ketann2000e699coverv05b.jpg

UKRAINE SINCE THEORANGE REVOLUTION:

A Business and InvestmentReview:

Consultant editor: Dr Marat Terterov

GMB

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Publishers note

Every possible effort has been made to ensure that the information contained in this publicationis accurate at the time of going to press and neither the publishers nor any of the authors,editors, contributors or sponsors can accept responsibility for any errors or omissions, howevercaused. No responsibility for loss or damage occasioned to any person acting, or refrainingfrom action, as a result of the material in this publication can be accepted by the editors, authors,the publisher or any of the contributors or sponsors.

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GMB Publishing Ltd.120 Pentonville RoadLondon N1 9JNUnited Kingdomwww.globalmarketbriefings.com

This edition first published 2006 by GMB Publishing Ltd.

Marat Terterov

Hardcopy ISBN 1-846730-04-X E-report ISBN 1-846730-05-8

British Library Cataloguing in Publication Data

A CIP record for this book is available from the British Library

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Contents

Acknowledgements

Editorial Contributors

1. Editors Introduction: Roses, Oranges andForeign InvestorsDr Marat Terterov,

2. The Political and Economic Environment inUkraineYevgen Zinovyev, Macroeconomics and IndustriesExpert, Raiffeisen Bank, Ukraine

3. Recent Legal DevelopmentsVladimir Sayenko and Partners, Kyiv,Ukraine

4. Recommendations for Improvements in theInvestment ClimateEuropean Business Association, Ukraine

5. An Outlook and Ratings for Investing inUkraines RegionsMarkiyan Dacyshyn, Director, Ukrainian EconomicThink-Tank, Institute of Reforms

6. Dragon Capital Case Study

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Acknowledgements

The editor would like to acknowledge the very helpful support provided for thisreport and further sources of information, including:

Dr Sergei Maslichenko (The Ukrainian Centre for Economic and Legal Analysis)

The BISNIS service of the US Department of Commerce

The European Bank for Reconstruction and Development

The Stefan Batory Foundation (Warsaw, Poland)

The Economist Intelligence Unit

The Moscow Times

The Financial Times

The Russian News Agency Novosti

Radio Free Europe

The Carnegie Endowment

The Nixon Centre

The RAND Corporation

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Editorial Contributors

THE EUROPEAN BUSINESS ASSOCIATION this non-governmental,non-profit, public organization was established in 1999. It currently brings together499 European, international and Ukrainian companies and acts as platform forinformation exchange and dialogue with Ukrainian authorities. The Associationsees its core mission as assisting European integration of Ukraine by advocating andassisting in the harmonization of Ukrainian laws and business practices with thoseof the European Union. The EBA offers its members: collective advocacy of theirinterests before the central and local authorities of Ukraine, foreign and interna-tional organizations; a voice in the EU policy-making process through strongworking links to the European Commission and the national EU embassies in Kyiv;regular information support on developments affecting business in Ukraine; net-working opportunities and social events - chances for the business community tomeet informally.

Contact details:The European Business Association1st floor, 1A Andriyivsky street, Kyiv, 04070, UkraineTel.: (380 44) 496-0601 Fax: (380 44) 496-0602 E-mail: office@eba.com.uahttp://www.eba.com.uaPresident Bjorn Markstedt (AVIS Ukraine)Vice Presidents: Jorge Intriago (PricewaterhouseCoopers), Alexander Pisaruk(ING Bank Ukraine)Executive Director Anna Derevyanko.

RAIFFEISENBANK UKRAINE is a 100% subsidiary of Raiffeisen International,the holding company for most important subsidiaries of Raiffeisen ZentralbankOsterreich Aktiengesellschaft (Vienna, (RZB) in Central and Eastern Europe. RZBis the central institution of the Austrian Raiffeisen Banking Group, the country's mostpowerful banking group. RZB operates, via Raiffeisen International, a network of16 subsidiary banks with approximately 2400 banking outlets in 16 markets of theregion. On 20 August 2005, Raiffeisen International announced the acquisition ofBank Aval, the second-largest bank in Ukraine. This deal was closed on 20 Octoberafter the granting of all necessary approvals by the relevant authorities. With thisacquisition, Raiffeisen International became the countrys market leader.

Yevgen Zinovyev is Macroeconomics and Industries Expert, the Risk ManagementDivision at Raiffeisenbank Ukraine. Prior to his engagement with the bank, he spenttwo years studying Economics at State University of New York at Albany. WithRaiffeisenbank he is involved in political, macroeconomic, and industry analyses.

