Analytical overview ESTONIAN INVESTMENT RELATIONS WITH THE EASTERN PARTNERSHIP COUNTRIES Raul Mälk, Senior Research Fellow, ECEAP 1. EU FDI IN EASTERN PARTNERSHIP COUNTRIES After ten years of Eastern Partnership (EaP), it is possible to say that the investments flow between the EU and Partnership countries is still rather limited1. The potential for investments has not yet been fully used. Looking forwards to post-2020, it is clear that further progress in investments is one of the crucial elements of the development of the EaP and relations with the partner countries. The European Union has concluded Association Agreements and Deep and Comprehensive Free Trade Area agreements with Georgia, Moldova and Ukraine. Membership in the Eurasian Economic Union affects EU economic relations with Armenia and Belarus. Investment activity between EU and the six Eastern Partnership countries has been influenced during the past decade by the global economic crisis, political tensions including the Russian war against Ukraine from 2014, Armenia-Azerbaijan war in 2020, the business climate and the problems with the rule of law in six countries. In the World Bank’s Ease of doing business index, the six EaP countries have improved their standings – Georgia is now (surprisingly) 7th, Azerbaidjan 34th, Armenia 47th, Moldova 48th, Belarus 49th and Ukraine 64th among 190 economies. For comparison, Estonia is 18th, Poland 40th, Hungary 52nd and Romania 55th2. However, despite such high rankings, the economic progress is still modest, and the living standards in most of the EaP countries are relatively low. The indexes tend to overestimate the legal acts and underestimate the real implementation. 1 – This analysis covers only issues of foreign direct investments (FDI), and it does not elaborate portfolio investments etc. 2 – http://documents.worldbank.org/curated/en/688761571934946384/pdf/Doing-Business-2020-Comparing-Business- Regulation-in-190-Economies.pdf 1 There is a need to develop investment legislation in partner countries and implement it correctly and impartially both on the national and local level. Especially crucial is fighting against corruption and nepotism. In this area, EaP countries positions in the world are much worse. In the Transparency International’s Corruption Perceptions Index Georgia is again at the highest rank – 44th, Belarus is 66th, Armenia 77th, Moldova 120th, Ukraine and Azerbaijan share 126th position. Also for comparison, Estonia is 18th, Poland 41st, Hungary and Romania share 70th position3. Except Azerbaijan with its high income from oil and gas, other five Eastern Partnership countries are in pressing need of outside investment resources. There are only a few studies of the EU and Eastern Partnership investment relations. The European Parliament think tank prepared in 2018 upon request of the Euronest parliamentary assembly economic committee a report “Foreign Direct Investment in the EU and the Eastern Partnership Countries” by Mario Damen4. His main conclusions were that EU investments in these countries are limited, do not grow significantly and were only 0.3- 0.6 per cent of the total amount of the EU-28 FDI during 2013-165. In September 2020 OECD published a report “Investment Perspectives in Eastern Partner Countries”6. This report examines recent developments in foreign direct investment in Eastern Partnership countries, without looking into investor countries in particular. It also considers FDI regulations, investment promotion activities, investment facilitation, investment tax incentives, and responsible business conduct. The stock of inward FDI in EaP countries has grown considerably over the period 2007-18- from around 30% to 55% of GDP7. In Georgia, FDI stocks had doubled from 55% of GDP in 2007 to over 100% in 2018. Azerbaijan, with FDI stocks now at almost 70% of GDP, has also witnessed significant growth over the decade. The other countries in the region have experienced more modest growth, with FDI remaining between 35% and 43% of GDP. In Moldova, FDI’s share in GDP shrank over the decade, from 50% in 2007 to just over 40% in 20188. OECD reports general conclusion is not optimistic about the future: “FDI in Eastern Partner (EaP) countries has grown considerably over the last two decades, and is associated with greater innovation relative to domestic investment, but it remains below its potential in comparison to neighbouring regions, and will likely suffer as a result of the coronavirus (COVID-19) pandemic and related economic disruptions”9. This analytical overview looks at Estonian FDI in Eastern Partnership countries in general and available company-level data; and more general information and some company- 3 – https://www.transparency.org/en/cpi/2019/results/table 4 – https://www.europarl.europa.eu/RegData/etudes/IDAN/2018/570489/EXPO_IDA(2018)570489_EN.pdf 5 – Ibid, p 11 6 – http://www.oecd.org/investment/Investment-perspectives-in-Eastern-Partner-countries.pdf 7 – Ibid, p 6 8 – Ibid, p 12-13 9 – Ibid, p 9 2 level information about FDI from Partnership countries in Estonia. The author uses both Estonian and EaP countries official FDI data, which sometimes differ significantly. Company- level information is mostly based on media materials and also on company websites and annual reports. On numerous occasions, it was impossible to control the correctness of the media articles, especially on the level of the details. 