Towards a strategic approach to FDI 2.0 for Ukraine

Towards a strategic approach to FDI 2.0 for Ukraine

So a systematic strategy is required answering the key questions Where should the investment come from? Why should it come? Where should it go? Will it be successful in medium and long term and are you ready for it?

First where should it come from? Investing in foreign countries is a risky affair. Millions of cases have gone wrong. Political risk, currency risk, business risk, mentality, wrong business partner or wrong sector or wrong assumptions and capital is flexible where to go but once you have invested you are kind of stuck, married to a new jurisdiction and bound for success and always depend on the political authorities if something’s goes wrong. So in general investor tends to invest in countries where the political framework seems secure and friendly. This is one of the reason why Central European transformation worked very well, SEE medium and Eastern Europe did not up to now. The stable framework of NATO and EU enlargement perspective makes all the difference. That is why clarity and a perspective for EU and possible NATO matter for much for Ukraine. Look at all the economic transformation stories of post WW2 world most of them depend on security first and most either on American backed security like in NATO or Japan, Israel and South Korea or similar arrangement there were specific factors like a economic partnership with American for Mexico and China or independent source of natural wealth like Saudi Arabia and a security partnership with the US. So when you ask the question where the foreign funds come from they will mostly come from friendly countries that in general invest in countries friendly to them or in a similar alliance system. And as Ukraine has changed its alliance system in 2014 and as we see if very serious trying to reduce Russian investment and exposure to Ukraine economy we can list the source of potential significant investment with US, Canada and Mexico, EU, Turkey, Israel, Middle East and Gulf countries and Japan, China, South Korea and possible India and south Africa and the off shore destinations where Ukrainian Oligarchs have parked their investments. When you want further to prioritize it is the EU, US and Canada and the rich part of the Gulf states and Japan and South Korea who have access capital to invest and are supportive of Ukraine post Maidan and want Ukraine to be successful. China is a interesting topic but the interest of China is in infrastructure and technology and it is a sensitive area to open for massive exposure as long as China and Russia are flirting and the same is true for the new found flirt Turkey Russia quite surprising given 300 years of war and the Russian occupation of Crimea and the bad treatment of the Crimean Tatars. So the Target Markets for Investment capital for Ukraine can be mainly reduced on North America, EU, Japan, South Korea and China and Israel and the Gulf States. And once this is clear than based on that it can be decided where to build Investment promotion offices, where to focus on trade fairs and how to combine foreign affairs, diplomacy and investment promotion. This is not to excluded anybody but open pro Russian supporter during the confrontation all of the countries having bilateral chambers should be included in the FDI and Competitiveness Council and for export links there can be some other priority countries but when it come for example training special investment officer with language links and put them into specific Ukrainian embassies or hire staff in the Investment Agency there should be the target markets and priorities in terms of networks and language skills.

Who are the investors?

