Investment opportunities in Ukraine August 2014 Time to Invest in Ukraine The chance for large scale modernization in the post-Soviet space July 2014 How to stop the endless “transition” of post-Soviet economy into the “crony capitalism”? Start reforms now and modernization tomorrow! The Ukrainian economy bears the scars, left by the former government. Exports to Russia have declined because of political reasons. But the major problem of the Ukrainian industry is a lack of capital. The recent political changes give Ukraine an opportunity to be the first big country in the post-Soviet space to make a real large-scale transition from the government-controlled to free market economy. Ukraine has the potential to for successful modernization and liberal economic reform. These are the prerequisites for success of the deep reforms and the modernization plan: The political revolution resulted in a “the turn to the West,” making a free market a necessity The new Ukrainian government consists of professionals motivated by the country’s best interests The domestic market is close to the “bottom.” This is true for both financial assets and consumer activity. To avoid deeper crisis, Ukraine needs to rise private capital in 2014-2015 Manufacturing in Ukraine is competitive due to (a) the low cost of highly qualified labor, (b) the large domestic market and (c) a weak local currency. It will help to attract capital for the first stage of reforms and modernization over the next 4-5 years. If the program of reforms really starts now, foreign direct investment will flow into Ukraine as it did into Poland, the Czech Republic, Slovakia 20 years ago. This is the unique chance, as the EU industrial producers will have to modernize local production facilities to get access to the market. Portfolio investment will return to Ukraine as soon as financial market institutions can be restored. 3 Ukrainian economic sectors expected to contract in 2014-15 Industries that are strongly dependent on the Russian economy: • Railcar production (e.g. Azovmash, Krukivsky Carriage Works, Stakhanovsky Carriage Works, Luganskteplovoz, Dneprovagonmash) • Heavy and power engineering (e.g. Turboatom, Elektrotyazhmash) • Paper and cardboard production (e.g. Kiev Cardboard and Paper Mill, Rubezhnoye Cardboard and Packaging Mill) • Ceramics (e.g. Slobozhansk Building Ceramics, Kharkov Tile Plant, Altcom-Keram, ATEM Group) Industries that are significantly dependent on the Russian economy: • Furniture manufacturing (e.g. MERX, Liga-Nova, Progress, Art Metal Furniture) • Electrical and special engineering (e.g. Yuzhmash, Motor Sich, Zorya-Mashproekt) • Confectionary (Roshen, KONTI, AVK) • Pipe and other metalworking (e.g. Metinvest) Energy intensive industries: • Fertilizers and other chemicals (e.g. Ostchem, Dniproazot) • Nonferrous metals (e.g. Artyomovsk Non-Ferrous Metals Processing Works, Zaporozhye Titanium & Magnesium Combine) 4 Sensitivity of Ukrainian economic sectors to exports to Russia Sensitivity of Ukrainian economic sectors to exports to Russia 60 , % , Railcar/locomotive production Heavy and power engineering 50 production 40 Paper and cardboard production Electrical engineering Ceramic industry 30 Furniture manufacturing Fertilizers and other chemicals 20 Textile industry, apparel and footwear manufacturers Pipe and other metal-working Sugar and confectionery industry Building materials industry Non-ferrous metals industry Iron and steel industry Ukraine's export to Russia as a part of total total of a part as Russia to export Ukraine's Bread and other cereal products 10 Glass industry Plastic and rubber products Milk and dairy products production manufacturers Pharmaceutical industry Alcohol and soft drink producers Oils and fats producers Vegetable producers and processors Meat and meat product producers Sunflower and other oil-bearing 0 plant producers Cereal0 producers 10 20 30 40 50 60 70 80 Ukraine's exports to Russia as a part of total exports, % Source: State Statistics Service of Ukraine 5 Actual and potential consequences of worsening trade regulation between Ukraine and the “Customs Union” (Russia) Ukraine finally signed the Association Agreement with the EU on June 27th. This is likely to lead to a decrease in Ukrainian exports to Russia. Russia is likely to implement both price (import duties up to 15-20% of Ukraine’s export price) and non-price trade (import quotes, strict certification, etc.) barriers. Ukraine’s exports to Russia were valued at $15 bn in 2013. Approximately 70% of this sum was paid for machines and equipment (incl. transport vehicles), ferrous metals and metal products and chemicals. But only Ukraine’s export of spare parts and components within the production chains in the defense industry and heavy and