Investing in Ukraine’s future

In an interview with UBI Andre Kuusvek, EBRD Director and Country Manager for Ukraine at EBRD (European Bank for Reconstruction and Development) and Member of the Board of the American Chamber of Commerce in Ukraine explained both his own and his organisation’s role and experience in the country.

Andre Kuusvek, an Estonian by birth, has worked in several European countries, and specifically asked to work in Ukraine. Kuusvek explained to UBI that he has always been interested in the region in transition, and Ukraine is EBRD’s second largest country in terms of business volume, making it his number one country, in the right place, adding that, “It was big enough to represent a challenge. I liked Ukraine because things happen here.”

Since arriving in Sept 2008, he has certainly seen the ‘challenges’ come to fruition with the country’s deep crisis occurring in his first month. But he adds that the worst also become the best experience due to “EBRD’s ability to act quickly and put together plans to recapitalise the key banks, avoiding deep collapse of the banking system.’”

The devaluation mostly happened in October/November 2008. Depending on the bank, it became clear in the next few months how bad the loan portfolio had actually turned and how much capital was needed for the banks to survive.

 “We can say that three years later those banks that recognised the depth of the problem early on are now doing much better compared to those that were first denying and then postponing resolution of the problem. We could have easily been in a situation in early 2009 when half the banks could have been bankrupt. This was the biggest systemic change, comments Kuusvek.

On the corporate side, the most satisfying development was described as seeing and financing such a large number of local dynamic young entrepreneurs this year,“…which we didn’t expect to see in those kind of numbers because Ukraine is largely dominated by large business groups, and one of the problems has been the too close linkage between politics and business.

Asked about his role on the board at AmCham (American Chamber of Commerce) Kuusvek noted that he is closely involved in both of the two leading business organisations, AmCham and EBA (European Business Association) and could easily have been on a different board, had AmCham not approached him first, but added that,“…both organisations do a great job. The key value that they bring is that they systematically identify what is important and what is less important in each sector and across the sectors… it can be difficult to work out what is really crucial for the EBRD to focus on, as we can’t do it all, and these two business organisations help us select from a wider membership what is really important and focus on that and push key points.” At AmCham the key focus has been on the long-term competitiveness of Ukraine. A lot of sectoral issues, investment climate issues and policy dialogue are seen as coming from that overwhelming drive for long term competitiveness, greater transparency, easing conditions for businesses to operate in.

UBI questioned what were the gains for the EBRD’s members of investing in Ukraine? And given that the EBRD itself has described the gains from financial integration in Europe as now being at risk due to the massive amounts of new capital needed by Europe's banks, Kuusvek was asked, should not Europe’s banks now concentrate on their own countries? Kuusvek pointed out that of course the EBRD is funded by countries, not banks, and that while it would be easy from the European countries’ perspectives to concentrate on resolving their own problems, integration is unavoidable and would bring benefits in the long term, though in the short term it could also multiply the risks that go beyond the borders of one country, be it for trade or financing. EBRD’s function is to focus on the region – Central and Eastern Europe, Central Asia and now also with expansion to the South east Mediterranean region, to focus on the areas surrounding the core EU region, ensuring it is stable and flourishing because the trade relations as well as cultural relations and others are crucial. “We have seen (isolationism) tested in the Soviet Union and we know it doesn’t work,” commented Kuusvek.

UBI pointed out that with the difficult situation that the EU and some of its more indebted members now find themselves in, the EU may not appear such an attractive model for Ukraine to pursue, compared to the more familiar environment of a Russian-led customs union, cheap gas and manufacturing cooperation in key sectors. Kuusvek was quick to counter that the EU model was preferable, stating, “Let’s not mix indebtedness, leverage and excessive leverage in some cases, with the EU model as such. The EU model is freedom, free trade, free movement of goods and services as well as people and these are all the long-term values that Ukraine should definitely pursue. The fact that some banks, some companies and some countries are over leveraged has nothing to do with that so let’s not criticise the model as such. The two (EU/Russian customs union) would not work together. Russia is a big neighbour that should be treated with respect, as should the other CIS countries that are not part of the EU. But I am convinced Ukraine will choose its long-term future in Europe. I hope Russia will as well. For the time being, until transition is achieved, further integration is necessary at the same time as keeping a relationship with Russia as a partner. Russia is Ukraine’s main trading partner and it’s not something that can be ignored or should be ignored, and a balance needs to be maintained and Ukraine has done that reasonably well in the past.”