We should separate different forms of investors. International corporate companies, SMEs in Manufacturing and IT, Tourism, Agriculture or energy, International Investments funds, Sovereign State funds, Diaspora Remittances, Returning Oligarch Capital. For all such investor segments an appropriate investment policy should be designed but the focus on IPA on International funds, big corporate, SMEs and Sovereign funds which should be specifically targeted in systematic manner but as well for the Diaspora remittance and the potentially returning oligarchic capital parked in off shore investment vehicles should be discussed and analyzed. In short the experience of the Western Balkans in terms of remittance shows that they are focused on the property market and if it is assumed that this is case as well in Ukraine the housing market, the rental market and the rental tax system as well with the online Kataster should incentives investment in the property market. In Ukraine case such investment might be directed as well towards the stock exchange. In both cases the tax situation, trust and transparency and a feeling of care and being welcome and being see as part of the project is important. Assuming that the figure often quoted that Ukraine has lost 8 Million inhabitants in 25 years there is a major group and capital pool to be tapped into with the right investment policy. Some of the Diaspora might return and as well for this segment as specific entrepreneurship and investment agenda should be developed as outlined in SME section. It can be assumed from the SEE experience that migration patterns to the West will accelerate and the defacto export of people has to led to a return on remittances partly to support family subsistence but as well to encourage investment in property for retirement or family members or possible return or simple for investment. As similar policy approach has to be developed for the enormous amount of Ukrainian capital invested in off shore and it is a major pool of capital to be attracted back into Ukraine with the right policies. In this sector the issue of a amnesty will have to be considered which many countries have decided to offer to attract capital of unclear origin back into the formal economy and accepting and clearing it shadow origin. No all societies are ready and it is always controversial and questionable but for the future economic development a possible amnesty model for flight capital could be to pay the new 10% income tax, declare and invest it in Ukraine for a dedicated period and receive amnesty for all past tax related offences. This would not clear criminal offences or the big issue of where such funds were accumulated and this has to be worked out by the courts anyhow and is inherently difficult in the Ukrainian context so at least such a approach will help to provide additional capital financing the future growth of Ukraine. For the sovereign funds mainly by the resource rich countries of the Gulf or other petrol exporting countries the key is first excellent government top level efforts and a list of well designed project, reasonable prepared and ready to invest and with a clear political mandate to propose them and a law on strategic investments which allows direct negotiations. It is not enough to visit the authorities in Doha and say you have a lot of land but still you have no land market but you want their investment. There needs much preparation to realize such investment and learning from Montenegro which is the only SEE country which has managed to attract significant players in some quantity might be useful. For the SME market it is useful to focus on Central European neighbors and see who is there already and might be interested in Ukraine after a positive experience in Poland, Hungary and Slovakia and prepare the situation with targeted invitation based on good sector analysis and prepare Ukraine in terms of industrial parks and investment conditions. For the international corporate market the best is to focus on their representative here in Ukraine as most of them are here already and listen what needs to be done to increase their investment and apply these lessons and advice. Mostly it is about land and labor market and tax issues and the bet is that the existing investment stock of global corporate companies already in Ukraine can be double within 5 years once the government start a relevant case by case investors listen-learning-applying and implementing strategy for with the CEO of global corporate already invested and not on a basis of gaining access for rent and favor seeking but a objective listening and learning and not handing favor easily and favoring one company over the other. No that would be wrong but supporting skills development, offering support with land access where investment is happening, speeding up licensing and operation permits and building permits and ensuring that the company can focus on its core business and not spending time and efforts on public affairs mainly. For the last category the international funds and the global capital market we have already outlined to bring Ukrainian capital market supervision in line with EU standards and adopt all such regulation and ensure decent standards at the stock market and work with the already quite developed investment banking scene here in Ukraine. The Government could appoint a Special Coordinator for the Capital Market like we did in Austria to revive the market and launch the Austrian model for 49% privatization of all remaining state companies in all area including infrastructure and so have state control but allow the companies to be managed according to the capital market requirement and so this will be attractive for the investment funds and the capital market analysts to start somewhere and not only to talk about privatization and not achieve it but be concrete and real and gradually more funds from new York, London and Frankfurt will move into Ukraine capital market. This task though should not be handled by the Investment Promotion agency but by the number of key professionals like the Special Coordinator for the Capital market, The Minister of Finance and the CEO of the Ukrainian Stock Exchange and the key CEO of the most important international banks active in Ukraine and than a specific road for capital markets should be launched and so discussed it is enough to have the in Frankfurt, New York, London and maybe Warsaw, Vienna and Milan and Paris and only people with capital market experience should attend and it would be helpful to have some solutions for the open issues of Ukraine with the capital markets ready by then. These are the investor’s categories and how to approach them.

Why should they come?