power engineering are vital for Russia. These exports are valued at only $4 bn per year. In the same year, Ukraine imported goods from Russia valued at $23.2 bn and more than 2/3 of this sum was paid for energy supplies. A deterioration in Ukraine-Russia trade terms in 2013 resulted in an $8 bn decline in Ukrainian exports to Russia and a $5.2 bn decrease in imports from Russia. According to expert estimates, further changes in trade terms could reduce Ukrainian exports to Russia by another $4-8 bn annually. The same time imports from Russia could be reduced by not more than $2-4 bn per year. The scale and severity of punitive sanctions against Ukraine following the signing of the economic part of the association agreement with the EU not completely clear yet, because: . Kazakhstan is in the process of joining the WTO and is not interested in problems from the Ukrainian side . Belorussia is economically interested in trade with its second most important neighbor . Such sanctions would be a double-edged sword for Russia itself, because Ukraine receives at least 5 per cent of Russian exports, including around $10 bn in non-commodity exports; the Russian defense industry also depends on some Ukrainian machine-building companies for components 6 Russia as part of Ukraine’s external trade Ukraine exports, $ bn (2013) Agricultural products Foodstuffs, incl. oils Mineral raw materials Chemicals to Custom Union Wood & paper products to Russia Textiles, apparel, footwear Total Products from stone, gyps, cement Basic metals and metal products Machines and equipments, incl. vehicles Other industrial products 0 2 4 6 8 10 12 14 16 18 20 Source: State Statistics Service of Ukraine Ukraine imports, $ bn (2013) Agricultural products Foodstuffs, incl. oils Mineral raw materials Chemicals to Custom Union Wood & paper products to Russia Textiles, apparel, footwear Total Products from stone, gyps, cement Basic metals and metal products Machines and equipments, incl. vehicles Other industrial products 0 5 10 15 20 25 Source: State Statistics Service of Ukraine 7 Trade between Ukraine and Russia Ukrainian exports to Russia (2013) 35,6% Agricultural products (5.0%) Foodstuffs, incl. oils (7.9%) 2,7% Mineral raw materials (4.9%) 5,0% Chemicals (11.7%) Wood & paper products (6.6%) 22,0% Textiles, apparel, footwear (1.4%) 7,9% Products from stone, gyps, cement (2.1%) Basic metals and metal products (21.9%) 4,9% Machines and equipments, incl. vehicles (35.5%) 2,1%1,4% Other industrial products (2.7%) 6,7% 11,7% Source: State Statistics Service of Ukraine Ukrainian imports from Russia (2013) 64,2% Agricultural products (0.6%) Foodstuffs, incl. oils (3.0%) Mineral raw materials (64.0%) Chemicals (9.9%) Wood & paper products (2.1%) Textiles, apparel, footwear (0.4%) Products from stone, gyps, cement (1.0%) 3,0% 0,6% Basic metals and metal products (6.7%) 0,6% 10,0% Machines and equipments, incl. vehicles (11.4%) 2,1% 11,5% 0,4% Other industrial products (0.6%) 8 6,7% 1,0% Source: State Statistics Service of Ukraine Russian companies potentially suffering from changing of trade terms • Natural gas producers ($8.7 bn)*: e.g. Gazprom • Petroleum product manufacturers ($3.9 bn): e.g. LUKOIL, Rosneft, Tatneft • Coking coal producers ($1.0 bn): e.g. Raspadskaya, Mechel • Nuclear fuel manufacturers ($600 mln): e.g. TVEL • Manufacturers of refrigerators, TV-sets and other household appliances ($ 420 mln): e.g. local Russian factories of Samsung, LG, Phillips etc. • Automobiles and component part manufacturers ($386 mln): AVTOVAZ, KAMAZ, Avtoframos (Renault), local Russian segments of Hyundai, Volkswagen etc. • Complex fertilizer producers ($379 mln): e.g. Eurochem, Phosagro • Automobile tire manufacturers ($154 mln): e.g. SIBUR-Russian tires, Nizhnekamskshina • Manufacturers of components for railcars ($100 mln): e.g. Russian Railways contractors • Electric generator manufacturers ($100 mln) • Tea and coffee producers ($78 mln) • Bearing manufacturers ($50 mln) • Controlling instrumentation manufacturers ($50 mln) * Total exports from current Russian industrial producers to Ukraine in 2013 9 Necessary reforms in Ukraine for the nearest future (2014-2015) 1. Rapid response to deterioration in Ukraine – Customs Union terms of trade Special incentives for Ukrainian exporters to Customs Union states (during transition period) Intergovernmental agreements on mutual protection of investments with Custom Union states tied to preserving a favorable customs regime for export of Ukrainian goods to EU countries 2 . Fundamental reforms to improve business conditions Tax reform (tax incentives for investors, tax holidays for new projects, accelerated depreciation, VAT refund) Arbitration court s Law enforcement system Increase the power of local authorities