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Contact details:Leonid ZyabrevPublic Relations ManagerRaiffeisenbank Ukraine43 Zhylyanska St, KyivUkraine - 01033Tel: +38 (044) 247 45 74 (int. 70-66)Fax:+38 (044) 490 05 36

URL: http://www.rbua.com/

SAYENKO KHARENKO is one of the leading Ukrainian business law firmsspecializing in complex cross-border and local matters. The firm has especiallystrong corporate, banking and finance, and capital markets capabilities. It is highlyrecommended by the international and local legal directories, including the mostrecent editions of Chambers Global (2006) and IFLR 1000 (2006). The clients ofthe firm include many of the largest multinational corporations and financial insti-tutions, including Fortune 500 and Forbes International 500 companies. The firmclosely works with and regularly acts as local counsel to major US and Europeanlaw firms in transnational projects.

During the last year the firm has handled over two billion dollars worth of finan-cial transactions, including the first subordinated debt offering by a Ukrainian bank;the largest Eurobond offering by a Ukrainian financial institution; the largest capitalmarkets transaction for investment in local currency; and some of the largest syn-dications to Ukrainian companies guaranteed by the Government. The firm hasserviced many of the most important Ukrainian cross-border M&A transactions,including recently the due diligence of one of the top five Ukrainian banks andKrivorozhstal steel mill. Last year the firm's competition lawyers obtained clearancefor over a dozen major multi jurisdictional mergers and acquisitions and success-fully defended Western Union against Antimonopoly Committee's claims regardingan abuse of dominant market position, which was the largest-ever claim for a vio-lation of competition law in Ukraine.

Contact details:Sayenko Kharenko, Attorneys at LawTel.: + 380 44 537-1000Fax: + 380 44 461-4060E-mail: info@sayenkokharenko.comWeb: www.sayenkokharenko.comContact: Vladimir Sayenko, Partner

THE INSTITUTE OF REFORMS is a Ukrainian non-governmental economicthink tank founded in 1997. A national research and educational organization, weare dedicated to creating a free and open market in Ukraine. We work to fosterdialogue at every level of government about the need for economic reform.Through our independent thought leadership and outreach, we seek to lower taxes,

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Leonid.Zyabrev@rbu-kiev.raiffeisen.at

keep government out of business, and bring transparency to regulatory processes.We support a fair marketplace where businesses of all sizes can compete equally.We believe an economy that is attractive for Western investors will bring new jobsand money to Ukraine.

Institute for Reforms is the only Ukrainian think tank working in every region ofUkraine across seven programs:

EUROPEAN INTEGRATION AND WTO ACCESSION Provide support and information to citizens about key issues in the field of EUenlargement INVESTMENT CLIMATE ASSESSMENT Evaluate factors impacting investment climate in Ukraine LOCAL AND REGIONAL DEVELOPMENT Provide ways to decentralize power, allocating resources to local governments PRIVATIZATION AND CORPORATE GOVERNANCE Analyze status of privatization efforts across Ukraine SMALL BUSINESS DEVELOPMENT Recommend actions to stimulate private enterprise TAX POLICY Issue tax structure analyses and work for tax reduction

Contact details:Markiyan Dacyshyn, DirectorInstitute of ReformsE-mail: info@ir.org.uahttp://www.ir.org.ua www.ipa.net.ua

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1.EDITORS INTRODUCTION:

ROSES, ORANGES ANDFOREIGN INVESTORS

kraine has drawn muchattention in the internationalmedia since the tumultuous

events of November 2004 January2005 have ushered in a new sense ofidentity building in the country theera of the so-called Orange Revolu-tion. During the latter stages of theregime of President Leonid Kuchma(19942004), Ukraine had developedthe reputation of a newly independentdemocratising state, with notableeconomic potential, but a countrystymied by a closed circle of inwardlooking ruling elites, accountable pri-marily to themselves and exploitingthe national economy as if it were theirown personal fiefdom. Corruptionand nepotism at the highest levels ofbusiness flourished in both perceptionand reality, critics of the regime in themedia were often dealt with ruthlessly,while the countrys emerging econ-omy was attracting miserly amountsof foreign direct investment (FDI)compared to regional levels. Foreigninvestors conducting business inUkraine often found themselves sti-fled by excessive government inter-vention in their commercial life, lackof transparency and predictability inthe rules and institutions governingbusiness a difficult business climateoverall. It comes as little surprise,therefore, that despite the substantialoptimism that Western governmentsand foreign investors held for itsdevelopment into a fully-fledged mar-ket economy and democratic state,

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Ukraine had attracted significantlyless foreign investment, not only incomparison to other transitionaleconomies in Central and EasternEurope, but had also attractedamongst the lowest levels of FDI percapita amongst other former SovietRepublics.

