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Foreign investments amid challenges of financial market development in Ukraine

The issue of attracting investments into the economy of Ukraine has been the cornerstone of numerous disputes, discussions, researches and developments since Ukraine appeared on the world political map as an independent state. For fifteen years this investment famine has never been satisfied in full. In spite of economic stabilisation and dynamic growth, direct investments into Ukraine made less than 5 billion euros for 5 years (2000 to 2004), less than one sixths of the investments into Poland. In total, direct foreign investments reached $7,761.5 million by 1 October 2004, actually $164 per capita, one of the lowest indices in Eastern Europe. There is a number of reasons to be blamed, including branch structure disparity inherited from the Soviet economy, inconsistent privatisation of state enterprises, wrong fiscal policy resulting in growth of the shadow sector and many other factors. Shaked by permanent political crises Ukrainian economy could not ensure a worthy investment climate. Ukraine has become more interesting for the world after the end-of-2004 events. Step-by-step studies of perspectives and feasibility of investing into Ukrainian economy started switching to practical implementation. As the result, the volume of investments into Ukrainian economy reached $2.3 billion in 2005 and is expected to approach $5.3 billion in 2006 according to the State Statistics Committee.

The City of Kiev tops the regional structure of foreign investments according to the volume of attracted investments. Dnipropetrovsk, Donetsk, Zaporizhzhya, Odessa, Kiev, Kharkiv and Lviv Regions are also among the leading investment attractors. In the branch structure the biggest investment volumes are enjoyed by trade, food industry, financial branch and engineering. Recently the capital flows into financial sphere (first of all into bank and insurance sectors), metallurgy and real estate have become more active.

Additionally to political reasons, Ukraine became more interesting for some economic achievements recently observed in our country. After a kind of lull in the dynamics of the economy in 2005, current year is significant for the growth of basic macro indices and relatively low inflation rate at the same time. Due to changes in the budget and macro-economics policies after the ‘orange’ revolution a gradual displacement of the economic growth factors is taking place. Due to increase of the population’s income and development of bank crediting the role of internal demand is getting more important in the economy. A serious increase can be observed in consumers’ demand (cars, tourist services, etc.), real estate and construction, retail trade and other sectors dependant on the consumers’ demand. With this in mind, investors’ interest in our country looks quite justified.

To provide optimal conditions for attracting investments into the country’s economy, first of all it’s necessary to keep in mind that any investor being a market subject, acts exclusively in favour of his/her business development with the maximum of profits and the minimum of risks. This is a very simple rule, however often neglected when national investment attraction is assessed. The internal investment level is one of serious attraction indicators. It gives a foreign investor an idea of the financial and crediting sphere, availability of consulting companies, development tendencies, main problem fields and potential free market niches.

Taking into account the positive dynamics of the Ukrainian economy for the recent years makes it possible to highlight an increase of investments made by Ukrainian economic agents. For the recent years there have been positive tendencies in the sphere of internal investments which can be traced through with the data of Table 1.

According to the results of the first half of 2006, the most successful branches in the branch structure of investments made by economic agents of Ukraine were construction, transport, real estate market and industry. High capital coefficient of these branches was one of the reasons of their leadership.

According to the National Statistics Committee (NSC), own means of companies and societies make the basic source of capital investments (about 60%) followed by credits (mainly from bank institutions) which reach 13-14%.

Table 1. Dynamics of internal investment activities.

 

2000

2001

2002

2003

2004

2005

Investments into fixed capital (capital investments)  in million hryvnias

23,629

32,573

37,178

51,011

75,714

93,096

Growth rates with reference to a previous year in comparative prices, %

114.4

120.8

108.9

131.3

128.0

101

Source: NSC data

According to the statistics, other sources including the state budget do not seriously contribute to the investment process. Additionally, the positive picture of the dynamics of the internal investment process is complemented by the structure of financial incomings making it obvious that the manifested successes can by no means reduce the demand for external investments.

So, what does the situation on the national market of financial services look like?

The monetary sphere where the first violin is played by bank institutions is the basic environment for distribution of investment resources. As of 1 September 2006, there were 190 commercial banks registered in Ukraine including 11 with a hundred per cent foreign capital. Total assets of the bank system make 283.3 billion UAN, 138 billion UAN of them are credits allotted to economic agents. In spite of being the most popular, the bank crediting is characterized by high interest rates and relatively short terms. However, recently there has been an increase of long term bank credits to companies endeavoring to implement investment programs. There are also special credit programs for supporting small and medium businesses, e.g. micro-crediting, credits to farmers, project financing, etc. These programs are realized in Ukrainian banks with financial support of international institutions, such as the World Bank, European Bank for Reconstruction and Development, German-Ukrainian Fund and others.

Factoring, as a form of attracting external financial resources, is underdeveloped so far. Only few of banks are promoting actively this operational direction. Though in developed countries factoring companies enjoy quite ponderable positions on the financial market, similar entities are only in their infancy in the Ukrainian financial space. Thus, as of the end of 2005, factoring services were provided by only 7 financial companies mainly to commercial enterprises.  

Mortgage crediting is a separate kind of bank crediting. The system of mortgage crediting is only heaving in sight in Ukraine. The mortgage re-financing system has not been introduced yet, though the possibility for this as well as for issuing mortgage securities is provided by the law.

Leasing could become a widely implemented alternative to the bank crediting as it accepts the absence of a separate security requirement. The object of leasing is the security itself in this case. However, this is not happening so far because leasing companies are often affiliated with a bank. That’s why leasing services cannot be considered as a separate sector of financial market in Ukraine. According to experts of the National Board on Regulation of the Markets of Financial Services, the leasing market volume in Ukraine is about $250-300 million every year. Vehicles (mainly cars) as well as industrial machinery are the most popular leasing objects. The volume of leasing operations is basicly made up of 2-3 year contracts. In general, leasing is currently more expensive for a lessee than a bank credit. A number of discriminative procedures in the tax legislation of Ukraine and the absence of a clearly formed demand for leasing services because of improper promotion of them are the main deterrents constraining the development of leasing in this country.

The stock market cannot be assessed as a developed one despite of positive dynamics in this field. Emission of securities is one of the ways most frequently used by companies in many countries to attract investments which gives access to large-scale financial resources and stimulates company’s image rating – any positive news about a company on a stock market raises its stock value immediately. Full-fledged functioning of the stock market is constrained by a number of problems mostly related to ineffective regulation of the financial market: opacity of security emitters’ activities, inconformity of their operational standards with world ones, including inconformity in information revealing, vulnerability of minority shareholders, etc. The possibility of attracting capital by issuing and distributing shares within the internal stock market is almost not used by the Ukrainian emitters, partially because of the reasons mentioned above. It’s important to highlight that only open joint-stock companies can place securities on the national fund market. Undoubtedly, according to the national legal standards, actually every company with a different pattern of ownership intending to emit, first has to transform itself into a “more public” ownership pattern.

Resources of international and foreign financial institutions represent an option for providing a cheaper and long-term investment. For receiving such resources a company has to meet a list of requirements which are so demanding that they deprive most of the companies of chances to get credits on the one hand, however stimulating at the same time the increase of the number of entities capable to meet the requirements of the international business standards on the other hand. Accordingly, this type of credits is available mainly for major companies with high level of corporative management, financial administration, marketing, planning of company’s activities, forecasting, etc. The same can be related to attracting funds on international markets. In conditions when it’s quite difficult to attract long-term financial resources with acceptable interest rates inside the country, many Ukrainian companies pay more respect to international capital markets. Exactly there, one can get long-term financing for a more acceptable price. However this requires from Ukrainian emitters some preparatory work in order to bring their practices in conformity with the requirements concerning openness of financial information and reporting, availability of professional management, ensuring a high profit level, providing a reasonable risk level assessment and a qualified project documentation development.

Currently the companies resolving to attract investments from abroad prefer debt financing. Among them there is a number of bank sector entities (e.g. Ukrsibbank, Ukrsotsbank, Nadra and others) as well as some companies from other fields (Kievstar, Neftegaz and others). For attracting debt financing both Eurobonds and structured CLN-type products are used. The European Bank for Reconstruction and Development and the International Financial Corporation are among the entities providing such resources. These institutions in Ukraine are gradually turning from financial support of the state towards crediting of promising Ukrainian companies and inviting them to contribute to the capital. For example, a number of national companies took the advantage of attracting resources from the above mentioned organizations, including Mironovsky Khleboprodukt, Velyka Kyshenya, Novaya Liniya and others. Besides providing the credit resources the EBRD has extended means for establishing a number of direct investment funds that function in different countries including Ukraine. The Baring Vostok Private Equity Fund,  Euroventures and others   are just examples of such funds.

Major Ukrainian companies can also get credits from foreign financial institutions, first of all from foreign bank holdings. The advantage of this opportunity was taken by the NJSC Neftegaz Ukrainy as well as by many banks engaged in attracting syndicated credits.

Slow development of financial instruments related to functioning of a financial market infrastructure brings national entrepreneurs into a situation when it becomes necessary to build up cooperation individually. An alternative of developing business in this case is joining efforts with a partner including a foreign one. Working within an agreement on joint activities is a widely spread form of implementing this type of interaction. Recently in Ukraine a quick development of the mergers and acquisition market has been observed. These processes are caused both by foreign investors’ arrival and by restructuring within the largest financial and industrial groups of Ukraine which are getting rid of marginal assets and investing into other directions. The field of franchising remains promising as it allows for selling the right to use a trade mark, brand or know-how in combination with adopting the production structures, business running techniques, negative and positive experiences with royalty payments to follow. This kind of business running is mutually beneficial for partners as it allows a brand owner to utilize the brand in an effective way and receive incomes on a regular basis and shields an entrepreneur from mistakes as well as saves expenses related to establishment and build-up of the production pattern and management.ю и вхождению в капитал зации в Украине постепенно переходят от финансовой поддержки госудасртв

Speaking impartially, somebody’s loss is always another’s win. This situation, with the financial market being at the stage of development, provides an excellent opportunity for foreign investors to build strong and reliable financial relations with the national companies. Foreign investment resources enjoy today higher demand which gives investors a chance to dictate terms and optimize their profits. Besides, a foreign investor has additional advantages including accesses to external financial markets, cheap long-term capitals, up-to-date technologies, international target markets as well as the possibilities of implementing effective management policies, international standards, business planning, etc.