Surprisingly, Kuusvek suggested that for EBRD there was little difference in how it operated in Ukraine or Russia, applying the same standards and model, pointing out that for sovereign loans to government, even the pricing is the same irrespective of the credit risk. But Russia being a much bigger country did mean that there are alternative sources of internal and external funding, especially for the development of hydrocarbon reserves.\\r\\nAs the largest foreign investor in the country, the organisation does meet with the President of Ukraine – about half a dozen ‘bilateral meetings’ last year to discuss specific issues as well as less formal meetings during wider gatherings such as international Davos or World Bank meeting in Washington. “It is important to have that contact, to hammer down the key message at the very top level is important. You don’t always necessarily get the results at the meeting, but they can get things rolling - a meeting with the President and then a follow up meeting with the President is something that in this part of the world is helpful,” said Kuusvek. The same applies for the National Bank plus sometimes opposition leaders too, such as “when, say, a board delegation of EBRD visits the country and we would like to get a variety of views and the focus is on economic aspects and less so on the political.”

UBI asked if there was evidence that the EBRD funding was indeed magnifying transition impact by giving firms added incentives to improve management standards, raise efficiency and find more innovative ways to compete.

Kuusvek responded that there clearly is evidence in development of the private sector; noting, “We have achieved significant progress here. EBRD will have funded over €1 billion to Ukraine by the end of the year (2011). Today its 38 projects, which, except for one, are all in the private sector, enable the private sector to get funding, operate with better corporate governance and transparency standards and on a project basis, bring together elements of modernisation, better care of the environment, energy efficiency. I think that is the most significant achievement.”

EBRD aims to fund the public sector for those purposes that the private sector cannot finance – intercity roads, electric transmission lines, certain municipality projects, in some cases working with a government owned public company targeting privatisation Ukraine International Airlines was one where EBRD went into a state controlled company that is now private. “If privatisation is not on the agenda then we are targeting higher commercialisation of the enterprise, making sure we recover the expenses including the investment cost all in order to make these enterprises more sustainable and able to provide better quality services in the long run,” explained Kuusvek.

EBRD has said that policy reforms are needed to attract domestic and foreign investment; UBI asked what reforms are needed? Kuusvek reiterated the historic issues, but added thatsignificant external challenges remain to building an image of the country for international investors. He commented, “I have to say Ukraine has not been successful in that. There is often a negative perception of Ukraine, how the country is risky, corrupt. ….companies that have invested…mostly understand the upside and the growth potential. If you ask, do you regret having invested in the country, very rarely is the answer ‘yes, we do’. In most cases, they say: ‘we do have these difficulties but we stay put because it makes sense, it’s profitable and we want to be in Ukraine’.

Key growth areas or low hanging fruit for investors inevitably included agribusiness, energy and energy efficiency, but Kuusvek went on to inform UBI that in EBRD’s view, “Policy reforms should include proper land reform, making land a tradable commodity and asset, and that would enable banks to lend based on land security, but it also goes beyond that in terms of some crisis reaction methods like the grain export quotas and export taxes – the free market should define these things. Many reforms are needed and the gas sector is another one. Clearly if the gas input price for exported gas is US $400 per thousand cu m and domestically you only collect, depending on segment, US $100, 200 or 300, it is bound to be a loss making business and that is not sustainable. Tax payers need to be responsible and pay for it, which will take a very significant reform in the gas sector which is what the EU, EBRD and our fellow international financial institutions (IFIs) are pushing for.”

Kuusvek described these as very significant and very real gaps where the reforms have not happened yet or are not happening at the pace that the EBRD would like to see, and the country is suffering as a result.

Commenting on effects of the July 2011 anti-corruption law Kuusvek prefaced his remarks by noting that it is positive that legislative initiatives have been taken, that the President, Prime Minister and other government ministers have identified corruption as one of the key constraints in Ukraine. But he suggested that the law itself is too young to comment on how well it works, going on to observe, “It’s also clear that sometimes the corruption goes beyond the legislation. While the legislation may be OK, if the implementation is not, and if everybody keeps ignoring the legislation then it’s not working. We have yet to see how measures to cut corruption are being implemented and if they are working so that companies and the population eventually feel that there is improvement. I can’t say that this has happened yet.”

Regarding concerns expressed both domestically and internationally about the state of democracy in Ukraine, particularly jailing of opposition leader Yulia Tymoshenko, Kuusvek confirmed that the EBRD ‘absolutely shares the concerns about the state of democracy, legislation, corruption and transparency.’ He told UBI, “We are not immune to the business environment here, and on top of that, being an international financial institution with 60 countries as shareholders we do carry the same values as our shareholders, so yes, we are concerned.” EBRD itself became a shareholder in Ukraine International Airlines over ten years ago and brought in two very significant strategic investors from the airline industry. One was Austrian Airlines and the other was Swiss Air. At that point a logical privatisation step would have been the sale to either one of the two, or jointly to the two, or maybe a third industry investor with specific knowledge in aviation. Asked about the privatisation, Kuusvek said,” A lot of things have happened in the past ten years, not least the terrorist attacks which have very significantly affected the airline industry, the financial crisis, the Icelandic ash cloud, so the aviation industry has had some really tough times and this is the reason why neither of the original two investing regional airlines was in a position to make a further commitment to an essentially privatised Ukraine International Airlines, which is a pity. Also there was a legal restriction on how the privatisation happened because UIA used to be a closed joint stock company and now, under new company law, is called a private joint stock company where the existing shareholders have the right of first refusal for any share sale and that by itself was a very significant limitation for the privatisation process and who was able to bid. Potential investors that are in there have a preemptive right to purchase. EBRD disposed of its shares in December 2010 and is no longer a shareholder.”

