UK Ambassador interview - Reform can drive up investment

In an interview with UBI at the Goring Hotel, London, the British Ambassador to Ukraine, Leigh Turner, highlights how trade and investment between the two countries continued to grow, and how UK investment could contribute to Ukraine’s development, but suggests that to achieve its potential, an investment climate with transparent regulation is a prerequisite.

The UK is the seventh largest investor in Ukraine, with £2 billion of investment since 1992 and exports of over £400 million last year. There are more than 100 UK companies operating in Ukraine, and the UK is continuing to make new investments in the country. Even so, Ukraine remains relatively unknown in the UK.

Summarising the main attractions of Ukraine for British companies considering investing there, Turner pointed to the enormous development potential of a country bigger than France with a population of 45 million, but with a relatively low GNP.  “The key question is the extent to which it (the Ukraine government) will allow the conditions required to develop economically. A number of reforms are necessary,” says Turner. In addition to the conditions stipulated by the IMF for loans, Turner also highlights those being negotiated to agree closer cooperation with the EU, in particular signing up to the Deep and Comprehensive Free Trade Agreement (DCTFA).  “If this were brought to a conclusion it would provide a stimulus for economic development,” says Turner.

Turner goes on to make the comparison with Poland, which had a similar wealth level in the early 1990s. He cites with approval how Poland then pushed through deep seated reforms which were painful and difficult including abandoning subsidies, but resulted in improved economic growth. “The latest IMF figures show that by 2010 GDP figures for Poland were four times those of Ukraine, and the Polish economy was three times larger. It made those fundamental reforms and undertook integration with Europe. If Ukraine were to take those same measures it too would see strong economic growth,” suggests Turner.

Prime Minister Mykola Azarov has declared that Ukraine intends to become a member of the EU by 2022, implying that closer integration with Europe as a potential driver of growth is not one rejected by the current government. However, UBI questioned how realistic EU membership is as an aspiration for Ukraine now and in the future – and whether it might preferable to pursue closer cooperation with Russia which would like it to take part in a CIS trading block. In true diplomatic fashion, Turner responds that whether moving closer to Russia or to the EU, it is for the Ukrainian people to decide what kind of country they want. But he goes on to quote a saying in Ukraine, that when people are getting a new apartment, they ask for a European standard flat – not a Russian standard. He adds, “The EU is a market of 500 million people with a GDP per capita of $32,000, whereas Russia has a population of 140 million, with a GDP per capita of $10,500.”  There is no question in Turner’s mind as to which was the most desirable outcome.

In terms of being achievable, Turner comments that, “Some EU Member States, including the UK, would be willing to allow Ukraine an EU Membership Perspective, which would give it the right to join the EU when membership requirements are met. Some other states are less keen on further expansion of the EU, but membership of the EU is not the main issue as there is a huge amount that can be worked on now, including signing up to the Free Trade Agreement and Association agreements, improving the rule of law, economic reform and political reform. The Deep and Comprehensive Free Trade Agreement is one of the most ambitious yet, covering 95% of traded goods. It would strengthen Ukraine’s legislative environment in line with the EU, which would encourage inward investment and deliver economic growth.” The message is clear – start heading down this path and there are benefits which accrue before membership – and we’ll support your membership application.

The Ambassador notes that over the last 12 months the British Embassy in Kyiv has been “immensely active”, with a wide range of activities aimed at encouraging UK involvement in the country, including talking to UK companies considering setting up in Ukraine, looking in detail at which sectors could be targeted, and identifying UK companies needing help in Ukraine, with difficulties with regulations or similar issues. Several promotional events have been run, the number of events hosted at the ambassador’s residence has doubled and during March a three day event, British Business Days in Ukraine, was hosted to showcase British business operations and raise the profile of British companies there. “We kicked off with a business to business debate, held at the Globus Shopping Centre in central Kyiv which was attended by senior figures, plus we held a press conference and a Gala reception. We had 30 British companies and groups of companies attending along with 500 invited guests. Visitors included Mr Popov, Head of the Kyiv Municipality. The following day we had a Q&A with Prime Minister Azarov for CEOs and senior staff.” The exhibition was open to the public, with JCBs, Bentleys, Jaguars and Minis on show, and stalls from companies ranging from multinationals to smaller operations, from energy to education, retail to pharmaceuticals. “The embassy is set targets by London for the number of events to be held and we have exceeded this by 100%,” he added.