This is the crucial question. It is not the investor’s task to invest in Ukraine. There are 200 countries and investment location and all are competing for capital. So why specifically should investors come to Ukraine? What makes you different, special, attractive, interesting and potential lucrative and reasonable investment location? Why not invest in Poland with full EU status? Why not in Serbia or Macedonia with secure EU future? Why not in Vietnam or China or Kenya? And to be cheap is good but cheap alone is not enough. It has to be a holistic approach of an attractive economic framework, good opportunities and reasonable costs with skilled work force and a certain consumer bases and living standards being attractive for work force and managers and many more factors and the most important that business can be conducted and profits repatriated in reasonable manner and foreign investors are protected, supported in conflicts and have reasonable support with institution and courts. Sadly normally the domestic institutions normally protected the domestic investors or the political connected whom they see as the long-term factor and who is ready to use all means to get the decision requested. An option which the international investors coming from a OECD jurisdiction no longer has due to the massive and very welcome restriction on corruption abroad implemented and enforced in the last decade. So, we have to analyze the competitiveness of Ukraine in terms of cost and investment framework and central pillars like the tax system, the treatment of land, people, capital, logistics and infrastructure, incentives, investors protection and the status of rule of law and then would you put your money in Ukraine right now? Good, we can say it depends on the opportunity if it is big and interesting one might take the risk due to the sad fact that the conditions for investors are similar bad in comparable countries and so why not Ukraine. And the conditions for investments are still quite bad. The currency has gone through major devaluation and the banking services are in development and there are still currency and repatriation restrictions on profit and foreign exchange, it is far from the security and stability of Montenegro and Kosovo with the Euro or the Macedonia Dinar firmly pegged to the Euro. The tax system is mainly unreformed and despite significant reform effort is seen as a major obstacle not only rate but heavy-handed implementation and incompetence of tax officials. Land for which Ukraine is famously still is very restricted and even the restituted small holder can not sell their holdings and the whole nation seems in mixture of Soviet and nationalist rejection of foreign land ownership despite massive underinvestment and a surprisingly empty landscape massively underutilized and potentially a major asset for the Ukraine and the public discourse as if the Arab would soon steal the black earth and transport it to the Nile or the Saudi desert. Such a discourse is not very encouraging in a supposedly FDI welcoming country. Yes, welcome but not for land ownership in agriculture when this is what Ukraine has to offer in good quality and quantity? Looking at the labor market it is still very restricted and a parallel consulting segment for individual experts organized as min entrepreneurs mad Mini SME has developed outside of labor law restrictions and the authorities now want to address this without reforming the labor market as there is not political consensus for liberalization and opening. Same for the access of foreign labor and even Western EU and US key manager and skilled staff have major hurdles to pass in Ukraine to work and reside legally like 10 years ago on the Balkans before all such issues were reformed by EU accession process. So how open are you, how open and welcoming is Ukraine for capital and investment yes but not for the managers and the staff working, trading and doing business? And this in country so successful that it lost 8 Million people in last 25 years? So, in all issues of treatment of land, people and capital Ukraine has major issue to tackle before the obvious opportunity and often cited potential can lead and in fact absorb even major inflows of capital and the question why should not be just in the head of the investment officials because they learn fast in contacts with managers and investment professionals but it should be in the head of the President and the Prime Minister and the whole political class every day and every night. In the Ukraine contact though as many of them belong to the Oligarch class and are themselves affluent and active investors many of them see foreign investment as an issue of competing interest with their own investments and so talk the talk but do not walk the walk. Yes, to openness but not in the sector I am active or we in Ukraine can do ourselves. And this combined with a public still educated in a largely post Soviet consensus being careful and restraint with foreign contacts and exposure and in the context of national building and the patriotic emotions it entails and spills over in the economic debate does not lead to the openness in land, capital or labor market required and as well not to the even handed regulatory decision of key regulators for markets like energy, transport, or pharmaceutical which all very much depend on regulatory approval and often are clearly controlled by one of the other oligarchic vested interest group in silent consent with another to keep each other market share and how to enter such a market and how to succeed. And the consumer pay higher proves and worse service in air transport, energy or medicines then necessary but are distracted by the big national issues and all are ready to fight corruption but the link between monopolistic rents and corruption is hard to explain and indeed not even the international bother to much because prices seem cheap due to devaluation and there are so many issues. But how to attract more airlines to Ukraine or energy investments in such a regulatory environment with such domestic competition? So, all who say yes to FDI should consider this question and the answer is not as in the Balkans we heard in the 2000ies just send the money and came back after some year we know how to handle it…this is not the way anybody will invest in Ukraine nor in the Balkans. Nobody is so rich to have money to waste in Ukraine. And there is another issue. The political elite in transformation often mixes up donor funds arriving in millions or billions with private investment capital. For them they get used to handled bug number in speech and presentations but it is one way to talk to political or EU official for donor funds granted for political purposes and private investment capital from whoever big, small or public or from a fund always they expect reasonable returns in reasonable timelines and not just returns but the security that the whole investment can be taken out as well again in reasonable terms. Investment is not donor charity. This is business and the managers or owners or fund managers will be asked by their shareholders, investors and boards where the money is gone and why they should go in the first place. What sound great project in Kyiv luxury hotel might sound quite less impressive and close to naive back in the Frankfurt board room and mere potential does not impress a lot. Hard facts, real improvements and concrete investment proposals and strong political commitment is required to convince anybody and please do not mix interest and opening of companies and friendly visit with real major investments. Everybody today is interested again in Ukraine in all EU because it is big and important and it matters and the potential is clear. Do not waste time explaining the geography, landscape and how cheap labor costs are. All potential investors in Ukraine in EU and US have been here and if not they have invested in the first and second wave of Central and SEE transformation or have invested in China for a reason and possible everybody know Ukraine and its reality. It is key to explain that Ukraine has changed from 2004 onwards in real and tangible terms and it is now on way to European standards of rule of law and economic governance and will not leave that road of improvement and the good old time of Oligarchic way of business are gone for good. As well this will take some time to be credible but that is the only possible convincing narrative and firm it up with facts of a fundamental change in land, tax and capital and labor policy in real concrete Parliament approved decision and the world will and it will look very different in 2018.

