by Adrianna Melnyk

Ukraine’s economy has been booming. Since 1999, the country’s economy has exhibited strong and sustained growth. Between 2000 and 2006, real GDP rose by an average of 7.5% annually, with an increase of 7.1% in 2006, in a year that saw an almost doubling of prices of Russian-supplied gas. This year, 2007, real GDP grew by 7.7% year-over-year from January-July, with double-digit growth rates in manufacturing, wholesale and retail trade, and construction. Paradoxically, such sustained growth has occurred despite a period of longstanding political tensions in Ukraine, a period that encompasses mass demonstrations against former president Leonid Kuchma in 2001, the Orange Revolution of November-December 2004, and recent political brinksmanship, culminating in snap parliamentary elections that took place on September 30th.

Ukraine’s GDP growth in the first half of this year is estimated to have been 8% or more. The country’s unemployment rate has steadily decreased from a rate of 10.9% in 2001 to 6.8% in 2006, while real wages have risen by an average of over 19% per year during the same period. Disposable incomes grew by an average of 15.2% per annum in 2001-06. This hike in real incomes, combined with substantial increases in labor productivity, is the main factor contributing to a reduction in poverty levels in Ukraine from 32% in 2001 to 8% in 2005. Since 2003, household consumption has been growing by double digits, a metric which can be attributed not only to the rise in wages, but also to the increase in volume of retail loans, which in 2006 surged by 137%, to $15.5 billion.

Financial services, fueled by this credit boom, have been one of the fastest-growing sectors of the Ukrainian economy, along with real estate and consumer goods. In the first half of 2007, the industrial sector regained its position as the leading driver of economic growth. Recent GDP growth has been supported by strong growth in the industrial and service sectors, particularly wholesale and retail trade, as well as by expansion of construction. The stock exchange in Kyiv more than doubled in size this year to reach a market cap of $76 billion, small by European standards but large in relative terms.

Since the pro-democratic Orange Revolution of 2004, Ukraine’s economy has seen substantial inflows of foreign investment. The Ukrainian State Statistics Committee reported in August of this year that FDI in Ukraine rose 50% in the first half of 2007 from the same period in 2006, to reach $2.55 billion. Foreign investors injected $3.28 billion in direct investments into Ukraine's economy in the first half of 2007, while withdrawing $820.3 million. The overall amount of FDI in Ukraine by July 1, 2007, was $24.17 billion, which was 11.8% up since the beginning of the year.

The largest deal to date has been the privatization and subsequent purchase of a 93.2% stake in the Kryvorizhstal steel company by Mittal Steel, a deal valued at over $4.79 billion.

Of all the sectors, the banking sector has been marked by the largest wave of acquisitions by foreign buyers, including the 93.5% share purchase of Aval (Ukraine’s second largest bank) by Raiffeisen International for $1.028 billion in 2005. Many other Ukrainian banks sold their shares to foreign investors, including UkrSibbank, Forum, VaBank, Mriya, Index-Bank, and Megabank. Over the past two years, four of the top five Ukrainian banks have been purchased by foreigners. Earlier this year, Swedbank, Sweden's largest bank, announced that it would acquire Ukraine's TAS-Kommerzbank for up to $985 million. Most recently, Italian bank UniCredit in July announced plans to acquire Ukrsotsbank, the second-largest Ukrainian financial institution, for $2.2 billion.

Foreign investment in consumer goods and foodstuffs has also increased. In August of this year, PepsiAmericas Inc. and PepsiCo Inc. purchased the country’s biggest fruit juice manufacturer, Sandora, which controls 50% of the Ukrainian juice market, in a $542 million deal. The two companies agreed to create a joint venture to buy Sandora, in which PepsiAmericas, which bottles Pepsi drinks, holds a 60-percent interest. In a smaller deal this year, Group Danone announced that it would invest EUR 20 million to upgrade a Ukrainian dairy plant which it had acquired in September 2006. Also earlier this year, French supermarket chain Auchan entered the Ukrainian market via a joint venture with local retailer Furshet, and stated its intent to build 10 hypermarkets in Ukraine by 2009.

