Motives and Obstacles for FDI in Ukraine

In order to identify the reasons for low FDI stock in Ukraine, Flemings/SARS Consortium performed in the year 2000 a mail survey of 65 companies with presence in Ukraine, grouping them into multinational enterprises (MNEs), multilateral financial institutions, private institutional investors and entrepreneurs. Besides requesting them to identify the major deterrents to investment and to estimate the significance of privatization for FDI, the questionnaire asked the sample investors about their motives, risk assessment and decision-making mechanism while investing in Ukraine. Inquiries were also made about the investor’s assessment of priorities for their investment-enhancing policy agenda¹¹.

The sample included 32 enterprises: 2 multilateral financial institutions, 5 entrepreneurial firms, 3 direct equity funds and 22 MNEs. The headquarters of 19 companies are located in USA, 1 in Canada and the rest in the European countries. The response ratio was 50 %.

According to this study, Ukraine’s low FDI stock was explained at least partly by its inferior investment climate (legal, economic and infrastructure aspects), as well as by deficiencies in the country’s privatization approach and effort.

Implicit evidence for the inadequacy of Ukraine’s privatization effort may be found in the fact that the most of the mail survey respondents (including 60 % of MNEs) reported that they had invested in Ukraine through greenfield projects of joint ventures with private companies, rather than through privatization offerings.

The mail survey respondents together have invested over USD 2 billion. They employ some 9000 people in Ukraine. The sampled firms were most frequently found in the food/beverage branch, followed by agriculture and telecommunications. Other prominent investment targets included the mechanical engineering, retail trade, fast food, banking and consumer goods sectors. Most of the respondents were medium-sized investors (USD 10-100 million). Besides the EBRD, only MNEs were able to commit amounts over USD 100 million.

11 Materials of Chapter 4.2 were adapted from the report published on www.investgazeta.com.ua

The survey provides strong evidence that market-seeking is the most dominant motive for FDI in Ukraine, well ahead of other possible reasons (including pursuit of cheap and qualified labour) (Table 29). Most investors are attracted to Ukraine’s domestic market of 48 million people. The availability of low-cost labour turned out to be insignificant for the majority of companies surveyed except entrepreneurial investors, who tend to be more sensitive to the availability of cheap inputs. Although Ukrainian wages are lower than in other Eastern-European countries, this competitive advantage is diminished by significantly lower labour productivity, the lack of capital, inferior management and regulatory burdens. Thus unit costs in Ukraine are not necessarily much cheaper than in neighbouring countries.

Table 29. Motives for Companies Investing in Ukraine

Rank Reason Total

1 Market size and potential for market growth 1.05 2 Access to a new regional (Central/Eastern Europe, CIS) market 1.92

3 Skill of labour force 2.15

4 Availability of low-cost inputs (e.g., cheap labour; energy; raw materials) 2.27

5 Production capacities 2.32

6 To improve competitiveness in supplying established markets (Europe) 2.53

7 Tax incentives 2.69

8 A chance to access research and technological expertise available in Ukraine 2.71

“major reason”=1; “minor reason”=2; “not a reason”=3 Source: Flemings/SARS survey

Most survey respondents reported that their investment decision-making takes typically more than 6 months. Institutional investors can usually decide on certain projects within a period of 3 to 6 months. However, they tend to have the highest number of decision makers. On the other hand, some entrepreneurial investors can commit to investing within a month after the opportunity is identified. On average, in such organizations 4 persons are involved in taking the decision on investment in Ukraine. The most complicated and lengthy decision-making process was reported by multilateral financial institutions. The survey also ranked the major deterrents to FDI in Ukraine (Table 30).

Table 30. Deterrents for Companies Investing in Ukraine

Rank Problem Total

1 Instability and exorbitance of regulations 1.03 2 Ambiguity of the legal system 1.21 3 Uncertainty of the economic environment 1.27

4 Corruption 1.34

5 High tax burden 1.46

6 Problems establishing clear ownership conditions 1.56 7 Depressed disposable income levels 1.69 8 Difficulty negotiating with government and privatization authorities 1.79 9 Volatility of the political environment 1.82 10 Lack of physical infrastructure 2.09 11 Problems in accessing domestic and export markets 2.16

“major reason”=1; “minor reason”=2; “not a reason”=3 Source: Flemings/SARS survey

EU’s New Neighbours: The Case of Ukraine

It is noteworthy that all these impediments were recognised as causing problems. Though on the lower end of ranking, the clarity of ownership rights and the ease of negotiating with government/privatization authorities were still ranked between “major problem” and “minor problem”, i.e., they were perceived as significant FDI deterrents.

As anticipated, the status of private ownership in Ukraine was significant for the majority of survey respondents. Only 5 percent of respondents (deep-pocketed SMEs) found it unimportant in their activity. For the rest of the investors (95 percent), privatization policy appears to be a very significant factor, which affects their investment decisions. It is expected that privatization will not only create new acquisition opportunities, but also improve the overall business climate, through productivity growth and reduction of harmful government interference.

Respondents provided their views on what should be done by the Ukrainian government to improve Ukraine’s attractiveness for FDI (Table 31).

Table 31. Priorities of Government Policy

Rank Priority Total

1 Liberalise capital, foreign exchange and profit repatriation controls 1.12 2 Lift restriction on foreign ownership and control 1.16

3 Minimise red tape 1.17

4 Reduce tax rates and the number of taxes 1.32 5 Lift restrictions on accessing domestic and export markets 1.78 6 Enhance the contract enforcement system 1.81 from “1 – a top priority” to “3 – not a priority”

Source: Flemings/SARS survey

In brief, the suggested policy agenda may be summarised as follows: investors want to deal with fewer government officials and less frequently. Many of them believe that a comprehensive and rigorous privatization approach would lead to this end. Russian companies investing in Ukraine were not included in the survey.

In contrast to western investors, Russian companies are not very interested in the international financial institutions’ opinions, internal political instability or how Ukraine is going to be integrated into the global economy in future. Many Russian companies tie up money in Ukraine in order to enclose the technological chain broken after the dissolution of the Soviet Union. Main interests of the Russian investors lie in the metallurgical (aluminium production), chemical and mechanical engineering industries.

4.3. Ukraine in International Ratings