Where should it go, which sector which projects?

For the SME sector as part of the Road the Growth we have decided on 5 sectors which are Agriculture and Food processing, Tourism and Hotel Industry, IT and the Digital Economy, the green Economy and energy efficiency and Manufacturing in light industry which are all clear cases and will take off or are taking off already. For induvial we have outlined the property market and for funds the Stock exchange and financing of large infrastructure projects and for the corporate sector in manufacturing industrial parks, infrastructure, and industry. Ukraine has obvious potential in all of them and has a major industrial basis in term of defense and aeronautics, automotive and energy. It has an own nuclear capacity, even a history of nuclear defense capacity and a working space and rocket industry. There is the human capacity and the skills bases for such industry and there are major industrial centers like Dnipro and Zaporozhe and Kherson along the Dnipro and there is amazing potential of significance in agriculture and all aspects connected to it from processing to logistics and packaging and marketing and all is already happening. Ukraine is as well already active on the export markets from Egypt to China to the Middle East with Defense and Agriculture from Honey to wheat and much more. The IT sector is very successful as well in outsourcing to the US and EU IT industry and really there are many sectors and opportunities in the private sector. The state sector is still not so open for cooperation with FDI as PPP and concession model are just starting and could not deliver their magic due to many restriction and lack of preparations. In Albania and Georgia, the Hydropower concession market has made a major impact and attract major investments and the energy market still requires more openness to include major investment. We have already outlined to start privatizing not with looking for strategic investors for big a complicated project but to start with 49% percent IPO on the Ukrainian stock exchange and to lift the economic and market upwards and it is political and technical more feasible then finding investors for eg Odessa harbor with all the issues of responsibility and exposure and country risk attached. We will have outlined more on this later in this paper. For the moment, it is enough to see the potential of L’viv, Kyiv and Odessa as tourism magnet and the Carpathians and Back Sea costs as major tourist centers required further investment but already in action and at full capacity during their season. But the sectors are clear and the amount of capital required is enormous just we have to develop the security and framework to absorb it reasonable well and long term successful to increase and multiple the FDI stock of Ukraine every 5 years from now for the next 25 years, ambitious but worth entertaining as objective and given the current level of Euro-Hryvna and hoping for concrete results in the reform effort along the lines outlined in this strategy actually a major inflow of FDI should be possible and would boost development of Ukraine but will Ukraine be ready for it?

Will it be successful in medium and long term and are you ready for it?