Among UK companies active in the country is BarCap (Barclays Capital) which last year set up a software centre in Ukraine, outsourcing high level software development, including the transfer of jobs from Singapore – “high value, high level jobs.” There are many other investment opportunities – highlighted by the Adam Smith investment conferences in London, which Turner noted have had a considerable record of success. He also points out that London is also the financial centre of choice for Ukrainian companies raising capital, launching IPOs. Just recently the egg producer Avangard raised £200 million to finance growth and development of its facilities. Consulting and legal firms are also doing business out of the UK and via operations in Ukraine to help the country develop more effectively.

When talking about Ukraine’s potential, it is not long before the subject turns to agriculture, the ‘black gold’ of the future being the black earth of the Steppe. UBI points out that although agriculture in Ukraine is described as cleaner (ie with less apparent corruption), and more transparent than some other sectors, many potential UK investors are still wary. Their concerns include suggestions that any land sale will be biased in favour of preferred organisations, that the rules are liable to change and are open to variable interpretation, and most recently  that last season’s grain export quotas were unfairly applied, and that new plans mooted for a state monopoly exporter  are fundamentally changing the rules of the game.

Does Turner think UK companies should invest in Ukrainian agriculture, and if so, what advice would he give investors, and what opportunities would counterbalance the risks? Turner first highlights the scale of the opportunity, noting how Ukraine has unique potential to expand its agricultural sector. He observes: “The more you invest per hectare in Ukraine, the more robust your yields become. Agricultural output is currently close to the maximum achieved in the Soviet era at about 45 to 50 million tonnes. If more favourable inward investment conditions were created, that figure could be doubled.” In fact some experts indicate Turner may even be cautious, and suggest that tripling, rather than doubling output is possible.

Turner goes on to address some of the ‘problems,’ suggesting that there is some good news on agricultural reform. This includes the fact that nearly all agriculture has been privatised, that most agricultural land is now in private hands, and that investment has grown over the past 20 years. But he acknowledged that at the same time there is a great deal more to be done. “The investment climate for all types of businesses needs to be improved; rules need to be clarified, unnecessary rules need to be abolished, regulations need to be transparent and predictable, and to be applied equally,” says Turner.

Turner notes that there are now serious proposals to lift the moratorium on agricultural land sales. “If it were liberalised this would create a tidal wave of inward investment – if it was done in a transparent way,” he cautioned . He goes on to explain that this would allow land to be used as collateral to guarantee loans for further investment. But Turner recognises that many people in Ukraine are uneasy about allowing just anyone to invest. And again he cautioned that as a result there is a risk that when the moratorium is lifted it could be accompanied by restrictions that will hamper development of a genuine free market. “The more restrictions there are, the more investment and development will be discouraged. There are even some suggestions that it may be made easier for favoured investors to buy at low rates – which would be the worst of all worlds, failing to achieve realistic revenues for the government, failing to secure development investment, and failing to encourage inward investment into the country.”

Specifically addressing the issue of last year’s ban on grain exports, Turner notes that while it did reduce prices in Ukraine, which may have seemed good for Ukraine’s poor in the short term, for the majority of inward investors the introduction of quotas was unexpected and at very short notice (hence previously agreed orders were unable to be fulfilled – in some cases with ships waiting to be loaded - UBI) and thus a major deterrent to investment. “Some large investors who were actively considering hundreds of millions of dollars of investment were put off making their investment.” Turner also notes how the reduction in prices also diminished the incentive to invest. In addition, he concurrs that the way the export quotas were implemented was not transparent, commenting, “It appeared to give preference to companies that were in some way connected to the authorities. An opportunity to raise investment funds for the country was not taken.”