However, the rallying of theUkrainian electorate behind the cur-rent president, Viktor Yushchenko,during last winters election campaignwas not the result of low levels of FDIduring the previous decade, nor dueto the challenging nature of Ukrainesinvestment climate for foreign in-vestors. Rather, it is worth noting oneof the paradoxes of Ukraines politicaleconomy during the latter stages ofKuchmas presidency: the fact that theeconomy was finally starting to growimpressively (topping 12% in 2004)and that FDI was starting to pick up(reaching $2 billion in 2004, com-pared to around $10 billion for theperiod approximating the entire pre-vious decade), at the same time asthe vociferous public demonstrationsagainst the government such as thosetaking place during the Orange Rev-olution. Countless ordinary Ukraini-ans both businessmen and averagecitizens - could rightly have been ask-ing themselves into whose pockets thebenefits of the countrys impressiveeconomic performance had gone?

Indeed, it was the pervasive levelof disenchantment with public mis-management and low quality ofgovernance felt by overly significantvolumes of Ukraines population,both sparked and institutional-ized by the fraudulent first round of

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presidential elections, that broughtcountless thousands of Ukrainians toKyivs now famous Maidan (indepen-dence square) in November 2004.It is now axiomatic that the would-beleaders of the New Ukraine,namely, the widely popular president-elect Yushchenko and his charis-matic acolyte, Yulia Tymoshenko,rode-the-wave of the public vote ofno-confidence in the Kuchma regimeand its nominated successor, ViktorYanukovych, and their ebullient cam-paigning during Kyivs cold winterdays resulted in the emergence notonly of a new government in Ukrainebut, as in ex-Soviet Georgia a year ear-lier, genuine expectations from themajor part of the population that theirlives would change for the better. In adomain traditionally dominated bypessimism and gloom, a new opti-mism seemed to permeate throughthe political culture of post-SovietUkraine, as Orangemainia swept Kyivand other (at least the Central andWestern) parts of the country in early2005.

Legitimacy: at the Heart ofGovernment

Legitimacy is often an uneasy conceptfor governments to deal with in anytype of political system, be it demo-cratic, democratising or authoritarian.As was the case with Georgias Roserevolution in late 2003, much of thelegitimacy of the newly inauguratedYushchenko government would lie inits ability to reverse the flagrant andwidespread incidence of state spon-sored corruption and business crony-ism, as well as promoting bettergovernance overall. In Georgia, thegovernment of new president MikheilSaakashvili had made some notableprogress in reducing corruption andpromoting better practices in gover-nance during its first year in office.

In the case of Ukraine, however,a much larger country of near50 million people where the ordinarycivil servant has been nurtured on arent-seeking culture, changing thementality of a society so as to reducemiddle level bureaucratic corruptionwould not be a task for the faint-hearted. Nevertheless, the newgovernments rhetorical position ofofficially seeking to move Ukrainecloser to mainstream European insti-tutions embodied substantial hopethat Ukraines Soviet style rent-seeking economic model could besuperceded by internationally accept-able practices in the future. The prin-ciple of separating business frompolitics, a formula flagrantly missingfrom Ukrainian economic policy-making in the Kuchma years, waspromised by the countrys new gov-ernment and needed to be adopted.State patronage doled out for selectiveprivate sector interests was one of thecharacteristics of Ukraines businessculture during the Kuchma years.Annulling such practices was one ofthe cornerstones to the new govern-ments policy promises, and togetherwith its increasingly pro-Europeanpolicy rhetoric, provided a majorsource of optimism for foreign part-ners contemplating working withUkraine in the both the governmentand business sphere.

In summing up the factors whichwere the primary drivers in ViktorYushchenkos camp sweeping topower during the Orange Revolutionas briefly introduced above, some ofthe major policy objectives thatUkraines new government set out toachieve as of early 2005 included:

Combating corruption at alllevels of society and primarilywithin the institutions of govern-ment. Pushing through withadministrative reform of publicsector organizations would be

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a major priority within thiscontext.

Combating cronyism in businesswhich had become pervasiveduring the Kuchma years, assymbolized by the states cut-price privatization of Ukrainesmajor steel producer, Kryv-orizhstal, in June 2004 toUkrainian oligarchs known to beclose to the top echelons of gov-ernment.

Driving Ukraine towardsgreater integration with Euro-pean political and economicstructures and the internationaleconomy, namely institutionssuch as the European Union(EU) and the World TradeOrganization (WTO). However,Ukraines new out-reach to-wards Europe should not comeat the expense of deeply estab-lished ties between Ukraine andRussia.

In parallel to moving Ukrainecloser to Europe, more con-certed efforts would be madeto attract foreign investment toUkraine, by way of levelling outthe rules and regulations fordoing business, making thesemore predictable and transpar-ent, as well as through efforts toimprove the direction of corpo-rate legislation, promote goodeconomic management and fis-cal stability, reduce excessiveregulations on business and tostrengthen the nature of taxadministration, thereby improv-ing the investment climateacross the board for both foreignand domestic investors alike.

