

"We could see a significant pickup in foreign direct investment as investor confidence recovers," he said.

At the heart of the discord between Yushchenko and Tymoshenko was her call for a wide-scale review of recent privatizations. During the presidency of Leonid Kuchma, whom Yushchenko succeeded in January, dozens of enterprises were suspected of being privatized under dubious circumstances. Yushchenko appeared more willing to forgive and forget for the sake of stability, Abromavicius said. Katia Malofeeva, an analyst at Renaissance Capital in Moscow, suggested that the second privatization of the country's largest steel producer, scheduled for Oct. 24, could also help lift investor morale.

"It is not often a steel company of this magnitude comes to market," Malofeeva said. "Although the investment preconditions are tough, there has been significant interest from Russian and East European investors."

Despite the recent political uncertainty, Ukraine's fledgling stock market has moved up over the summer. But if the experience of Russia and Latvia is anything to go by, an investment in Ukraine is not going to be smooth.

Once voted one of the least corrupt countries in the world, Ukraine was ranked among the 20 most corrupt nations in the latest survey by Transparency International. Low levels of financial transparency and corporate accountability have hindered foreign direct investment, and doubts have been raised about the government's economic growth forecasts.

The International Monetary Fund reported last month that Ukraine's government was unlikely to reach its target of 8 percent growth in gross domestic product in 2006 because of decreasing industrial output and accelerating inflation. A more likely figure is 5 percent, the IMF said.

Malofeeva pointed to Ukraine's social welfare system as an additional cause for concern. The country has a population of 50 million, of which 14 million are retirees. A further four million are dependent on state benefits.

"Whoever wins the parliamentary elections will have to address this issue," Malofeeva said. "We have cautioned investors not to expect a capitalist economy to develop overnight, let alone within the next year or two."

Tim Ash, managing director of emerging markets for Bear Stearns in London, said Ukraine's troubled relationship with Russia, a key export market, would have to be improved if the country was to move forward.

"The Russian government never wanted Yushchenko in power, and it has gone out of its way to create difficulties for the regime, including renegotiating energy prices and instigating a trade war over fuels," Ash said. "Bridges have to be mended. The question is whether or not Russia is prepared to listen."

But despite caveats, the long-term investment case for Ukraine is hard to ignore.

"Ukraine is starting from a very low base," Abromavicius said. "Disposable income is increasing, and the country is on the cusp of a consumer boom. Any company involved in real estate, cement and construction looks attractive."

The Ukraine stock market has a tiny free float of around 7 percent, and liquidity is poor. The market is also dominated by energy and metals companies, which no longer look cheap after their strong run over the summer months.

An alternative way to play the market is through a Ukraine proxy like MTS, the Russian mobile telecommunications company that owns UMC, Ukraine's largest mobile operator.

Raiffeisen International, part of Raiffeisen Banking Group, is another company with significant exposure to Ukraine. In August, the bank, based in Austria, acquired Bank Aval, making Raiffeisen the No. 1 bank in Ukraine.

The growth potential for retail banking in Ukraine is compelling when comparing GDP with the volume of lending to private customers. In the euro zone, this ratio averages about 50 percent; in Ukraine, it is 4.5 percent.
Barbara Wall

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