Traditionally it is the energy sector that is regarded as notoriously lacking transparency, and subject to overt political influence, including from Russia, yet UK companies are active and successful in the sector. Asked how UK companies might contribute to Ukraine’s energy development plans, Turner first points out the enormous growth potential, noting that it is likely that the country has significant untapped resources, in both oil and gas, but especially gas, and especially offshore. He adds, “UK companies have the capital resource and the technical skills that Ukraine needs to exploit these resources. For example, there are very deep gas reserves that are deeper than have been commercially exploited before, there are complex gas-shale resources, and there is offshore gas under the Black Sea which is difficult and risky to exploit. Ukraine needs funding and technical help to utilise this potential.” Turner added a cautionary note, saying, “again, the question is, can Ukraine create the investment climate whereby companies will come? Most would say the investment climate is difficult, with Ukraine appearing at No 145 on the index of ease of doing business, and 134 on the index of corruption – a slight improvement on 146 the previous year, but not where it wants to be to encourage investors.”

Turner emphasises that, although some Ukrainians will say that the business climate doesn’t matter so much as business will always carry on, the issue is about realising Ukraine’s potential, adding, “It’s true that, even without improvement, there will be some investment from companies that can afford the costs, or those with a higher risk appetite, but Ukraine could do so much better – including in the energy sector.” Turner cites an example: “In autumn 2010, a senior government minister informed me that there was about to be a series of transparent auctions for oil and gas licences. Senior energy professionals at the time did not believe this would happen. Seven months later there have been no transparent auctions of licences.”

Last year, the UK Government announced new legislation to combat bribery, ‘The Bribery Act 2010 (the Act)’ which came into force in July. Given the comments attributed to senior oligarchs on Wikileaks suggesting that it was not possible to secure major Ukraine government projects without unofficial payments, how has this new legislation affected UK companies working in Ukraine and their ability to win major contracts and their contribution to cleaning up business practices? Turner responds: “I have addressed this issue in my blogs of August last year and April 2011. There are two separate groups to be addressed. UK businesses – and all readers operating in Ukraine - should take a close look at the guidelines and see what it means for them. Companies report that corruption is a serious issue in Ukraine. At a recent seminar we provided anti-corruption experts from the UK’s Serious Organised Crime Agency who advised on how to crack down on corruption. We need determined action from the authorities.” He continues, “There is new Ukrainian anti-corruption legislation under discussion but assessments of its efficacy have been mixed. Not all experts agree that it is sufficiently hard hitting to achieve the results wanted. One of the things that the authorities can do is to make sure that the anti-corruption law is something that anyone in Ukraine would be frightened of if they engaged in such practices. “When we had our Business to Business debate on 17 March , it was asked, how quickly could programmes be made that would end corruption? Some said there were actions that could make a big difference in a day. Georgia was cited as an example where an alleged problem of corruption had been tackled. As a result it had moved rapidly up the table to show it now had an excellent anti-corruption climate. Others said it would take decades for Ukraine to change its attitudes toward bribery and corruption. “Rapid progress can be achieved if it is led from the top, to show that nobody, not even members of the government, are immune from the anti-corruption legislation. It needs leadership. I am not convinced that it is being tackled with as much energy as it could be.”

What other areas of reform are impacting on business? Leigh Turner’s blog had previously suggested that introducing automatic payment of VAT refunds would be a “quick win” for the government, then on 21 March  the government announced that is doing just that. What does Turner see as the benefits of this policy for both the government and for business?

He confirms that the lack of automatic VAT repayments remains one of the biggest areas of complaint that the embassy receives from UK companies who are owed substantial arrears. There are allegations that more well-connected companies get paid early, and even that some less well-connected companies’ payments are deliberately withheld. “This is bad for business. It deters investment and means that companies are unable to plan because it is unpredictable. The government has said that it will be automatic – but there are reports that the authorities have a list of companies that are to be automatically repaid – and it is a short list –and that the majority are not getting automatic refunds. We would urge the government to make this automatic for all and in a predictable way,” says Turner.