Furthermore, it would beimportant to ensure that thebenefits of the high economicgrown Ukraine was experienc-ing in recent years would be feltin a broader manner by societyas a whole, with adequate spend-

ing into a multitude of socialprogrammes being one of thegovernments main priorities

Given the new levels of hope andoptimism for the future that such vastnumbers of Ukrainians now felt (aswell as the disenchantment felt bythose in Ukraines blue camp supporters of Kuchmas incumbent,Viktor Yanukovych, many of whomfelt that Ukraine would now be lost toa government captured by the inter-ests of Western neo-imperialists), thelegitimacy of the leaders of UkrainesOrange Revolution would be at stakeif the government was unable todeliver on its major policy objectiveswithin a reasonable time span. In theremainder of this article, therefore, wewill turn our attention to evaluatingthe performance of the new govern-ment, referring the discussion, wherepossible to issues relevant to foreigninvestors contemplating doing busi-ness in Ukraine.

THE ORANGE REVOLUTION INHINDSIGHT: PERFORMANCEOF THE NEW GOVERNMENT

Social Perception and Realities

On November 20 2005 Kyiv markedthe first year anniversary of theOrange Revolution. The governmentof Ukraine supported the celebrationstaking place on Kyivs Maidan, whichincluded symbolic soup kitchens andthe erection of a huge stage commem-orating the events of 12 monthsearlier. However, these celebrationswere a far cry of the atmosphere ofNovember 2004. Yulia Tymoshenko,the heroine of the revolution, hasfallen out politically with PresidentYushchenko, leading to her dismissal

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from government in September. Asimilar fate met with other membersof Yushchenkos cabinet, and many ofhis most high profile supporters fromone year earlier have likewise left thegovernment. Most of the dismissalswere surrounded by corruption alle-gations, similar in nature to thosewhich haunted the Kuchma regime.Elements of the media which sup-ported Yushchenko during his elec-tion campaign, have becomeincreasingly critical of the corruptionallegations associated with the newregime, causing more than a few tensemoments between the press and thegovernment. Ukraines Pora move-ment, the civil society youth groupwhich organized many of the protestsduring the Orange Revolution, hasbecome largely disenchanted with thecountrys new government, and hasitself split into factions one of whichintends to run as an independentpolitical party in the March 2006 par-liamentary elections.

Societys perceptions of Yush-chenkos current government, as ofSeptember led by Prime MinisterYuriy Yekhanurov, have slumpedfrom the obvious highs immediatelyfollowing the Orange Revolution andare, for the most part, currently quitelow. A recent opinion poll conductedon several thousand Ukrainians inOctober revealed that just 12.3% ofrespondents said they would vote forYushchenkos Our Ukraine party innext years parliamentary elections.Up to 20% claimed they would insteadvote for former Prime MinisterYanukovych and his Regions Party,while nearly 14% were planning tovote for the Yulia Tymoshenko bloc.Further opinion polls demonstratethat an increasing number of Ukraini-ans believe that under the currentgovernment the country is movingin the wrong direction (or, for some,a direction contrary to what theyperceived during the Orange Revolu-

tion) and many (both supporters andopponents of the current govern-ment) claim that there is little or nodifference between the previous andcurrent ruling elites. The new govern-ment has, for example, raised publicsector wages and salaries early in2005, but its economic managementhad fuelled inflation and higher pricesfollowed, making life as difficult formany Ukrainians as during the previ-ous regime.

A Fragmented Policy Making Process

Although the Orange Revolutionseemed to create an outward sense ofpolitical unity during last winterspresidential elections, the emergenceof several different power blocs withinthe institutional framework of the newgovernment undermined any gen-uine semblance to coordinated policy-making that the government couldinitiate. Some initial differences inthe policy-making approaches ofthe new government were alreadybecoming evident as early as February2005, when President Yushchenkoand Prime Minister Tymoshenkoappeared to contradict each other intheir respective positions over the gov-ernments intent to review some of thedubious privatizations of the Kuchmayears. The populist Prime Minister,whose calls to put bandits inprison (in reference to UkrainesKuchma era oligarchs who allegedlymade some of their fortunes throughsuch privatizations) were met by rous-ing applause during the Orange Rev-olution, created the impression thathundreds of privatizations would bereviewed. The President, however,gave the impression that only some ofthe most conspicuously fraudulentprivatizations would be reviewed, andthat Ukraines business communitywould not be subject to a state-spon-sored witch-hunt.

