MBS Blog

This article in the Kiev Post illustrates that even with the great potential of investing in an emerging market like Ukraine, it is often too difficult given the stifling bureaucracy and endemic corruption. Companies and individuals are giving up, or delaying entry until the climate improves.

Predictability is the biggest challenge as the political situation has not stabilized the environment enough to make investment palatable…and the ability to realize returns, attractive. Ukraine has a long way to go before it attracts the kind of investment it desperately needs.

IKEA, HP and Cargill announce cuts to planned investments amid tough business climate

President Viktor Yanukovych has pledged to improve Ukraine’s business climate from its lamentable 142nd place out of 183 countries in the World Bank’s Doing Business 2010 report. But with three foreign companies recently announcing cuts to plans for investment in the country, he’ll have his work cut out to convince foreign investors that Ukraine is worth the risk.

The troubles of home furnishing retailer IKEA provide an insight into the impenetrability of Ukraine’s market. For more than a decade, the international big-box, flat-pack furniture giant has been struggling to roll out its solution for middle-class households. But with the sale of its three processing plants in western Ukraine earlier this year and the shelving of plans to open a store in Odesa in 2011, it may be another decade before cheap and chic beds and tables will appear on the local market.

IKEA is not the only big international firm pushing the retreat button. Cargill, the agriculture giant, and Hewlett Packard, the information technology company, have curtailed their plans for Ukraine since the start of 2010.

The multinationals are scaling back for economic and political reasons, said Volodymyr Klimenko, a member of the management board at Sokrat Investment Group. “Big companies like growing trade markets and predictable rules of work.”

Predictability, however, is in permanent deficit in Ukraine.

IKEA has been here long enough to be no stranger to the unpredictable environment. Having opened an office in 2005, the retailer obtained a land plot in Kyiv and another one on the Black Sea coast in Odesa. With the potential for some 25 outlets across the country, the company planned to debut in 2011. But not anymore, said Ukraine’s country manager Frida Malmquist.

“IKEA has decided to postpone its plans for establishing shopping centers in Ukraine. IKEA will follow the development in the country, and at some point re-evaluate its decision,” she said.

Leaving the Odesa plot empty for now, IKEA Group also sold three plants in western Ukraine at the end of April. They used to manufacture IKEA’s famous furniture for Russian markets. Danish lumber company DDS bought wood-processing firm Sten in Ivano-Frankivsk region. Romania’s Plimat took over Proza furniture factory and Karpaty wood-processing plant from Swedwood, IKEA’s daughter company.

“Ukraine has suffered more than any other western and eastern European countries in terms of main economic indicators,” said Klimenko. “It means that Ukrainian incomes tumbled further than others, so IKEA’s target group has diminished significantly. Klimenko predicted, however, that IKEA would return in the next three or four years.

A similar tide swept away Hewlett Packard’s expansion ideas in Ukraine. The company was gearing up to open HP Global e-Business Center in 2010, which would have serviced HP workers around the world. The information technology giant planned to hire 300 local people at the start of the project, eventually expanding it to a 1,000-staff office. Lviv authorities expected HP to invest $3 million to launch the project. But the plans have been halted “for a variety of reasons,” said Iryna Sokolovska, the company’s marketing manager.

Oleh Berezyuk from the Lviv mayor’s office blamed Hewlett Packard’s exit on the tax authorities. “We had to change one aspect of taxation, of absolutely no great importance,” said Berezyuk on April 27. “[But] they did not do this, and HP went to Egypt …. These were things that did not affect the amount of taxes, but impacted the term for paying taxes. Small items, which did not require changes of the budget code and tax law,” he said.

Sokolovska denied that Hewlett Packard chose Egypt over Ukraine. “Over the last couple of years, Ukraine’s government significantly improved its investment climate. But because a different team came to power now, we hope that they will not only support this strategy but work at improving conditions for foreign investors.”

One company that has had a hard time with tax issues is food and agricultural giant Cargill. The multinational has threatened to pull back from the grain market because of the state’s failure to refund value added tax payments.

In comments to Delo business daily on March 19, Vadym Miroshnichenko, head of Cargill’s commercial department, said that in 2010, the company “will export only 300,000 tons of grain,” which is four times less than in 2009.

The firm is not disclosing the amount the state owes Cargill. But officials working for the Donetsk mayor said, after a meeting with Cargill’s management in January, that the figure might be up to $100 million.

Anastasia Dudley, a spokesperson for Cargill, said that VAT issues are not unique to their company only. “For an investor like Cargill, VAT refunds are a routine part of day-to-day business. The lack of timely refunds reduces the attractiveness of Ukraine for foreign investments and limits the competitiveness of Ukrainian agriculture in world markets,” she said.

Sokrat’s Klimenko said that declarations to pull out are a method of pressure on government rather than a real intention. “Cargill may temporarily reduce volumes of operation but most likely will not do it because it will result in a smaller market share, and it’s not profitable for such a strong player,” Klimenko said.