Reform of the gas sector is generally accepted as a priority for the countrybut given EBRD’s own recent Transitions report noting that consumers were cutting back on basic food consumption, UBI asked if market prices for gas could be achieved in the short term, particularly given the current relatively impoverished state of many of the population, and in the face of the country’s often severe winters?Kuusvek affirmed, “We certainly don’t believe in artificial price limits on any goods and that includes food and energy prices that are not sustainable in the long run. Prices have been going up globally and it’s no surprise they have also been going up in Ukraine. What is different in Ukraine compared to more developed European countries is that the inflation basket in Ukraine is very much weighted to the food element in that basket; in Ukraine it’s about 52% or so whereas in the UK it’s about 20%, so food prices have a very significant inflationary aspect. Energy, interestingly enough, doesn’t play such a great role in inflation. I would say that energy tariffs going up don’t necessarily have a huge impact on food prices per se. I also don’t think that Ukraine is as poor as the statistics show. GDP per capita of US $3,000 per year to the end of last year in Ukraine is showing a gloomy picture for the state of wealth of the nation, yet when you go out, you see what people wear, what they drive, and where they live and in fact it’s not too bad, so I don’t think the statistics are always right in that respect. But yes, reforms in the gas sector are absolutely necessary. It will have a short-term effect on the country. People will not be happy but they will adjust eventually and it’s necessary to work toward long-term reforms.”

Naftogaz is one of the organisations that EBRD had suggested should be restructured and corporatised to strengthen its financial viability. UBI asked Kuusvek how this might be achieved.\\r\\nKuusvek suggested that it should be in the context of the overall gas sector reform. “I know the government is working on a draft reform paper at the moment. The President set the goal for the draft to be ready for the year end. I can’t comment on whether this is achievable or not, but I know there are ongoing discussions between Ukraine and Russia in terms of the formula of the gas price. Naftogaz itself is clearly a huge drag on the government budget at the moment. I have already touched on the price differences and said that the company is bound to make a loss.”\\r\\nAn additional problem has been the non-transparent structure of Naftogaz which makes it unclear which part of the business is more loss-making and which part could potentially be breaking even or even making a profit. Commentators certainly believe that the gas transit system should be making a profit, however small. “Ukraine is a very significant transit country and that is further confirmed by a technical study we have commissioned and is now available to us, which shows that Ukraine clearly has a role to play in the gas transit system. But that system is under strain. There has been little or no investment in the system and there is only one choice. The system must be modernised, but it can only be financed subject to lenders knowing where the money is going and to stop the leakages from Naftogaz through an international audit on individual business lines. A leading issue in the agricultural sector was the fallout from grain export quotas introduced in October 2010. Action has been taken including lifting of duties, but the question remains whether these actions are adequate.

Kuusvek confirmed EBRD was very closely involved in the policy dialogue. “We organised two grain roundtables in Kyiv, one in January and one just recently where we brought together around the same table representatives of the ministry of agriculture and the market participants; grain traders and the unions of those institutions. In January (2011) we had 60 companies around the table. We do take pride that it was also thanks to our own involvement that we managed to convince the government to abolish grain quotas, which in the intermediate period were replaced with export taxes, but which have now also largely been abolished except for one type of grain. I think it was damaging to Ukraine, it was damaging to business in Ukraine and ultimately to the budget of Ukraine.”

Despite issues over some policies, Kuusvek concluded that he would still advise foreign investors to invest in Ukraine. “Ukraine has a lot to offer, it’s a large domestic market, and there’s still relatively cheap labour, even though this is not solely a reason for investment. In terms of sectors, it could be for any sector in fact, obviously bringing in modern technologies and innovations would be the first place to look at but this can be applied to any sector, bringing value added services. \\r\\n“For example, this year (2011) we have financed a French company in the air separation business which has purchased air separation units from one of the Ukrainian steel mills and is planning to do more. We know there is at least one other very reputable German investor in the same sector operating in Ukraine providing services that will help to cut waste, recycle the gases from the steel mill partially back to the mill to operate it, but also to create products for other industries, medical services, laboratories, service sectors that never previously existed in Ukraine and where foreign investors can bring very significant value. So yes, Ukraine remains open for business – you need to pick your partners very carefully though, and any big investor that fits the EBRD minimum deal size, I would recommend to speak to us, and whether they decide to do business with us is up to them, but clearly we could be helpful.”