Come to Kyiv (please)

Friday, September 26

Although Ukraine still lags behind most other CIS countries in terms of per capita FDI, this somewhat belies its record of unprecedented growth in inward foreign investment over the last several years. Until recently, Ukraine's economic performance had made it an increasingly attractive destination for foreign investment. However, current domestic and external conditions will test the country's ability to continue attracting FDI.

Ukraine suffered from a precipitous economic decline throughout the 1990s, and was devoid of any large-scale inflows of foreign direct investment (FDI) until well into the 2000s. Until 2003, registered inward FDI barely exceeded 1 billion dollars per year. However, FDI inflows have rapidly accelerated since 2005, growing by no less than 5 billion dollars per year, or over 100 dollars per capita. At first, the acceleration was due almost entirely to the one-off reprivatisation of the Kryvorizhstal steel plant for 4.8 billion dollars. However, solid growth in FDI inflows has continued. While foreign investors have focused on the country's financial and real estate sectors, FDI has by no means been confined to one particular area of the Ukrainian economy.

However, according to quarterly data from the State Statistics Committee (SSC), net FDI inflows slowed in the second quarter of 2008.  This is a result of both domestic and external factors:

• Economic fundamentals. Although the Ukrainian economy has continued to expand at a relatively strong and steady pace, this growth has been coupled with severe inflation. Apart from creating serious risks of stagflation, galloping inflation has prompted the central bank to resort to controversial countermeasures such as a sharp currency revaluation. The one-time 4% appreciation of the hryvnia in late May correspondingly lowered the value of monetary resources brought in by investors from abroad.
• Global crisis. s important as the domestic factors may have been, the global credit crunch and ensuing financial crisis have also had an obvious negative impact on Ukraine's FDI inflows. Crisis-inflicted risks and challenges have forced many investors either to revise or suspend altogether their plans for emerging markets in general, and Ukraine in particular. Even investors who were willing to invest in Ukraine may no longer be able to do so with the same diversity or quantity of resources.

However, the full impact of the global financial turbulence is not yet reflected in the SSC's relevant FDI statistics. Given that a typical investment cycle lasts about 12-18 months, investments that came into the country in the first quarter of 2008 were probably the result of decisions made prior to the serious financial deterioration that began in late 2007.

Outlook.

Considering the lingering effect of the global credit crunch, as well as the traditional seasonal slowdown in investment activities during the summer months, the slowdown in FDI inflows will likely extend at least into the third quarter. Perceptions of increased political risk have also risen in the aftermath of the Russian-Georgian conflict, which has had a particularly acute impact on foreign investment in Russia. Estimated gross outflows from Russia may total as much as 40 billion dollars since the conflict began on August 7-8.

The danger for Ukraine is that the conflict could not only frighten investors away from the warring countries, but also from the CIS region as a whole. Furthermore, investor confidence in Ukraine is hardly going to be enhanced by the serious domestic political infighting that culminated in President Viktor Yushchenko's withdrawal from the governing coalition on September 3. With new parliamentary -- or possibly even presidential -- elections on the horizon, Ukraine appears to be heading towards yet another period of protracted political uncertainty.