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Needless to say, with both Presidentand Prime Minister being capable ofmobilising their bands of supporterswithin government and business com-munity, contradictory positions overpolicy issues (from leading membersof government) such as review of pri-vatizations, debates over Ukrainesentry into the WTO, administrativeand other areas of needed reform andeconomic management led to theemergence of competing interestsamongst Ukraines new ruling elitesand the emergence of different cen-tres of power within the government.Political analysts identified the emer-gence of four major centres of powerwithin the new government: the Pres-idency and its Presidential Secretariat;the Cabinet of Ministers headed up byPrime Minister Tymoshenko; theVerkhovna Rada (Parliament) ledby its Speaker, Volodymyr Lytvyn;and a bloc emerging around PetroPoroshenko, one of the business fig-ures closely linked to Yushchenkoduring the Orange Revolution, whowas appointed as the head of theNational Security and Defence Coun-cil. The emergence of the differentpower blocs within the Ukrainian gov-ernment soon after the Orange Revo-lution prevented the state from actingin a coordinated manner, and policy-making particularly in the economicsphere often became drowned indiatribes between the competingpower blocs. The Cabinet of Ministersoften failed to receive the support ofthe Parliament when it initiated keyreform oriented legislations, while dif-ferent high profile members of gov-ernment often accused each other oflobbying their own individual businessinterests rather than promoting policymaking.

By the middle of the year, with theinitial euphoria of the Orange Revo-lution now a thing of the past, the lackof a clearly defined, consistent andcoordinated strategy for Ukraines

development by the countrys newruling elites was ushering in the starkrealities of Ukraines political predica-ment. Nation-wide polls were by thatstage showing the government, led bya President who had commandedalmost hero-like status only monthsbefore, was clearly losing its popular-ity amongst the mainstream popula-tion. The primary reason for thisdownturn was precisely that the gov-ernment had failed to promote anyof the meaningful socio-economicreforms and foreign policy initiativesthat it had seemed certain to embarkupon after it came to power. Further-more, given the manner in which thecompeting factions within govern-ment prevented the development ofcoordinated policy making, it nowseemed highly unlikely that any fur-ther noticeable government policyinitiatives could be expected untilafter parliamentary elections wouldtake place in March 2006.

Polls show popularity of thegovernment declining

The governments popularity, whichaccording to a nation-wide poll takenby the Razumkov Centre, stood at52 per cent in April 2005, fell to just37% in August, indicating that wellunder 50% of Ukrainians now felt thatthe new authorities were better thanthe old ones. The Razumkov Centrepoll also showed that more Ukrainiansare holding the belief that the countryis heading into the wrong (social,political and economic) direction(43 per cent in August compared tojust 23 per cent in April). Also, accord-ing to the poll results, the numberof Ukrainians who think that thecountrys economy has deterioratedunder the government of ViktorYushchenko is more than double thenumber of those who think that ithas improved 41.5 per cent versus

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20.5 per cent (compared to 19 percent versus 27 per cent in April).Perhaps the only positive develop-ment coming from the RazumkovCentres poll was the fact that it indi-cated that Ukrainians continued to be-lieve that the level of democracy andmedia freedom under Yushchenkosrule increased rather than decreased(38 per cent versus 20 per cent ondemocracy and 46.5 per cent versus14.5 per cent on press freedoms).

Perhaps the biggest problem for thecountrys political development, how-ever, was that Ukraines new rulingelites were not only unable to convinceUkrainians that they were combatingcorruption, but numerous allegationsemerged where leading members ofthe new government were themselvesgetting tangled up in corruption scan-dals. Whilst it was promised by thenew elites that Ukraines members ofgovernment were to be selectedon the basis of their technical abilit-ies, leading members of PresidentYushchenkos entourage were dulybeing accused of abusing their politi-cal positions to promote their businessinterests, causing a number of politicalscandals during the summer. In fact,by late summer corruption, in fact,had become such a recurring theme inUkraines political life that a crisisseemed just around the corner. Itcame in early September, when Olek-sandr Zinchenko, one of the politicalarchitects of the Orange Revolutionand subsequently head of PresidentViktor Yushchenkos administration,tendered his resignation.

Zinchenkos resignation was a signof protest against what he described aspervasive and blatant practices of cor-ruption by leading members of thePresidential Administration, particu-larly Petro Poroshenko and Olek-sandr Tretyakov, Yushchenkos firstassistant, who were together accusedof forming a shadow government andpromoting a Byzantine system of

management. Zinchenkos resigna-tion led to a major crisis within thecoalition of alliances which held thenew government together. It was fol-lowed by a number of other resigna-tions and dismissals, including thoseof Poroshenko and Prime MinisterTymoshenko. After a series of crisisnegotiations and some further tensemoments between the PresidentialAdministration and the Parliament,Viktor Yushchenko managed tosecure the necessary support forparliamentary approval of YuriyYekhanurov as the new prime minis-ter on September 20th. Yekhanurov isperceived as a technocrat with fewdirect ties to business, who was, how-ever, chairman of the State PropertyFund from 1994-97, during whichtime he oversaw Ukraines massprivatization programme. As thefirst deputy to then-prime ministerYushchenko in 2000-2001, he over-saw the smooth workings of govern-ment and is perceived to be loyal toViktor Yushchenko. However, thenew prime minister has taken on achallenging post at a difficult time,however, and faces a huge taskin striking a balance between theconsolidation of power blocs and frag-mentation of Ukraines political envi-ronment following the Septembergovernment crisis.