For investors success and again successful investor are the best promotion for further investment it is essential to treat existing investor better and allow them to be successful, allowing ownership of land, visibility of ownership and success result in profit repatriation and in the visible success of foreign investment and a gradually full integration of Ukraine in the European and global market. What means allowing? Each society can decide its own prosperity level by the degree of openness it is ready to accept and the degree of adaptability to global markets demands and investment capital. It is a conscious public policy decision. Not destiny or fate of history, geography or mentality. It is a public policy choice – each nation can make. And this decision is the factor for its success. There is some exception with specific natural wealth like Saudi Arabia or unique historic determination for development like mid 19th century Japan but the both do not apply for Ukraine. Ukraine future prosperity level depends on its openness and degree to readiness of welcome and sustainable support the success of international capital in Ukraine. This is needed for capital, technology, management know how and market networks and for western integration reason and all these factors will decide if after 25 relative stagnation now a long-term growth phase is possible for Ukraine to bring it to European levels of prosperity. We have already outlined that flying 2 hours from Kiev to Frankfurt brings you to 20 times as prosperous or flying east from Frankfurt sets you back possible to prosperity levels of Germany in the late 1950ies. Hard to accept and if ready to pick up growth rates should be significant, best double or triple the German one closer to 7 or even above. And only a high degree of openness to international capital can achieve this. But both the Oligarch factor and the post-Soviet mentality of administration and public and SME community are against this and as well the misinterpreted economic patriotism is a factor. So why is this? In the specific context of Ukraine chaotic development in a potentially extremely rich but extremely badly governed country a small group of smart and well-connected people seize opportunities and assets and control via these assets now the public policy making and they are hell bent to allow international competition on fair meaningful basis to compete not heir home market. The public of brainwash and anchored in Soviet concept distrusting the foreigner and assuming worst intentions and mixed with standard patriotic lines of thinks like our land is ours and own people need jobs and our SMEs are in danger there is a coalition of support for such measure like land sales moratorium, wood export moratorium and others which in fact are like moratoriums on prosperity and moratorium of the chance to have a better life. It is quite sad. And only in the EU accession framework this can be successfully overcome and so this is very much why the Central European transformation has worked and the Balkan is working depending on how realities EU accession is and was in case of Slovenia, Croatia, Bulgaria and Romania and the Balkan 6 waiting group out there is already working less well and Ukraine’s transformation in 25 long years has not resulted in any meaningful improvement of living standards for the population on GDP per capita basis. The EU matters not for the sake of EU or the size of market and number of member states but for the liv9ng standards of the whole population and compare Poland, Serbia, Bulgaria and Ukraine and you see the difference.

Why? Because all the regulatory framework decision that really matter like competition and anti-subsidy and anti-cartel laws and their implementation are intrinsically difficult to make for small and medium and big countries as long as the is not supra national enforcement and power to ensure it is happening otherwise the nexus between power and big business will be always stronger than good intention even of the most benevolent Prime Minister. Without the pressure and power and incentives and the wide public support of EU support these very crucial and critical reforms cannot be done against vested interest in any country in the post socialist context as all independent institutions are so called independent only in the name and all are waiting for orders from the political leadership and this make the political leadership to powerful and politics to lucrative that the ones sitting and controlling it will never release such lucrative power and if they would they would be replaced faster than they have reformed it by the same vested interest and as they know this why they would try even if not part of the widely backed EU accession agenda. I mean we talk now about the USA but about small and medium states most no longer of 100 years of history as independent states and mostly with a small business and political elite highly interconnected. It was and is like this still in Greece today even in EU and is only now changing during the major transformational crisis to a modern states Greece is going through since 2008 in a 30years delay due to politician and geostrategic reasons and was that way in Austria before 1995 and it is that way in each country between from the Baltic Sea to the Balkans.

Maybe the least in the Baltic as a specific history situation has allowed a specific freedom orientated thinking take power there in the 1990-es and with amazing results but small countries have an intrinsic issue with competition as the elite can control all important issues easy by telephone within a day or dinner and lunch and more complicated take a week and power is shared easy by the few. And small states are seen as protection mechanism of small nations and in way strategically they are and the same mechanism required to defend the nation in justified manner, police, military, customs, tax police, courts, secret service are so each and so lucrative as well use to control domestic and international business and the economy as a whole and like a  heavy weight stone constitute a joke on all people, business and hold the prosperity level down –of most people and very high of the few in charge of the power structures.

In the extreme you see that in Russia today but Ukraine is second in line and you see the result with a Million people living in wealth and power and 40 Million in subsistence level in Ukraine today at the poorest level in all Europe with Moldova the only competition for the last place. And do not start claiming it is the same in the West, it is not. It is simple propaganda and not true. Come to Ukraine, or see the reality in Russia now and visit the West, and despite it is never nice to be poor it is better to be poor in the 40.000 $ GDP per capita society than in 2500$. But the essential issue how economies can develop and for Ukraine it is clear it needs a stable European and Western Unification Framework that means the EU, NATO, the EU Customs Union and the EU Competition framework as well as low competitive tax rates with 10% and the Euro as currency. And new public political consensus for openness of the land, labor and capital market and then investment levels both domestic and international will be amazing and lift all of Europe to European prosperity levels – like it was done in Poland and the Baltics and is now happening in Balkans and all SEE and it is time for Ukraine to adopt SEE success model of reforming to European standards and European economic reforms agenda based on stable regulatory European framework and market access to Internal Market with a US backed European security framework and a clear Ukraine SME, FDI competitiveness consensus for growth and openness. And the result will be amazing.