Ukraine is rightly lauded as a leading example of democracy in the CIS, but are the sporadic outbreaks of physical violence seen in the Verkhovna Rada symptomatic of an underlying undemocratic tendency to resort to the use of force to achieve one’s aims in Ukraine, or simply a demonstration of passion for strongly held opposing viewpoints being openly demonstrated in a vibrantly pluralistic society? Turner notes two tendencies in the country. The first, the Freedom House Index shows Ukraine as the freest democracy amongst the former Soviet states, excluding the Baltics – and this represents a change in the structure of Ukrainian society. But Ukraine has slipped down the rankings from being considered Free to Partly Free – on a par with Moldova among non-Baltic CIS states. He comments, “There is still everything to play for and we are closely engaged in promoting democracy which has been shown to be the best system for promoting freedom and stability.”  Turner adds, “As for fighting in the Rada – it is deeply disappointing. There are two groups who are responsible – those physically fighting, who need to understand that they are doing Ukraine and its reputation and image considerable damage with each brawl in the chamber of democracy; making this the most popular image of Ukraine on YouTube. And the second group with responsibility are the leaders of the parties concerned who need to put a stop to this. Some say that it’s very difficult to do anything about this, but I disagree. Members could be disciplined by the parties to ensure that there are no future fights, and show responsibility for this situation which is harming Ukraine.”

An opportunity to improve Ukraine’ image is on the horizon with next year’s Euro 2012 football championship which will put a spotlight on Ukraine. What should the country be aiming to say about itself to the world? Acknowledging that Euro 2012 football  is a fantastic opportunity for Ukraine to put itself on the world map, Turner notes some of the reasons for the current lack of positive perception. He points out that with just 20 years as a country in its current borders there is a less clear image or brand for the country compared to those countries which have remained with essentially the same borders for hundreds of years. Euro 2012 will bring images of Ukraine to hundreds of thousands on TV and a huge upsurge in visitors from Western Europe. Turner agrees that it will be an opportunity to show what Ukraine is, what kind of a country it is, and what is good about Ukraine.

He adds that the infrastructure – stadiums, hotels and transport - is progressing at a high rate. “I am optimistic that it will be completed in time. The PR and information services infrastructure that goes with it, and the attitudes toward welcoming visiting fans are things that the UK can contribute to – and we are. We are conducting exchange visits with law enforcement agencies, to tackle cyber-crime, corruption, counter-terrorism, and technical experts advising on how to manage major events, using best practice to create and maintain a holiday atmosphere for visiting fans. About 100 people took part in a recent project on diversity, from the four host cities of Lviv, Kyiv, Donetsk and Kharkiv. They include military officers, social workers and media representatives. We have provided this help to try and ensure all goes well – and I hope one of the British home nations will be able to qualify for the tournament.”

Are there any signs that the situation is improving under the government of President Yanukovych? Has there been any noticeable impact from anti-corruption legislation? Has the provision of IMF loans had any positive impact on government tendering policies and fiscal policy? Turner confirms that there are indeed good things that have happened – greater macro-economic stability, inflation is down, there are promises of action in various spheres including VAT, the land moratorium, transparent public procurement. The government has also reduced the number of regulatory bodies, and the compliance regulations for sectors such as building. Inevitably though, there is also a ‘but’. “But there are also continued reports from companies of problems with the rule of law, with customs, corruption, and some changes have been repealed, and many of those that have been announced do not take place. The aforementioned grain quotas and plans for an export monopoly create uncertainty and have the potential to have a negative impact,” Turner adds.  The Ambassador concludes with another but… “But I am not negative about the prospects for investment, and I am happy with the changes that have occurred, and hope their effects will feed through to the overall economic climate.”

Also see blog: http://blogs.fco.gov.uk/roller/turner