Chapter 2. Role of External Sector
2.6. Financial Account Developments
2.6.1. FDI
Permanent increase in FDI is often perceived as a sign of irrevocable changes in investment climate of a home country, and thus, a sign of sustainability of economic growth.
In Ukraine, FDI has shown modest positive development. First of all, the stock of FDI in Ukraine is low: $89 per capita at the beginning of 2002, compared with $253 in the Czech Republic and $239 in Hungary in 1998. Second, the inflows of FDI are moderate. In the case of a country that has initially low level of foreign-capital engagement and pursues deep and comprehensive reforms, one might expect a sharp increase in FDI. This was not the case in Ukraine. As one can see from Figure 2.10, a year after the 1998-crisis FDI inflows decreased sharply (which was not surprising). Also in 2000 and 2001, when Ukraine experienced economic growth, FDI did not increase drastically.
The reasons for such development lie in excessive regulations and investor doubts concerning sustainability of the reform progress in Ukraine. According to the Heritage Index of Economic Freedom, Ukraine has bad conditions for attracting FDI: the index is 3.15The best overall rank that Ukraine received was in 2000 (116 out of 155), when the growth has started. Since then, the rank has deteriorated, which might be a sign of the beginning of the reverse trend.
The low level and negligible inflows of FDI persist in Ukraine, because the domestic situation is still perceived as unstable. Therefore, FDI cannot be regarded as a factor, which contributed to the economic growth of 2000-2001, but rather as a by-product of the other growth-related factors. As can be seen from Figure 2.10, there was a decline in the FDI inflows for the majority of activities regarded as competitive (catering, wholesales, financial
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CASE Reports No. 55 – The Sources of Economic Growth in Ukraine ...
151 for very good conditions, 5 – for very bad and this component of index does not change from 1997. The index also includes such factors as fiscal burden, government interventions, banking and finance, property rights, regulation and black markets, which also have substantial impact on FDI.
Overall Rank
Country Fiscal burden
Govern-mental
inter-ventions
Banking and finance
Property rights
Regulation Black markets
45 Poland 4.5 2 2 2 3 3.5
108 Bulgaria 4.5 3 3 3 4 3.5
116 ↑↑ Ukraine-00 4 ↑↑ 3 4 4 4 4
122 Ukraine –97 4.5 3 4 3 4 4
131 Russia 3.5 2.5 4 4 4 4
137 ↓↓ Ukraine-02 4.5 ↓↓ 4 ↓↓ 4 4 4 4
148 Belarus 4.5 4 4 4 5 5
Source: The Heritage Foundation.
Note: Overall rank out of 155 countries, which were assessed. The smaller is the number, the better are the conditions.
Table 2.1. Selected Indices of Economic Freedom in 2002
services) in 1999. When the situation became more predictable (2000), FDI into these industries increased significantly. The opposite developments took place in industries, which could be regarded as less competitive. The predictability of economic conditions was not a concern for those investing into less competitive industries, which happens, probably because they are (or at least they expect to be) powerful enough to keep the situation under control. For example, Korean investors were a major investor into the automobile sector (DAEWOO), Russian – into oil refineries and Ukrainian oligarchs into ferrous metallurgy (see Figure 2.10 and footnote16). While appreciating the fact that any investment is better than no
16Korea invested about 160 USD millions into AUTOZAZ-DAWOO in 1998, Russia – 30 USD millions and 100 USD millions in oil refineries in 1998 and 1999, Virgin Islands (British) – 40 USD millions and 100 USD millions in ferrous metallurgy in 1998 and 1999 respectively.
Figure 2.10. Dynamics of FDI in Ukraine by industry of destination and country of origin in 1997-2001, USD millions
Other ind.
Retail trade
Communi-cations
Commercial banks Whole
sales Non-alcoholic
beverag.
Ferrous metals
Auto-mobile ind. Oil refin.
-100 100 200 300 400 500
-100 100 200 300 400 500
1997 1998 1999 2000 2001
Source: State Committee of Statistics.
625
747
471
593 531
-50 0 50 100 150 200
1997 1998 1999 2000 2001
0 100 200 300 400 500 600 700 800
UK Netherlands Germany
Switzerland Cyprus Korea
Virginian Islands USA Russia
TOTAL (right axis) A. Destination
Industries
B. Countries of Origin
investment, we should stress here that the importance of FDI for the country lies not only in the amount of capital invested, but also in the managerial skills, technological innovations, and business culture brought along with. Taking into account the closed nature of the above industries and the origin of FDI, one should doubt ‘quality’ of the above-mentioned inflows.
Controlling for this type of investments, one could claim that FDI inflows slowed down even in the pre-crisis period (to about 610 USD millions in 1998) and further decreased in 1999 (to about 270 USD millions). Investments into these ‘less-competitive’ industries practically stopped after 1999, most probably, as a result of increase in hard budget constraints imposed by the government of Yushchenko.
FDI inflows from the offshore zones (presumably domestic capital which flowed out of the country in the previous periods) have continued in 2000 and 2001. However, this capital (from Cyprus) has been invested in the wholesale business – a more competitive industry comparing to metal and oil ones. The fact that this type of investors started to enter into competitive industries, but not monopolized ones (subject to possible ‘governmental intervention’) has been the result of equal treatment of investors. The fact that direct investments increased in 2000 and decreased in 2001 underlines the importance of this equal treatment, together with political and economic stability and predictability for potential investors.
Although there are no available statistics on the so-called ‘Greenfield’ investments in Ukraine, our indirect estimates suggest that only about 10-15% of all FDI for the period 1997-2001 had a ‘Greenfield’ character.17This is an indication that investor with a long run intensions
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Figure 2.11. Distribution of investor’s capital stock by the type of organization, USD billions
0.0 0.2 0.4 0.6 0.8 1. 0 1. 2 1. 4 1. 6
1997 1998 1999 2000 2001
Closed Stock Company
Enterpr. totally owned by a foreigner Subsidiary
Joint Venture Limited partnership Open Stock Company Others
Source: State Committee of Statistics.
17We estimate the level of 'Greenfield' investments by assessing a share of enterprises (recipients of FDI), which are established in the way that allows for entire control over the activity of the enterprise, i.e. those having a legal status of 'Enterprise totally owned by the foreign investor' (see Figure 2.10).
do not consider Ukraine as a prospective country. Considering that about one third of all
‘Greenfield’ investments in Ukraine were made by one company (Coca-Cola), we cannot expect them to contribute significantly to the economic growth in the observable future.
A popularity of ‘closed stock companies’ remains high mainly because investors want to limit the possibility of hostile takeover from domestic partners, which is also a reason for a reduction of capital invested into ‘joint ventures’ during the whole period. The increase of FDI into ‘open stock companies’, in this respect, is a result of acquisition of a stake in state enterprises, which are required to go ‘public’ before they can undergo privatization.
To sum up, the situation with FDI did not change much despite recent economic growth:
(1) level of FDI per capita in Ukraine is much lower than in other transition economies, (2) FDI inflows during the years of economic growth were not boosting (despite large increase of FDI in 2000 compared to 1999, they decreased already in 2001), (3) substantial share of FDI comes into ‘sub-competitive’ industries and from ‘offshore zones’, thus, bringing little positive externalities into the country, (4) share of ‘Greenfield’ investments remains low.
Therefore, the analysis of FDI in Ukraine reveals neither clear evidence of sustainability of economic growth, nor enough reasons for its continuation in the short run.