The Economy

The overall performance of Ukraineseconomy failed to keep pace with theimpressive growth achieved during2004. The economy grew by just3.7 per cent during the first 7 monthsof 2005, and was forecast to reach4.3 per cent by years end. This com-pared to annual GDP growth of12.1 per cent in 2004 and 9.4 per centin 2003. Furthermore, the economyexperienced a noticeable decline inindustrial production and investmentduring the year, while the positive

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trade balance that Ukraine had devel-oped during 2004 has eroded fromnearly $4 billion to a little less than$2 billion during the first half of2005. Critics of the previous gov-ernment of former Prime MinisterYulia Tymoshenko primarily placedthe blame of Ukraines startlingmacro-economic deterioration onthe governments economic policies,including:

Creating investor uncertaintyand under-mining propertyrights by initiating a widespreadpublic discussion of nationaliza-tion of privatized companiesand their onward sale to newinvestors in so-called re-privati-zations;

Substantial increases in the taxburden (to some 5%-6% of GDP)in order to finance social welfarespending and public wages;

Far reaching government inter-vention in the economy whichhas included measures such asattempts to regulate petrolprices (as well as prices for meatand grain), reinforcing statemonopolies and doubling therailway tariffs for metal freight;

Lower levels of governmentinvestment in the economy dueto increasing social expendi-tures.

Some analysts, such as AndersAslund of the Carnegie Centre inWashington, have referred to the eco-nomic programme of Tymoshenkosgovernment as a form of socialistpopulism, which has included fre-quent public attacks on well known,individual businessmen in a style notdis-similar to the case of the Russianstates attacks on Mikhail Khodor-kovsky and his Yukos oil company.However, we should note that as in thecase of Russias easy years of higheconomic growth on the back of

favourable global energy prices,Ukraines growth during 2004 wasalso driven by a commodity exportboom, particularly in metallurgy.Prices on the world markets forUkraines chief commodity exportshave been less favourable in 2005,contributing to a deceleration ofgrowth rates and a decline in thepreviously favourable trade balance.Public sector wage increases takingplace during 2005 have also fuelledhigher levels of inflation, reachingalmost 15 per cent for the year upto August another aspect detrimen-tal to the governments economicmanagement. However, a combina-tion of wages-prices inflation hascaused some alteration in the struc-ture of Ukraines economy, fuellingincreased domestic demand and ele-vating domestic consumption to theposition of key driver for economicgrowth in 2005.

Re-privatizations

Despite the poorer economic perfor-mance during 2005, there have notbeen any public demonstrationsdemanding that economic growth berestored to the levels of the previousyears, nor has there been much publicoutcry against Tymoshenkos attackson the oligarchs from the Kuchma eraand the nationalization of some oftheir assets acquired previouslythrough scandalous privatizations.Although the governments talk ofre-privatization is bound to havecaused some uncertainty amongstinvestors considering business inUkraine during the year, it is becom-ing evident now that the re-privatiza-tion discourse has been limited to asingle litmus-test, through which by allinitial accounts the government seemshave to come through positively. Thatlitmus-test has been the nationaliza-tion and re-privatization of Kryvorizh-stal, perhaps the main talking point in

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Ukrainian business during 2005, abrief account of which is given below.

Kryvorizhstal is the flagship ofUkraines steel production, employ-ing 56,000 people and producingaround 20% of Ukraines entire metalsoutput, or some 8 million tons of steelper year. In June 2004 Kryvorizhstal,a Ukrainian state-owned enterprisedating from the Soviet era, was soldthrough a privatization to a companyowned by the son-in-law of the thenPresident Kuchma, for a little under$800 million. The sale price was sub-stantially below independent valua-tions of the company, as well as otherbids submitted during the privatiza-tion tender. The sale of Kryvorizhstalin June 2004 aroused vigorousprotests both within Ukraine andabroad and became the symbol ofthe blatant business corruption ofthe Kuchma years. Reversing theKryvorizhstal privatization becameone of the campaign shibboleths ofthe Orange Revolution elections andwas the main item of policy imple-mentation which the Ukrainian gov-ernment had in mind when it spokeof revising some of the countrysmore controversial privatizations.Kryvorizhstal was returned to stateownership during the summer aftera sequence of legal and administrativeprocedures by the Commercial Courtof Appeal in Kyiv, which finally ruledthe June 2004 privatization illegal and was subsequently slated for anew privatization round during theautumn.

