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Barriers to Investment in Ukraine

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Barriers to Investment in Ukraine

BARRIERS TO INVESTMENT IN UKRAINE

    Report presented to the EU-Ukraine Co-operation Committee

February 2001

European Business Association Barriers to Investment in Ukraine

    European Business Association, Kyiv, Ukraine c/o Esplanadna 20, 9 th fl. Kyiv 01023

    Tel (+38 044) 229 7777, fax 227 0626 office@eba.com.ua www.eba.com.ua

    The European Business Association was established in 1999 as a forum for discussion and resolution of issues facing the European private sector in Ukraine. As of February 2001, it brings together representatives of 143 companies operating in Ukraine.

    The Association is grateful to all members that contributed to the discussions, drafting and approval of this report, notably to the EBA committees on transport and customs, taxation, manufacturing and investment, and to the legal committee for their comments and suggestions. Particular thanks are due to representatives of Alstom, Altheimer & Gray, Arthur Andersen, the Austrian Embassy, Credit Lyonnais, Dusseldorf Chamber of Commerce and Industry, Euro-Ukraina Consulting, Hertz, Novo Nordisk, Philip Morris, Raffeisenbank, Scania, The Deane Group, Unilever, West Ukrainian Venture Partners, and Zovnishinformaudit for their assistance and advice on drafting.

    Additional information on the Association, its activities and members is available online at www.eba.com.ua..European Business Association Barriers to Investment in

    Ukraine

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INTRODUCTION

    This report has been prepared in February 2001 by the European Business Association at the request of the Swedish Presidency of the European Union and the European Commission. The aim is to review some of the barriers to the investment process identified by members of the Association, and consider some ways forward based on practices adopted in many other parts of the world.

    A focus on barriers to investment necessarily gives this report an emphasis on negative features of the Ukrainian business environment. This does not mean that the Association fails to recognise the progress that has been achieved in Ukraine, the continued stability of the hryvna and the stabilisation of government finances being good examples of the latter. Nor should it imply that the Ukrainian authorities themselves are unaware of the problems; in many cases, resolution of these problems is a central part of current policy.

    Nonetheless, it is important to acknowledge that many difficulties with the investment process are longstanding and tenacious, and are reflected in consistently low levels of foreign direct investment. Ukraine has received, as of October 2000, only USD 3.7 billion in foreign investment since independence in 1991; Ukraine’s own estimate of its

    investment needs in the five-year period from 1996 was USD 40 billion.

    This report does not claim to be a comprehensive overview of all issues related to investment, and it re-states issues that have been raised before. It is, however, reflective of the views of the members of the Association, and also reflective of their readiness to work with the Ukrainian authorities to find constructive solutions to these problems.

    Working in Ukraine over many years, EBA members are aware of the potential of a large and resource-rich country. Those with whom they work, and those that they employ, have also become aware of the benefits that foreign investment can bring in terms of new technologies, expertise and capital. They reaffirm their willingness to support, through their activities in Ukraine, a sustained effort to create the business framework that can spread these benefits more widely within the Ukrainian economy.

SUMMARY

    A critical challenge for Ukraine is the attraction of significant new capital investment. International investment flows are huge, yet investors still face a choice about which opportunities to pursue and which to postpone or delay.

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    In evaluating these options, a company must be confident of its ability to generate a return commensurate with the risks taken. Availability of natural and human resources are key criteria in this decision-making process. However most important is a stable, clear and predictable business environment, where the legal, fiscal and commercial terms under which the investments are made are clearly defined, and consistently and fairly applied.

    This report notes some specific problems related to the business environment, and the Association respectfully submits its own suggestions on ways that these might be resolved. However, the specific points are secondary to two fundamental categories of risk associated with doing business in Ukraine. The Association considers that a concentration on these two areas is a necessary condition for the creation of an internationally competitive investment climate:

1. Decreasing intervention in the operation of private businesses.

    Excessive state presence, intervention and regulation is a pervasive encumbrance on the operation of private businesses, and market mechanisms in general. While many Western European countries have significant levels of public ownership, nowhere is this incompatible with a flourishing private sector. In Ukraine the private sector contributes less than a quarter of GDP; it needs to be given at least the chance to develop. To illustrate part of the problem: an EBRD survey in 1999 suggested that enterprise management in Ukraine spends up to 17% of overall management time in complying with government regulatory requirements; this finding coincides with the experience of EBA members.

    2. Increasing consistency, stability and uniform application of legislation.

    Ukraine has a vast body of legislation and regulation, some of which is contradictory, some on occasion introduced retroactively, without any clear hierarchy of legislative acts to establish precedence. Interpretation, enforcement and execution of legal acts is far from predictable across the country.

