Doing Business In Present Ukraine: Challenges And Opportunities
By Dmytro Fedoruk & Andriy Olenyuk
Posted: 29th April 2015 09:16Ukraine has always been regarded as a land of extensive potential and neglected opportunities. Despite having a favourable geographical location, fertile agricultural lands, low-cost but high-skilled labour and large consumer markets, Ukraine has for long been unable to build up on its strengths and develop into a sustainable economy with a comfortable business environment. Now, however, a year after the overthrow of the corrupt and largely authoritarian government of President Yanukovych, Ukraine is enduring fundamental social and economic transformations aimed at integrating with the European Union and revitalising its stagnant economy. The government of Ukraine announced an ambitious plan to enter the top 30 countries in the World Bank's Doing Business ranking and to apply for membership of the European Union in 2020 as part of a broader plan. As never before, such transformation is supported by major international financial institutions and sends positive signals for both domestic and foreign investors.
In this context, we have looked into some of the current challenges and market opportunities of doing business in Ukraine and set out our key findings below.
Balancing Public Finances Remains a Challenge for Ukraine
Ukraine's public finances have seriously deteriorated in 2014 with the consolidated public sector fiscal deficit amounting to about 12% of GDP and increased public debt amounting to about 72% of GDP. To address this, in 2015 Ukraine introduced significant budget cuts on public spending, increased prices for certain household utilities that were previously subsidised and made substantial efforts to attract external financing. Ukraine has already completed negotiations with the IMF on a $17.5 billion loan program, forming part of a wider $40 billion financing package being negotiated with the major international financial institutions, the US and the European Union. Further, Ukraine is currently negotiating the restructuring of a portion of its public debt, of approximately $26.3 billion, as reaching a deal on the restructuring of this debt is a condition to obtaining further international financial support. However, Ukraine's ability to improve its public finances remains uncertain.
Uncertainty around public finances creates a number of implications for doing business in Ukraine. Firstly, there is a direct negative impact on the assessment of country risk by investors and their willingness to invest in Ukraine. Secondly, within the country, this creates additional risks for the banking system and indirectly affects the private sector through lack of available bank lending and potential solvency issues. Lastly, under the current circumstances Ukrainian companies are not able to access foreign capital markets for financing purposes. Overall, it is expected that balancing Ukraine's public finances will be key to improving the local business environment and attracting foreign direct investment into the country.
Ongoing Military Conflict in the East and Crimea Annexation
The military conflict with pro-Russian rebels in the eastern Ukrainian regions of Donetsk and Luhansk and Russia's annexation of the Crimea created additional challenges for doing business in those parts of Ukraine.
Ukrainian government adopted a set of "emergency" laws and regulations governing business activities in the affected regions. In respect of the Donetsk and Luhansk regions that are not controlled by the Ukrainian government, the major impediments to doing business include the suspension of all types of banking operations, the absence of legitimate public authorities and the unavailability of social insurance benefits for local personnel. In respect of the Crimea, companies doing business in the Crimea are considered non-residents for the purposes of Ukrainian currency control and customs regulations with the resulting regulatory implications (e.g., limitations on money transfers, customs clearance of goods produced in the Crimea, etc.), sales by Ukrainian companies of real estate property to Russian companies is prohibited and any investments into the Crimea by Ukrainian companies are not permitted.
Further, the Crimea annexation prompted a negative reaction from the US, the EU and certain other countries that did not recognise the outcome of such annexation. As a result, both the US and the EU banned their domiciled companies from making investments into the Crimea and trading in any goods, services or technology originating from the Crimea.
The above challenges are likely to remain in place for at least in the medium-term and should be factored in by investors interested in doing business in these regions of Ukraine.
Transparency of Actions by Public Officials Needs to be Ensured
Corruption accompanied by excessive bureaucracy has been Ukraine's longstanding and major impediment to creating a sustainable investment climate.
Despite some considerable effort to tackle corruption, Ukraine ranked 142nd in the 2014 Corruption Perceptions Index published by Transparency International. According to polls held by Transparency International in April 2015, more than 80% of CEOs in companies doing business in Ukraine believe that corruption remains an issue for Ukraine, with the tax authorities recognised as leaders among those blamed for corrupt activities. That said, Ukrainian government has recently adopted a comprehensive legislative package aimed at conforming the Ukrainian anticorruption laws with those of the EU and ensuring their effective enforcement. Among others, the laws established a special independent national anticorruption bureau authorised to investigate high profile corruption related offenses and vested with the necessary enforcement powers.
Although it is likely that the Ukrainian government will further strengthen its efforts in fighting corruption and excessive bureaucracy, we believe that eliminating them is going to take a long time, if it proves at all possible, to eliminate them entirely.
High Risks Bring High Returns: Market Opportunities in Ukraine
Despite the challenges set out above, Ukraine remains a land of opportunities.
This is especially relevant if one considers entering into Ukraine's most promising markets that include agriculture, pharmaceuticals, energy, IT and public infrastructure. The agriculture market even today is noted for its extensive export opportunities and low-cost labour. The Ukrainian demographics, which show a trend of increasingly ageing population, lead one to believe that the pharmaceuticals industry is likely to increase its turnover and expand its client base in Ukraine. The energy sector (including traditional and renewable electricity, oil and gas subsectors) in Ukraine requires substantial investments due to a need to ensure Ukraine's energy security from Russia. The market for IT outsourcing and software development services has demonstrated steady growth in the last couple of years. It is also anticipated that major infrastructure projects will be developed to facilitate trade and other business activities in Ukraine.
Ukraine market attractiveness is backed by such important factors as increasing trade with the EU due to the favourable terms of the EU-Ukraine Association Agreement, reduction of regulatory and administrative barriers resulting from the deregulation of business activities and availability of commercially viable projects at low market value.
Generally, with the economic transformation underway, strengthening bilateral relations with the EU and proper legislative reforms in place, Ukrainian markets will improve their business climate and attract foreign investments. Whilst Ukraine remains a risky economy to invest in, the potential rewards may be worth taking the risk.
Dmytro Fedoruk is a counsel in Clifford Chance's Kyiv office. Dmytro has significant professional experience in corporate law, capital markets, banking and finance and securities regulation. Having over 10 years’ experience in practicing law in Ukraine, Dmytro has advised on a broad range of corporate transactions, including joint ventures, mergers and acquisitions, IPO's and corporate restructurings. He originally graduated with a degree in law from Taras Shevchenko National University of Kyiv, worked in the leading international law firms in Ukraine, and joined Clifford Chance in October 2008.
Andriy Olenyuk is an associate in Clifford Chance's Kyiv office, specialises in corporate law and M&A as well as banking and finance matters. Andriy has recently acted for a large financial services group in connection the acquisition of an insurance company in Ukraine as well as represented shareholders of a mid-sized Ukrainian bank in connection with its sale to the group of investors. Andriy is a graduate of the Faculty of Law at the University of Lviv (2008) and holds LL.M. degree from Georgetown University Law Center (2010). He joined Clifford Chance in August 2010.