It became evident that the govern-ment was to make a show-case ofthe re-privatization of the companywhen it was announced that theprivatization auction would be broad-cast live on Ukrainian television onOctober 24th., demonstrating the newlevels of transparency that the govern-ment was trying to adopt. Kryvorizh-stal was offered at a starting price of$2 billion and the bidders included

Mittal Steel (the worlds largest steelproducer), Frances Arcelor (whichcombined with Ukraines IndustrialUnion of the Donbass) and a consor-tium of Russian-Ukrainian steel com-panies. The auction was won by Mittalwho ended up paying $4.8 billionfor a 93.02 per cent stake inKryvorizhstal a massive influx of FDIinto the Ukrainian economy and a ma-jor policy coup for the Yushchenkogovernment. The sale price was some$4 billion more than the price paid forthe company during the June 2004privatization and outstripped signifi-cantly the governments targets forrevenues earned from privatizationsduring 2005, which were set at$1.4 billion.

FDIWhat was in effect - the second pri-vatization of Kryvorizhstal was also thelargest ever foreign investment madeinto Ukraine, roughly equating tosome 20% of this years anticipatedentire budget revenues. Given theserious nature of the investment byMittal Steel into the Ukrainian econ-omy, where the worlds largest steelproducer has paid such a significantprice for a Ukrainian governmentasset, it is not difficult to suggestthat 2005 is turning out to be avery favourable year in UkrainesFDI experience. Furthermore, theKryvorizhstal auction took place justdays after Raiffeisen International,the East European arm of the Austrianbanking group, completed its acquisi-tion of Aval, Ukraines second largestbank controlling some 8.7% of totalbanking assets in the country. Raif-feisen initially acquired a majority93.5% stake in Aval in August and,upon completing its acquisition of theUkrainian bank in October, injectedanother $1.03 billion of FDI intoUkraines economy. Furthermore, it

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was recently confirmed that otherforeign banks are in advanced stagesof negotiation for the acquisition ofother Ukrainian banking assets, in-cluding Ukrsotsbank and Ukrsibbank,the third and fourth largest Ukrainianbanks respectively.

Thus, while analysts cite contradic-tory government policies resulting inminor inflows of investment in the ini-tial six months or so after the OrangeRevolution, in the space of just a fewshort months Ukraine has attractedmore than half the entire cumulativeFDI stock it has attracted during theentire period since the collapse of theSoviet Union: close to $6 billion in FDIhas flowed into the Ukrainian eco-nomy between August-October 2005,compared to less than $10 billion dur-ing the remainder of the post-Sovietperiod. FDI from Russia continued toflow into Ukraine during 2005 andthe country continued to hold theposition of one of the most importantdestinations for Russian investmentwithin the CIS market. In mid-November, for example, Russiasnumber two mobile phone firm,VimpelCom, entered Ukraines fast-growing telecommunications marketthrough the acquisition of Ukrainianmobile RadioSystems (URS), arelatively small Ukrainian mobiletele-communications operator for$231.3 million. Dynamic Russian cor-porations, often flush with funds andless averse to risk than more cautiousinvestors in the West, have in recentyears seen in Ukraines fast-growingconsumer market quite an attractiveinvestment opportunity and, despitethe outwardly more European stancetaken by president Yushchenko andhis governments in 2005, Russianinvestment has continued to prolifer-ate in the country.

Investment Climate

Although the new government ofUkraine has sought to present itself asa champion of international standardsin governance, while it has put for-ward business friendly legislation tothe Ukrainian parliament, and while2005 is already proving to be far andaway the most successful year for FDIthat independent Ukraine has wit-nessed, the country still has a moun-tain to climb before an investmentclimate commensurate to EU coun-tries begins to prevail within its terri-tories. As already stated, fightingcorruption by reforming the publicadministrations, and ending the prac-tice of using political power to pro-mote selective interests in the privatesector were amongst the major publicpriorities of Ukraines new govern-ment. In respect of the latter,Ukraines crisis of government dur-ing September and PresidentsYushchenkos dismissal of Prime Min-ister Yulia Tymoshenko and severalother supporters of the Orange Revo-lution, underscored the fact that someof the presidents major allies who hadbeen rewarded with senior govern-ment positions, had once again suc-cumbed to the lure of confusing publicand private interests.

By official accounts, the new gov-ernment has dismissed some 18,000civil servants in an effort to reform thepublic administration, and has like-wise carried out reforms of the cus-toms administration, reportedly amajor source of corruption underthe previous political regime. How-ever, despite these efforts, as lateas November 2005 PresidentYushchenko spoke of the systematiccrisis in Ukraines economy, wherethe president cited administrative in-terference as the main cause of theeconomic problems (Russian NewAgency Novosti, Kyiv, November

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9th 2005). Yushchenko added thatAdministrative intervention in thecountrys economy has been a serioussetback in the country's developmentduring the last nine months. We mustface up to this. This interference hascaused a systemic crisis.