    The often-discussed issue of corruption in Ukraine is a symptom of the failure to make adequate progress on these two problems. To assist with their resolution, the EBA urges the Ukrainian authorities to pursue a consistent objective of increasing regulatory transparency and business liberalisation. Where possible, Ukraine should look to adopt international standards on a whole host of issues from accounting and banking through to health, safety and the environment. If such measures can be introduced, rigorously applied and enforced, Ukraine can do much to gain the confidence of both foreign and domestic investors.

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SPECIFIC BARRIERS TO INVESTMENT IN UKRAINE

1) MARKET ENTRY

Property ownership

    The Ukrainian authorities recognise the need for clarification of property ownership in general, and ownership of land in particular. The current situation is that while ownership of buildings and other structures on land is normally allowed, sale and purchase of land remains difficult, if not impossible. Industrial property rights (trademarks, patents) are difficult to enforce, and intellectual property in some cases remains unprotected.

    The land code in force dates back to March 1992; it declares state ownership as the principle form of land ownership and forbids foreign ownership of land. The 1996 Constitution is less restrictive, stipulating that the right to land ownership is guaranteed for citizens and legal entities of Ukraine. An uncertain legal base has meant that subsequent presidential decrees on land have failed to encourage real estate transactions, and the situation regarding foreign investors is particularly unclear.

    The Verkhovna Rada is considering a new land code; the present draft prohibits foreign ownership of agricultural land, and prohibits sale or purchase of land until 2010.

Measures advocated by the EBA:

    Adoption by the Rada of a new land code that will give substance to the constitutional recognition of private property. All other legal acts should be brought into line with the new code.

    Establishment of an effective and comprehensive registration system for land and for fixed assets to remove uncertainties over title, including tax liens which are currently not required to be recorded under applicable Ukrainian laws.

    Adoption by the Rada of a civil code that can be the foundation of a system of enforceable property rights.

    Co-ordination of the different legal acts governing intellectual property rights, including the civil code, criminal code, customs code, procedural norms and specific legislation, to ensure a level of protection and enforcement in line with international standards.

Legal status of unfinished constructions

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    Due to the lack of sufficient legal regulation and difficulty of establishing ownership with respect to objects of unfinished construction, such objects are effectively excluded from the immovable property market. Their use as collateral or debt security is also extremely difficult.

Measures:

    Adoption of legislation to clarify the legal status of objects of unfinished construction, in particular the procedures for establishment, registration and transfer of ownership, and methods of valuation.

Land lease

    The current land code establishes land lease as the main option for foreign entities. Leases are limited to a maximum of two 49-year terms, and the rent payable is often

    much more expensive for foreigners than for Ukrainian users. Such discrimination is possible because the existing legislation on payments for use of land gives the local authorities complete discretion to establish levels of rent.

Measures:

    Adoption of legislation that would guarantee non-discrimination and equal rent for the state-owned land of the same quality for both local and foreign land users.

Privatisation

    Thus far, foreign participation in the privatisation process has been limited. The main deterrents have been discriminatory pricing requirements, a lack of transparent procedures, exhaustive investment obligations, and the fact that few of the most attractive enterprises were included in the privatisation process.

    The privatisation programme for 2000-2002 looks to correct all of these perceived weaknesses, and explicitly targets long-term strategic and foreign investors. However, the State Property Fund still lacks the authority to ensure that the process is fully predictable.

    In addition, more could be done to prepare the companies for privatisation in ways that could re-assure possible investors, with debt restructuring a priority.

Measures:

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    Strengthen the independent status of the SPF within the Cabinet of Ministers to increase the credibility of the case-by-case privatisation process; adopt legislation defining the limits of SPF authority and scope of its functions.

    Alongside debt restructuring, the SPF to ensure that social assets in the enterprise are transferred to local authorities, that full information on the enterprises is available, and that satisfactory shareholder protection be written into the enterprise charter prior to privatisation (see also corporate governance issues below)

    The Government and the SPF to adopt and regularly update a clearly stated investment policy to indicate to current and prospective foreign investors those enterprise objects and sectors in which it clearly has no intention of divesting, and those from which it seeks to exit, either gradually or in the short-term.

Corporate governance and shareholders’ rights

    A further explanation for limited foreign participation in the privatisation process and in the Ukrainian securities market has been weak provisions for and enforcement of shareholders’ rights. Current legislation allows or does not sanction effectively such

    machinations as share dilution, asset stripping and diversion of profits. In addition, the concept of fiduciary duty of company directors is poorly developed.

Measures: