Ukraine undoubtedly needs foreign investments to boost its economic growth. It has become a tradition for our Presidents to call on foreign investors, promising protection of their investments, etc. Speaking of things which have been said, the overall message is right. But who exactly are we waiting for and what do we have to offer?
For a while now our statesmen have used simple and faulty logic. Ukraine is cheap. Come first and buy while the prices are on the bottom, earn more when the prices go up. But this time, what is good for a foreign investor is not equally good for the state. In addition, beyond words and cheap assets we do not offer any instruments.
For the last five years, we have managed to attract around $13 billion in foreign currency, around $310 per citizen. But most of it is Ukrainian money coming from offshore accounts or through manipulation of bank capital.
Perhaps the most actively discussed option for foreign investment in Ukraine today is sovereign bonds. Since the Ministry of Finance offers high rates on these securities, investor purchases have witnessed exponential growth. This, in turn, strengthens the Hryvnia against the Dollar and the Euro and provides even greater yield on bonds.
This is hot money. Sooner or later, rates will begin to decline, and the occurrence of force majeure circumstances in world markets cannot be ruled out either. The sale of Ukrainian government bonds to foreign investors, that is, the withdrawal of money from Ukraine, can turn out to be as prompt as the purchase. Naturally, this will also hit the Hryvnia, and JP Morgan says about that in its latest analytical report.
Government bonds give us speculative capital. Its injections do not affect the structure of the economy of Ukraine. It does not help us increase exports or develop production facilities or engineering, science and transport infrastructure.
Significant growth in business activity is also not observed here. The key export items remain the same as 10 years ago, which are agricultural and metal industry products. The remaining industries show weak dynamics and are much inferior to imports.
Therefore, we have reason to ask what investment opportunities we have to offer and which investors we want to see here. Are they all equally beneficial for our economy? And what output do we want to reach?
To begin, let’s evaluate what we have. Among the countries of Eastern and Central Europe, our country is an outsider in boosting investments. The National Bank regularly publishes statistics related to foreign direct investment (FDI) in Ukraine. Between 2010 and 2018, nearly $38 billion was invested, with nearly 80 percent going to the real sector of the economy.
But even of these funds, about $8.4 billion, or 22 percent of the total volume, is made up of so-called “pseudo-foreign investments” (FDI round tripping), which is money whose controlling investors are Ukrainian residents. The largest number of other investments are made from Cyprus, Switzerland, the Netherlands and Austria, and the volume of these investments depends on relations with the current Ukrainian authorities. As a rule, they do not result in added value among domestic companies.
Raising more money: how and where
Let’s look at the initiative of the team of the new President Volodymyr Zelensky and the opening of the land market in 2020. In fact, we are talking about opening a new market for foreign investment, but will such a lifting of the moratorium result be successful in the long run? The analysis says no.
The purchase of land by large businesses and foreign investors will lead to a decrease in development potential for Ukrainian small and medium-sized farms. Perturbation in the country’s land bank is less likely to affect agricultural holdings, but small farms deprived of access to financing will not be able to participate in the purchase of land shares. In addition, the lifting of the moratorium will attract speculative capital, which will exorbitantly inflate prices at the initial stage and cause a bubble in the market.
If there are concerns that in a certain sector of the economy foreign capital may approach 20-30 percent, this is an occasion to seriously consider introducing restrictions on foreign investment in this industry.
The entire agricultural land of Ukraine is about 40 million hectares, and according to our forecasts the average price per hectare is less than $3,000. A thoughtless sale will give us a maximum of $120 billion, but let’s think about the losses that we will have if we “kill” our small farmers.
Hungary provides an instructive example, where ill-conceived land reform resulted in a virtual absence of small business in agriculture. What does the Hungarian agricultural market look like today? It is very small with a low share of processing. Meanwhile, Poland and Slovakia behaved more wisely, and in Poland, small farmers form a fairly large part of the market with being supplanted by foreign holdings.
Why do we need a firm segment of small and medium-sized farmers in Ukraine? First of all, it leads to an increase in self-employed residents in rural areas and a decreased need for government subsidies. Second, small farmers tend to grow crops that provide a large profit per hectare, and as their business grow, they start processing, which ultimately leads to more efficient use of land. Third, farmers stimulate additional business around their work, (the so-called spillover effect) including suppliers of fuels and lubricants, fertilizers, equipment, IT development, construction and the advent of retail and financial centers in rural areas. Ultimately, this results in the rural development that is talked about so much as well as food security for the country.
What will foreign investments create in rural area? We already have the answers. Huge land banks to be sown with wheat, corn and sunflower to export as raw material to world markets without being processed it into finished products in Ukraine.
In addition, what will the sellers of land shares do with the money they make? Invest in the banking sector? In the stock market? Open a new business? Or will they spend it on desirable commodities such as cars, plasma TVs, washing machines and trips (if not to Turkey, then to Europe)? The answer is obvious.
In connection with this let’s take a look at who we can call foreign investors. In the retail sector, large retail chains are also investors at the first glance. But when large multinational chains enter a market, they tend to “kill” locals. Where does the money settle? In the jurisdiction of the shareholder rather than the country they invested in.
Indeed, the injection of foreign investment, even in an industry such as retail, creates positive spillovers including additional jobs, increased competition and subsequent improved quality of services and additional demand on real estate. But this is largely an investment in consumption by the population, which will result in an increase in imports, not vice versa.
So what was the problem with the boom in foreign investments during Yushchenko’s presidency? Bank investments came into the country. Foreign banks bought Ukrainian banks, and they quickly expanded consumer lending, which is at least three times more profitable than business lending.
Such investments increase the debt load of residents and sales of international brands that produce goods that are not made in Ukraine. As a result, the balance of payments is deteriorating because imports increasing more than exports.
Let’s remember the best examples from the history of the world economy. Foreign investment came into Japan, Korea and China in order to produce goods there for export to third countries, whereas in Ukraine, money mainly comes to expand sales markets.
What kind of investment do we need?
To answer this question, we need a detailed, long-term development strategy not only on the matter of foreign investments but also on the matter of the structure of our economy.
Take Germany, where they’ve developed a clear 2030 strategy in numbers and figures. They want the share of industry in the GDP to grow, while Ukraine simply wants to attract investments by opening the land market. Do you feel the difference?
We need investors who will come here and not only create jobs but also technologies we can use to create products, where our people can gain experience.
As an example, Slovakia has a priority target on foreign investments to such sectors: Automotive, IT, Electronic Product Manufacturing, Engineering, Pharmaceuticals. Ninety percent of foreign investment is attracted to the production of goods with high added value.
Investments should be about more than money. They should mean technology
“Digital Country” and “State in a Smartphone” are cool concepts. But if we really plan to advance as an IT country, we will need our own state fund for supporting startups in the fields that are strategically important for our country. Whether it is an alternative energy sector or AgTech.
Let’s again turn to the experience of Asian countries: Singapore, South Korea, China, and Japan.
The United States invested $220 billion in China between 1975 and 1990. Investments went to factories and industry, which provided advanced technology, a management culture and and an understanding of production processes. In 1980, more than 40 percent of Chinese exports were raw materials and agricultural products. By 1990, 75 percent of exports were manufactured products.
Making Ukrainian real estate attractive for long-term investment is one of the best ways to get a foreign investor, but to do so we need to start with zoning areas for development and high high-quality legislation that regulates the rights of both tenants and landlords.
The instruments are as follows: Industrial parks with infrastructure, science parks linked to leading universities and preferential taxation or tax exemptions for high-tech production.
In the age of smartphones we need smart investments. Only with a well-thought-out strategy will it become clear what kind of money we want to see in our country and the legislation we should create to position Ukraine in foreign markets.