Despite visible frustration with Ukraine’s economy, none of the three companies has slammed the door shut on the country yet. Representatives from all three said they are committed to working in Ukraine to find a workable solution.

Their complaints leave a bitter taste, however. “When respected firms depart or reduce business operations, it decreases the already small appetite of multinationals for Ukraine,” concluded Klimenko.

The debt crisis in Greece has been called the “canary in the coal mine for the Western European economies.  Indeed, the crisis could spread further to the U.K. and the USA, both of which share high levels of debt.  The effect will most certainly be felt in Eastern Europe given the source of funding for consumer loans and corporate funding and could hinder a recovery that was under way.

East Europe Threatened by West’s Debt, Euro Crisis, EBRD Says

May 17 (Bloomberg) — The Greek debt crisis, which is threatening to bring down the decade-old euro, may spoil east Europe’s nascent recovery, the European Bank for Reconstruction and Development said.

The EBRD, a London-based development bank that helps former communist states in eastern Europe and central Asia transform their economies, said May 15 that the 30 countries it invests in may expand a combined 3.7 percent this year. The struggle to contain the debt crisis in western Europe may ruin that forecast, especially on the Balkan peninsula, the EBRD said.

“We have the Greek crisis, and it poses a risk in particular to southeastern Europe,” EBRD Chief Economist Erik Berglof said during the bank’s annual meeting in Zagreb, Croatia. “But there is a broader risk for the region. Clearly this is something we are very concerned about.”

The former communist countries in Europe and the former Soviet republics in central Asia are recovering from the deepest recession since switching to free-market policies two decades ago. Challenges include adjusting to a slower pace of growth as the European Union, the largest export market for most of the region, grapples with mounting fiscal problems, the EBRD said.

The euro has fallen 3.9 percent to $1.2358 in the past seven days. It traded for $1.2311 at 9:14 a.m. Central European Time.

German Chancellor Angela Merkel said May 14 that Europe is in a “very, very serious situation,” even after a rescue package for the region’s most indebted nations. The Spanish newspaper El Pais reported the same day that French President Nicolas Sarkozy threatened to withdraw his country from the euro. Finance Minister Christine Lagarde and other government officials denied the report.

Euro Defense

EU Monetary Affairs Commission Olli Rehn told participants at the Zagreb conference that “it is important that markets read our package and see that we are serious about our defense of the euro area.”

Yesterday, Greek Prime Minister George Papandreou said his country may take legal action against U.S. investment banks that might have contributed to the country’s debt crisis.

The euro region’s tensions may affect eastern Europe through “a disruption of capital markets” as well as “a decrease in import demand from countries like Germany or France,” EBRD President Thomas Mirow said at the close of the annual meeting. “There are potential risks that can be channeled through the subsidiaries of Greek banks. Up until now we haven’t seen this materializing. We have to watch and encourage policy makers to bear this risk in mind.”

‘Uncertain’ Outlook

The EBRD raised its forecast for Russian economic growth this year to 4.4 percent from 3.9 percent. It also boosted the outlooks for Turkey, Poland, Hungary, and Ukraine, while lowering expectations for Romania and Bulgaria.

“The outlook remains very uncertain because of a shift in risks from the domestic to the external,” Berglof said. “External risks have risen dramatically.”

While the EBRD now expects most countries where it operates to rebound, the recovery will be protracted, it said. Growth rates will remain below pre-crisis levels and former drivers of expansion, such as investment from abroad and consumer spending, will remain subdued. The region grew at an average pace of 5 percent annually before 2008.

The EBRD’s shareholders increased the bank’s resources for the next five years. They approved raising the bank’s capital by 50 percent to 30 billion euros ($37.2 billion), enabling it to invest about 52 billion euros until 2015. That’s more than the bank’s combined investments since its 1991 inception.

Capital Increase

The capital increase will open the way to investments of 9 billion euros in each of the next two years and 8.5 billion euros in the succeeding three years. The bank this year will spend 8 billion euros on loans and company stakes. Funding reached 1.76 billion euros in the first quarter, 60 percent more than in the same period last year, the bank has said.

The bank also announced a plan to limit foreign-currency loans by east Europe banks, after they brought some countries to verge of default during the global credit crisis.

Underdeveloped financial markets, low saving rates and high local interest rates contributed to a surge in foreign currency loans during the boom years, the EBRD said.

East European banks struggled to refinance foreign-currency mortgages, car and consumer loans because their parents in Austria, Italy, Germany and Sweden reduced funding during the credit crisis.

The EBRD helped limit the impact of the financial crisis, which hit Europe’s emerging markets hardest, by persuading western banks to remain in the region and providing them with funds to lend.

The bank’s 63 shareholders also pledged to support an EBRD program designed to help countries with excessive reliance on raw-material exports, such as Russia, or few manufactured goods, such as central Europe, to diversify their economies.