PriceWaterhouseCoopers
31.10.2002
Jorge E. Intriago
Ukraine has recently I introduced significant legal reforms to enable it to position itself to realize its potential as an attractive market for foreign investors. This comes at a time when other external factors, mainly EU enlargement, could increase even fur-ther Ukraine's attractiveness as an investment destination. Until recently, it was difficult to be optimistic about the poten-tial for a significant upswing in foreign direct investment because there was a general perception that legal reforms undertaken on many different fronts were progressing at a very slow pace. There was also a general belief that the experiences of foreign investors in Ukraine were, in general, negative. Unfortunately, and unfairly, strong macroeconomic indicators and the positive experiences of many foreign investors were completely ignored. In other words, success stories remained untold while war stories were overblown. Consequently, the general perception that Ukraine was not an investor friendly country persisted until recently, with the end result of Ukraine lagging significantly behind its neighbors in foreign direct investment levels. In fact, most macroeconomic indicators have been quite healthy for the last couple of years, but foreign direct investment has consistently been the exception. Ukraine is now increasingly viewed in a more positive light by investors and there is a sense of cautious optimism about its future as an attractive destination for foreign direct investment. A key ele-ment underpinning this change in perceptions is the depth and speed of legal reforms recently undertaken on several fronts.
To understand a key element leading to this shift in percep-tion, we must analyse the Ukrainian legal system vis-a-vis what I call the "Investor's wish list", that is, stability, predictability, transparency and enforceability.
Stability
Stability tops most investors' wish list. Legal stability is commonly associated with a legal system that experiences few changes enabling investors to forecast with some accuracy the potential outcome of projects. If a legal system undergoes con-stant changes, investors will feel uncertain as to whether the assumptions made at the beginning of a project will hold true for the life of the project, and thus whether, all other things being equal, the expected results will be accomplished. Thus, an unstable legal system does not encourage investment. However, in Ukraine's case investors would agree, to a certain degree, to waive the requirement for stability, provided the reforms introduced improve the system and enhance the busi-ness environment. With a few exceptions these have been the type of legal reforms introduced recently. Another key stability element to attract foreign investors is not to revoke benefits originally granted for attracting investors. In this area the track record has improved significantly and the Ukrainian legal system has begun to acquire the degree of stability required to gen-erate trust from investors, especially when tax benefits granted through legislation on free economic zones have been maintained, despite the impact on tax collection generated by the abuse (tax evasion) from dishonest businessmen. Rather the Government has resorted to increase control over these zones rather than cancelling the benefits granted.
Predictability
Legal predictability flows from legal stability. In Ukraine's case predictability refers to whether the legislative changes are following a clear and predictable path, which investors may cherish as progressive. Analysing this element we can conclude that, in general, the legal reforms intro-duced are progressive and should improve the business climate. Another important element of predictability that investors are monitoring is whether promises for legal reforms are fulfilled, since investors are normally factoring these into their business plans. Ukraine has recently scored major points in this area, with the long awaited promises of setting the legal framework for private ownership of land by foreign investors now passed into law, albeit with some retouches still needed. Although the much debated and promised Tax Code has still to see the light of day, significant reforms promised for quite some time were finally intro-duced, like the reduction of the tax burden on individuals. In fact from 2004 the top marginal personal income tax rate of 40 % (widely considered overly oppressive thereby prompting massive tax evasion) has been cut to a 13 % flat rate. Also, the long awaited reduction of the tax burden on companies is now reality with the corporate income tax rate dropping from 30 % to 25 % in 2004, and also with a significant increase in the depreciation rates for fixed assets helping to reduce the gap between accounting profits and taxable profits.
Another area of predictability, which is of paramount im-portance, is honouring commitments made, especially tax incentives granted. If certain incentives such as tax benefits over a defined period of time are granted to investors entering the mar-ket under certain conditions or in certain locations (free economic zones), investors want to have an ironclad level of assur-ance that any future legislation, curtailing some or all of the benefits or incentives will not be applied retroactively against them. To do otherwise would totally erase any signs of pre-dictability in the legal system. As I said earlier Ukraine has sco-red points in this area. Since investors have agreed to waive their otherwise normal requirement for stability, it is clear that they need to be able to understand where the legal system is heading towards, and which reforms are likely to be introduced. I am glad to say that in this area Ukraine scored very highly in 2003.
Transparency and Enforceability
The openness of a legal system in resolving disputes and enforcing the law is required for transparency to exist and for the laws to be enforceable. Investors want at the very least incor-ruptible courts and regulators and government officials who enforce the law without discrimination. Investors want deci-sions based solely on the law and not through influence peddling, money peddling or coercion. One's legal arguments rather than political connections or financial wealth should be the only thing the authorities and the courts find relevant. Investors want acts enforced in a fair and timely manner. In a stable, predictable and transparent system, enforceability comes naturally, through an independent and powerful judici-ary, which must exist to maintain the rule of law. Without enforceability the rest of the investor's wish list is totally unat-tainable. In this area we also believe that significant progress has been made, with investors turning with more confidence to authorities (for instance the Antimonopoly Committee has been much more active and its resolving of conflicts has been praised by some foreign investors) and the courts to enforce their legal rights. Despite this, there is still a lot of work to be done to improve the perception of the level of enforceability and transparency of the Ukrainian legal system.
Ukraine's rating under the investor's wish list has definitely improved in 2003, as investors note the speed and depth of legal reforms introduced. Arguably, Ukraine seems to have passed a decade worth of legal reforms in a little over 12 months. This could be easily perceived in the passing of the Land, Customs, Civil and Commercial Codes and the tax reforms discussed above. These means that Ukraine is finally purging Soviet-era legisla-tion and setting legal foundations aimed at regulating business activities in a more structured and grounded manner, compati-ble with the way in which business is conducted nowadays. These reforms are both a substantial and a formal (symbolic) move away from the post-Soviet legal regime which Ukraine inherited to a legal system based on the principles of the European Union and OECD (Organization for Economic Cooperation and Development). The more ingrained the norms of the latter two become, the more likely it will be that Ukraine will be regarded as a attractive environment for foreign investors.
A significant and necessary step in this process is acces-sion to the World Trade Organisation (WTO). The WTO, and the principles its signatories (over 140 countries) must abide by, are in essence the principles upon which global trade and investment operate. Ukraine has implemented aggressive strategies to fulfil WTO accession in 2004, which would significantly improve its overall image as an attractive investment destination. In fact, 2003 has seen Ukraine transition from virtual isolation to the position of a poten-tial strategic regional business partner.
Logic dictates that foreign investors come to a market beca-use of its competitive advantages over other markets. However, investors must have certainty that the legal condition will improve or at least will not worsen for the foreseeable future. On the business front 2004 could well prove to be the single most important year since independence. Almost all the neces-sary elements for a big rise in foreign direct investment are in place. In addition, external factors are playing a significant role in turning Ukraine into a very attractive investment location. One of these factors is EU enlargement set for 2004, which will bring the European Union right to Ukraine's doorstep. EU enlargement is resulting in countries joining it losing some of the competitive advantages, which led them to attract signifi-cant inflows of foreign investment in the past. This will spur many companies currently operating in accession countries to move their operations away from the highly regulated and ex-pensive labour markets of accession states. This factor, together with Ukraine's geographic proximity to the EU, complement-ed with its treaty network (including free-trade agreements) with CIS member states, will mean that it will be in a unique position to attract significant inflows of foreign investment. If foreign investors continue to see a serious reform path and if they see that the pace of reform continues to gain momentum Ukraine will be in an excellent position to attract a significant amount of new investment over a sustained period of time.