Assessment and recommendations

Since 2014, Ukraine has deployed significant efforts to improve its investment environment. Ukraine’s post-Maidan authorities have been moving forward with a reform agenda to create a welcoming business environment. In parallel, ongoing economic and social reforms that aim to bring Ukraine closer to international standards in fields such as human rights or labour relations are important steps in shaping and strengthening the country’s policy that promote sustainable development and responsible investment.

Ukraine’s policy framework for investment

Since 2011, Ukraine has been wracked by a period of severe political and economic turmoil that culminated in unprecedented tensions with its Russian neighbour in 2014. The situation in the Autonomous Republic of Crimea and in Eastern Ukraine remains extremely complex, with important economic and financial implications. While external forces triggered these events, this young democracy suffers from a deeper malaise of destructive policies and corruption.

During this crisis, Ukraine has upheld the generally open stance that has characterised legislation since the country gained independence in 1991. This includes introducing the principle of non-discrimination of foreign investment and enhancing general provisions to protect it, including against nationalisation and changes in relevant legislation as well as guarantees for compensation and the repatriation of profits. Protection against expropriation is guaranteed by the Constitution and conditions and procedures are stipulated in the 1996 Foreign Investment Regimes Act as well as in legislation addressing private land, national defence-related legislation and privatisation laws.

At the same time, Ukraine still applies some restrictions on foreign investment, which qualify for the list of exceptions to national treatment and measures reported for transparency in the meaning of the OECD Declaration on International Investment and Multinational Enterprises. As a result of these statutory restrictions, Ukraine has a score on the OECD FDI Restrictiveness Index (a measure of statutory restrictions on foreign direct investment) higher than the OECD average, albeit lower than the average of non-OECD countries. Public monopolies still apply in some significant sectors such as energy transport, transmission of electricity, supply and distribution of water, centralised heating supply, and railways.

In the scarcely two years since a new attempt at economic reforms was launched in earnest, the reform momentum has grown stronger and Ukraine has achieved quite important progress in introducing a modern legal framework that is conducive to investment in general and foreign direct investment (FDI) in particular. The ratification of the Association Agreement with the European Union and preparation towards full implementation of its economic part – the Deep and Comprehensive Free Trade Area – in January 2016 have provided an anchor for many different measures.

New legislation aiming at simplifying business registration procedures and cleansing government procurement is in place. Ukraine has now a comprehensive framework regulating public procurement. Developed in the framework of the EU-Ukraine Association Agreement, it is largely modelled on the 2004 EU Procurement Directives and has been designed to streamline and facilitate government procurement in Ukraine. Public procurements are open to foreign and domestic economic operators on an equal basis. A dedicated web portal (www.tender.me.gov.ua) is run by the Ministry of Economic Development and Trade, which places advertisements about upcoming public procurement. E-procurement practices are increasingly being used and should soon be generalised.

To address corruption, in particular in the judiciary, judicial reform is underway: the powers of the Supreme Court were enhanced and new rules now apply to the selection and disciplining of judges. Ukraine has also begun to reform its independent prosecutors. To cope with commissioned tax-related criminal investigations and inspections of the target business, Ukraine established a Tax Ombudsman in 2015. In the crucial area of anti-bribery, amendments to the National Anti-Corruption Bureau of Ukraine (NABU) law were passed and a NABU director was appointed. In a major step forward towards the improvement of the investment climate in the country, a Business Ombudsman institution also became operational in 2015. It provides a platform for the business community in Ukraine to file complaints about unfair treatment by the state or municipal authorities, state-owned or controlled companies, or their officials. Since then, businesses have voiced support for the Ombudsman institution and have been encouraged that the government was addressing issues such as administrative and legal abuse by state or local agencies, repetitive tax audits or investigations, excessive fines or retaliation.

Ukraine has signed over 70 international investment agreements (bilateral investment treaties and investment provisions in free trade agreements) with partner countries. These agreements offer covered foreign investors substantive and procedural protection. The review of the investment provisions suggests that Ukraine should consider updating its international investment agreements with a view to ensuring that they well-reflect government intent and emerging trends in investment treaty policy. Ukraine ratified the 1958 Convention on the Recognition and Enforcement of Foreign Arbitral Awards (New York Convention) in 1960 and the 1965 Convention on the Settlement of Investment Disputes between States and Nationals of Other States (ICSID Convention) in 2000. Expropriation of property has been rare in Ukraine. Expropriations have primarily occurred on the territory of the Autonomous Republic of Crimea in the aftermath of its self-declared independence.

Problems in applying existing (and a fortiori new) laws and regulations, however, continue to plague the business environment and depress domestic and foreign investors’ sentiment. Access to agricultural land is an additional issue: foreign investors are subject to a foreign ownership restriction, while the absence of a unified registration system for land and real estate imposes additional bottlenecks. Vagueness in defining the scope of “strategic” sectors closed to foreign investors or subject to authorisation procedures continues to increase legal uncertainty and discourages foreign multinationals from bringing their expertise to Ukraine. Additional obstacles to FDI include the uncertainty and duration of judiciary processes – seen by many investors as one of the most corruption prone areas in Ukraine – and persistent scepticism regarding the fight against corruption in the highest echelons of power.

The role of FDI in the economy of Ukraine

Combined with the ongoing conflict in the Donbas region, political instability, and capital-account restrictions introduced to stabilize the exchange rate, such problems make it very difficult to match the country’s vast economic potential with commensurate investment. Ukraine’s FDI inflows have indeed proven particularly volatile in the face of an adverse global environment for world investment. Hardly had they recovered from the global economic slowdown that FDI flows to Ukraine declined by 45% in 2013 and plummeted again by 81% in 2014. Preliminary data suggest a mild recovery in the first semester of 2015.

The round-tripping phenomenon, whereby Ukrainian investors use legal entities in offshore jurisdictions to channel local funds, which subsequently return to the local economy in the form of foreign direct investment, is widespread. Because of round-tripping, official statistics tend to overestimate genuine FDI inflows.

Financial services and manufacturing (for the most part metallurgy and food processing) together account for 53% of the total inward FDI stock, with trade and repair representing an additional 13%. Despite the country’s comparative advantage in agriculture, this sector has a very modest share of the total FDI (1.3%). EU27 countries are the main source of Ukraine’s FDI, representing over 75% of the total stock. The principal mode of entry is acquisition, including through privatisation deals, although the privatisation process has stalled in recent years.

There are fewer foreign-owned companies among the largest Ukrainian companies (7 out of 32 in 2014, based on Deloitte CE Top 500 rating) than in almost all of Ukraine’s...