Open for Business

Fresh from co-hosting the Euro 2012 football championship, Ukraine appears to have proven the pessimists wrong, having successfully attracted about one million football fans and their spending money to the country. Now, on top of the US$14 billion already spent on new stadiums, roads and infrastructure to prepare for the tournament, Ukraine is planning mega projects worth a further US$15 billion – and is hoping that foreign investment will play a major role in their funding. Gemma Carter reports.

Now Europe’s second-largest country, the Ukrainian republic used to be the second most important economic component of the former Soviet Union (after Russia), producing about four times the output of the next-ranking republic. In the west, its wide, fertile agricultural plains produced more than a quarter of Soviet agricultural output, while the large pockets of heavy industry in the east supplied unique equipment and raw materials to industrial and mining sites in other regions of the former USSR. Since becoming an independent democratic state 21 years ago, however, Ukraine’s economy has been on a rollercoaster. GDP fell steadily over the decade following independence, before enjoying rapid growth until 2008, when the economic crisis had a devastating impact – the economy contracted more than 15 percent in 2009, one of the direst economic performances in the world.

Caught between east and west Ukraine’s turbulent history is characterised by conflict, invasion and insurgence – a reflection of a country located at the crossroads of Europe and Asia, shaped by influences from both east and west. After the official creation of the Ukrainian Soviet Socialist Republic (SSR) in 1922, Ukrainian culture and education flourished, but with Josef Stalin’s rise to power and the campaign of forced collectivisation beginning in 1929, the Soviet leadership imposed a reign of terror that ravaged the intellectual class. The policies of Stalin’s government also created a man-made famine, which killed approximately seven million previously independent peasants and others throughout the country. Ukraine’s suffering continued during the Second World War, when it was occupied by the Nazis. More than 700 cities and towns were virtually destroyed, their industrial plants dismantled and their railways, telecommunications networks, power stations and medical institutions razed to the ground.

Indeed, the material losses sustained by Ukraine during the conflict comprised an estimated 40 percent of the country’s wealth. Only 20 percent of industrial enterprises and 15 percent of agricultural equipment and machinery remained intact, and the country’s transportation network was severely damaged. As soon as the Soviet authorities re-established control, economic reconstruction commenced, with an emphasis on heavy industry that was to the detriment of consumer needs. Over the next decades, the Ukrainian republic not only surpassed pre-war levels of industry and production but was also the driving force of Soviet power, becoming the centre of the Soviet arms industry and high-tech research. The products of these activities were largely directed for military consumption, however, and the supply and quality of consumer goods remained low.

Soviet energy policy focused its attention on nuclear power, but the 1986 explosion at the Chernobyl nuclear power plant, the worst accident of its kind in history, and the Soviet government’s initial efforts to conceal the extent of the disaster from its own people and the world, were a turning point for many Ukrainians in exposing the profound problems of the Soviet system. In August 1991, Ukraine was declared an independent democratic state, and it had immense potential – it was the second-largest European country in land mass and fourth-largest in population, with a well-educated and skilled labour force, and it had extensive and rich agricultural soil, good mineral resources and reasonable infrastructure. Despite these favourable conditions, Ukraine had one of the most difficult transitions in Eastern Europe, a consequence of its dependence on other former Soviet republics, its large percentage of military industries and the energy-intensive nature of many of its industrial processes.

Unsustainable trading

Little was done to restructure the economy until 1995, and the Russian financial crisis in 1998 led to severe problems for Ukraine, which was dependent on Russia for 40 percent of its foreign trade. In 1999, at the lowest point of the economic crisis, Ukraine’s per capita GDP was about half of that which it had achieved before independence. Moreover, corruption remained rampant, and as a result Western investors showed only minimal interest.

GDP growth was first registered in 2000, by which time – thanks mainly to exports of metals, petroleum products, chemicals, machinery, transport equipment and food products – the economy was performing well, enjoying real economic growth of about seven percent per year. In under a decade, Ukraine went from being an economy not based on money to having a banking sector comparable in relative size to those of many well-established market economies. Mean-while, the price of gas from Russia remained low – despite a number of disputes, the price paid by Ukraine for gas was still less than half of that paid by Western European countries.

This growth pattern of earning revenue by turning cheap, often Russian raw materials into world market-priced commodities proved to be unsustainable, however – Ukrainian industry had not diversified or become more sophisticated, hence it lacked the competitiveness necessary in modern markets. As a result, the economic downturn that commenced in 2008 hit the country particularly hard, Ukraine’s lack of sound domestic economic structures and debt accumulation making it especially difficult for the country to weather the storm. The construction sector was one of the worst affected by the financial crisis, with the global downturn leading to a colossal contraction in industry net output of 46 percent in 2009. However, due mainly to much-needed investment in infrastructure – the poor state of which has been acting as a drag on economic growth potential – Ukraine’s construction industry now looks to be on the brink of a revival.

Taking to the skies

In April 2007, while in the midst of a political crisis, Ukraine was chosen to host the Euro 2012 football championship along with neighbouring Poland – much to the surprise of the rest of Europe, after a bidding process that saw Italy emerge as the clear favourite – and the impact of the tournament on Ukraine’s economy has been significant. In a report published in May this year, London-based consultancy Capital Economics estimated that the ‘economic benefits of Euro 2012 for Poland and Ukraine are more significant than is usually the case with major sporting tournaments’. Spending by one million visitors could boost GDP by around ‘0.4 percent in Ukraine’, said the report.

The majority of Ukraine’s strategically important infrastructure development plans were completed in time for the event, including a number of regional airport projects: a new, UEFA-compliant international terminal was built at Kharkiv International Airport, while a US$200 million expansion project at Lviv International Airport included a 700-metre extension of the existing runway and a new airport terminal capable of handling more than 10 million passengers annually. In a July 2010 interview with Business Ukraine Online, Valery Levko, Ukraine Director of Dutch-based consultancy and engineering company Tebodin, predicted that this airport development trend would go way beyond the framework of Euro 2012 preparations: “Generally speaking, the development of Ukraine’s airport infrastructure is a kind of chain reaction. As soon as you begin constructing modern airport facilities in two or three regional capitals, every big city will begin looking at its airport facilities.” Indeed, work is already underway on a US$180 million project to rebuild Odessa International Airport, which includes extension of the existing runway, reconstruction and modernisation of the terminal and construction of a new 19,500 square-metre terminal building.

Levko went on to explain that the construction sector could also be one of the many beneficiaries of a free trade agreement between Ukraine and the EU, which would likely mean a substantial reduction in the price of construction materials entering Ukraine from European markets. “The construction industry depends to a large extent on EU imports for its raw materials and equipment, so a free trade zone would remove many of the tax barriers and force prices down,” he stated. According to Eurostat, European exports to Ukraine account for less than two percent of EU export output, whereas Ukrainian exports to the EU make up as much as 33 percent of its total export output, so the country’s efforts to enlarge its exports generally pervade the negotiations for a free trade agreement. Certainly, the benefits of a free trade agreement involving trade in agricultural outputs and processed food are likely to be particularly beneficial for Ukraine. Negotiations on the implementation of the so-called Deep and Comprehensive Free Trade Agreement (DCFTA) had been ongoing since 2008, but ground to a halt last year when former prime minister Yulia Tymoshenko was sentenced to seven years in prison – an action condemned across Europe.

Projects of national importance

Buoyed by the success of Euro 2012, Ukraine is now plotting a proposal for the 2022 Winter Olympic and Paralympic Games as part of a strategy to help develop the west of the country, one of the more underprivileged parts of the nation. The ‘Olympic Hope 2022’ project, one of 11 spearheaded by the State Agency for Investment and National Projects, involves major development in the valley of Borzhava, in the Carpathian Mountains, where residence blocks, tourism infrastructure and winter sports facilities would be built on a plot of nearly 350,000 square metres. Vice Prime Minister Borys Kolesnikov, who is in charge of the project, also anticipates the construction of 420 kilometres of new roads and the modernisation of railways in the region – all of which could create around 100,000 jobs.

Another of the country’s National Projects is the construction of a new LNG terminal to bring liquefied gas from various sources to Ukraine and beyond. Planned to come into production in 2015 in the Black Sea port city of Odessa, the terminal will have a capacity of 10 billion cubic metres of gas per year and is estimated to cost US$1.5 to US$2 billion to build. In addition to providing Ukraine with cheaper gas than it is currently getting, the terminal will play a key role in the Asia-Europe supply route and will help the country diversify and access LNG from various sources, such as Nigeria, Oman, Qatar and upcoming fields in Western Australia and Azerbaijan – thus reducing imports from Russia. In addition to minimising the nation’s dependency on Russia for natural gas, the Ukrainian Energy and Coal Industry Ministry is also aiming to cut down on natural gas consumption, having recently gained access to a US$3.7 billion credit line from China. The funds will be spent on building coal gasification plants and encouraging utilities to switch to coal instead of gas.

The agency is also focusing on ‘Energy of Nature’ projects, which are intended to become a driving force for new industry development. The country is already making strides in the field of solar power – in December 2011 Activ Solar finished the fifth and final construction phase of its 100MW Perovo Solar Power Station, adding a further 20MW to its capacity and making it the largest solar PV system in Europe. Indeed, solar power capacity in Ukraine is forecast to double this year, spurred by incentives a third higher than anywhere else in the region, while three new wind power projects are due to be commissioned in 2012, including a 100MW wind farm requiring an investment of 150 million euros (US$184.4 million).

After the final whistle

The multitude of projects in the pipeline would suggest that Ukraine is determined to avoid the dreaded ‘tournament curse’, which has seen other emerging-market hosts of major sporting events experience a deep and sometimes prolonged dip in economic growth following the tournament – South Africa being a case in point, the country having experienced a lagged and hard-hitting impact of the recession after hosting the FIFA 2010 World Cup. The US$15 billion or so in mega projects that the country has planned should help to ensure growth in those sectors, while in the same five years it took to plan and stage Euro 2012, the Ukrainian government endeavoured to cut red tape and deregulate the economy, making it easier for investors to enter the market.

These efforts to showcase Ukraine as an efficient, reform-focused nation are of immense importance, not only because the country is seeking greater European integration, but also because the aforementioned and other projects are intended to be funded 80 percent by the private sector – with the State Agency for Investment and National Projects aiming to increase total FDI in Ukraine to US$72 billion by 2013. If it is to attract such investment, however, Ukraine will have to go much further in cleaning up its act and eliminating corruption and excessive government regulation from its business climate.

Since Viktor Yanukovych took over as President in 2010, Ukraine has dropped from 134th to 152nd in Transparency International’s Corruption Perceptions Index, below Nigeria and Pakistan, and the government has been accused of lacking the real political will to act against corruption. Nevertheless, on 1st June 2011 the final version of a new Anti-corruption Act went into force, and, for the first time since the independence of Ukraine, government officials are being investigated and prosecuted for corruption. While this may be a positive sign, it will not be possible to assess the effectiveness of the legislation for some time.