But the Ukrainian market is far from saturated: even though the increase in FDI is large by Ukrainian standards, it is miniscule compared with its neighbor Poland, which joined the European Union in 2004. Foreign direct investment in Ukraine reached just over 16% of the corresponding figure for neighboring Poland, whose population is 38.5 million, compared with Ukraine’s 48 million, according to Christian Gianella and William Tompson, authors of a study published in August 2007 by the Organization for Economic Cooperation and Development.

As the international investment community’s interest in Ukraine continues to grow, so too has its need for advisory services provided by legal specialists, consultants, and financial professionals skilled at navigating Ukraine’s often complex legal, financial, and regulatory system. In May of this year, The Boston Consulting Group (BCG) opened an office in Kyiv. Over the past four years, the consultancy had served Ukrainian clients from its Moscow and Warsaw offices, but after a comprehensive analysis of the Ukrainian market, decided to enter the market and to make a “strong and solid commitment to Ukraine,” according to a company spokesman. Another provider of consultancy services, Ernst & Young, has grown its Ukraine-based business to a team of 400 professionals, and has opened a second office in Donetsk.

Domestic law firms, with strong know-how about operating in the country’s complex regulatory and legal environment, have been growing rapidly. Over the past two years, Magister & Partners has doubled its staff. Foreign legal firms have also expanded their presence in Ukraine, and major European firms have begun scrambling to open offices in the dynamic Ukrainian market.

In order to ensure that Ukraine continues its strong growth and economic transition, policymakers must address areas of concern for both foreign investors and local businesspeople. As Ukraine prepares to join the World Trade Organization as expected next year, experts say growth can only be sustained if the next government embarks on an ambitious economic agenda. Party of Regions leaders believe that key legislation pertaining to structural economic reforms must be passed: pension reform, tax reform, and most important, judicial reform. Yulia Tymoshenko, leader of BYUT, and now Prime Minister of Ukraine, focused on the economy as an election issue, and has promised to make Ukraine a more hospitable country for foreign investors by improving the transparency of the legal and tax system. She also criticized a recent privatization deal: the sale of Dniproenergo, the largest power-producing thermal power generator, to Rinat Akhmetov, one of Ukraine's richest men and a major force in the Party of Regions. "That privatization deal lacked all transparency and was politically motivated," said Hryhoriy Nemyria, an adviser to Tymoshenko. Meanwhile, the Party of Regions has pledged to reduce the highest corporate tax rate in a bid to spur greater foreign investment.

Ukraine’s president, Victor Yushchenko, has recommending that the business community in Ukraine formulate a group of draft laws aimed at improving further the country’s business climate. “We are formulating an action plan which could become a list of urgent measures for the government and parliament,” he said in September. The action plan is expected to address issues of how to improve permit and license procedures, remove technical barriers for business and reform the national tax system.

Thus, as business rapidly evolves in new areas like telecommunications, software, travel and tourism, consumer goods, and real estate, and as growth continues in more traditional sectors, Ukraine will require government reform in key strategic areas. Privatization, infrastructure development, and restructuring of heavy industry will become priorities. WTO accession will put new competitive pressures on Ukraine, particularly in heavy industry, like steel, metallurgy, and aluminum, all of which can benefit from foreign investment and expertise to modernize and make the sector more energy-efficient and competitive. Efforts will also be needed to combat widespread corruption and strengthen the rule of law in Ukraine.

A key area to watch in upcoming months is inflation: the most recent inflation report published by the Ukrainian State Statistics Committee showed a rise of 2.2% in consumer prices in September, bringing the inflation rate over the first nine months of 2007 to 8.6%. This exceeded the government’s 2007 budget estimates of 7.5%. Inflationary growth in Ukraine is expected to continue as the dollar weakens, as remittances from Ukrainians working abroad continue flooding the economy (Ukrainians working abroad sent home $8.4 billion last year, equivalent to 8% of the country’s GDP), and as Ukraine braces for another increase in the price of natural gas charged by Russia.

With the recent elections likely to put an end to recent political turmoil, and with a configuration of the ruling coalition and government likely, new impetus should come to the internal economic reform agenda. Together with continued foreign investment, this should help Ukraine fulfill its vast potential, as it catches up to the progress made by its Central European neighbors.

 

Adrianna Melnyk is Director of Research and Outreach at the Orange Circle, a New-York based not-for-profit initiative focused on Ukraine’s democratic and economic development.

 

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