2. PROBLEMS WITH DATA Detailed analysis of foreign investments in Eastern Partnership countries is a complex challenge. The first problem is a lack of data. Estonian central bank country-specific statistics cover only Ukraine and Belarus and does not include separate data for Georgia and other EaP countries. European Commission DG Trade data and Eurostat does not reflect the role of particular EU member states in Eastern Partnership countries. Data from EaP countries about FDI is comprehensive only in Ukraine and Georgia. Unfortunately, there is little use for our study of UNCTAD EaP countries fact-sheets, which are oriented towards their investment relations in the region, but not with the EU countries10. The second problem is related to the use of third countries registered firms or using third- country financial institutions for providing investments to the EaP country. For example, from small Cyprus, the FDI to Ukraine, according to the Ukrainian official statistics, was at the end of June 2020, around 15.5 billion USD from a total of 50.3 billion USD11. A significant part of that money is of Ukrainian origin. Return of the Ukrainian capital back to home is also part of the FDI from Netherlands, Luxembourg and some other countries. Part of the investments comes from well-known tax-havens. Business-friendly policy in Estonia also led to the establishment here of wholesale trade companies from Ukraine, Belarus and even for some time from Azerbaijan, which mostly works virtually, as the goods do not enter Estonia. During the last years, a new business model appeared in the IT-sector and start-up activities. Often it is connected with the Estonian e-Residency programme12 – business people obtain Estonian e-Residency and use it to establish here a headquarters for the company which uses Estonian business environment and is a foothold in the EU. At the same time, the scale of the investment is often small, and the number of employees also minimal, even zero. The owners of such companies are firms registered somewhere at the British Virgin Islands or some other place with liberal taxation regime and use of English business law and language in legal proceedings. Their formally Estonian investments at home are in many aspects similar to the return of capital through Cyprus. The spread of such practices complicates the analysis of the Estonian FDI relations 10 – https://unctad.org/en/Pages/DIAE/World%20Investment%20Report/Country-Fact-Sheets.aspx 11 – https://bank.gov.ua/en/statistic/sector-external/data-sector-external#5 12 – https://e-resident.gov.ee/ 3 with particular Partnership countries. The third problem is the role of political factors. Except for Belarus, all other EaP countries statistics are in some way affected by the issues of territories in the military-political conflicts. The fourth problem is related to business secrets. Often companies do not publish data about their particular investments, costs of the takeover of other firms. Sometimes they invest directly from headquarters, sometimes through their branches in some country, in this case, in Estonia. Investors turned more and more tightlipped for journalists about their investments and especially financial results, except of course stock exchange-listed companies which are much more open because of the regulations. Companies were reluctant to provide data also for this analysis. The author is aware that in some cases, there are missing substantial elements in the picture this paper presents about company- level activities in EaP countries. The nominal value of the investment may change during the years a lot because of the changes in company build-up. There are challenges in courts over ownership of some projects in EaP countries, and it is sometimes not so evident what situation is the basis for the statistical data. In conclusion, we must always consider FDI data with some doubt. It is at the same time essential field of economic relations, and we have to analyse it notwithstanding all the listed issues. 3. UKRAINE 3.1 GENERAL OVERVIEW OF THE EU AND ESTONIAN FDI The most significant amount of FDI to the Partnership countries goes from the EU to Ukraine as we see from Chart 1. Taking into account the size of the country and its economy it is natural. Five other Partnership countries have received a relatively modest amount of EU FDI, especially if we exclude the particular case of Cyprus from which to the EaP countries often returns local money. The general tendency during the last years was stability if not stagnation of the stock of the EU investments in these countries.