The presidents sentiments in rela-tion to the governments failure tostamp out grass roots corruption andexcessive state intervention in the day-to-day lives of businessmen appearto be shared by Ukraines foreign in-vestor community. In October 2005,the European Business Association inKyiv, a lobby group representing theinterests of some of Ukraines domi-nant foreign investor interests, statedthat:

In order to build sufficient private sectorconfidence to revive investments, the gov-ernment will need to give stronger signalsthat it is addressing one of the main con-cerns of the private sector: that is, theconcern that the Ukrainian Governmentstill retains many of the characteristics ofSoviet public institutions overloading theprivate sector with heavy and unpredictabledemands and requirements, includingheavy regulations and interventions in theworkings of the market.

Furthermore, as confirmed in astudy by the EBRD and the WorldBank evaluating the business environ-ment in CIS countries during 2005,tax administration and the (states)regulatory burden rank among thetop three obstacles to doing businessin Ukraine. As will be discussed inmore detail in the ensuing part of thereport, legislative changes takingplace during the year did not reflectthe expectations of the business com-munity: the business code of Ukrainewas neither abolished nor amended toremove the inconsistencies with theCivil Code of Ukraine, whilst a lot ofexpected legislation including draftlaws on Joint Stock Companies, theSecurities and Stock Market, Cur-

rency Regulation, Real Estate Tax andthe Tax Code were not adopted.

Another government measure ofconcern for investors in Ukraine thisyear was the governments abruptremoval of special economic zones(SEZs) and the lack of consultationwith the investor community in thelead up to this measure. This concernis summarized in the following ob-servation, from a commentary onUkraines investment climate pro-vided by the BISNIS service of the USDepartment of Commerce:

Ukraine created special economic zones(SEZs) in the mid-1990s to encouragedevelopment in certain regions. The SEZswere aimed at providing incentives, such astax breaks, to foreign businesses investingin Ukraine. In March 2005, Ukrainewithdrew all privileges associated withSEZs through a revision of the 2005 bud-get. Removal of SEZs was a condition toinclusion in WTO and eventually also inthe European Union (EU) free trade area.Moreover, some expert observers point outthat while SEZs benefited specific regionsof Ukraine, the problems associated withtheir existence, especially tax evasion bylarge Ukrainian businesses, provided legit-imate reasons for their removal. However,negative perceptions of this action arosebecause, while the elimination of SEZs wasnot completely unexpected, there wasapparently no discussion with establishedbusinesses before their removal. Also, revo-cation of SEZs reportedly adversely affectedmany existing businesses and led to someforeign businesses deciding not to invest inUkraine.

The commentary from BISNIS goeson to observe that:

Although Ukraine does seem to be mak-ing progress, many issues concerning lackof effective law enforcement, transparency,and excessive registration and compliancerequirements remain unresolved. The for-eign business community in Ukraine hasreportedly been disenchanted by the failureto significantly strengthen the rule of lawand eliminate some government regulatory

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procedures. A survey conducted in July2005 by Ukrainian National Committee atthe International Chamber of Commercereveals the sentiment among investorswith experience in Ukraine and EasternEurope almost universal disappointmentwith the Government's efforts to improve thebusiness environment. At the same time,however, these respondents said they wouldmaintain or increase their investmentsin Ukraine. During the World Eco-nomic Forum in June 2005, PresidentYushchenko adamantly stated Ukraines in-tention to provide a receptive environmentfor foreign investment.

Overall, despite the optimism andseeming good-will created by theOrange Revolution, it would be diffi-cult to conclude that the new govern-ment has worked in a manner yieldingevident improvements for businessin Ukraines investment climate. Fac-tionalism and competing interestswithin the government of YuliaTymoshenko, as well as a dividedparliament has inhibited the promul-gation of much needed legislationdeemed necessary for the develop-ment of business. For the most part,the lack of progress with legal as wellas administrative - reforms has notbeen well received by investors.Ukraines success with FDI during theyear has predominantly been theresult of several overly significantinvestments by some of the worldslargest multinationals, who possessthe necessary resources to operate inthe most challenging of business envi-ronments should they sense a concretepossibility of an attractive return ontheir investments. Discussions withthe investor community and furtherresearch continues to show that theenabling environment for the main-stream investor in Ukraine, as well asthe small and medium size enterprise(SME) sector, remains as challengingif not tougher than in the remainderof the CIS countries. Certainly, thenew government of Prime Minister

Yuriy Yekhanurov will have to workdiligently and seek to find an effectivebalance between competing politicalfactions in the run up to the March2006 parliamentary elections if it is tofacilitate the realization of investorexpectations created by the OrangeRevolution. Some of the Yekhanurovgovernments immediate policy prior-ities, as seen by analysts and represen-tatives of the investor communitysubsequently, include:

Taking a clearer position on there-privatizations and stating thegovernments intentions in un-equivocal language;

Pushing draft legislationthrough the parliament seekingto cancel hundreds of regula-tions that stifle the smooth flowof business and investment

Promulgating the remaininglegislation that Ukraine needs topass in order to succeed in its bidto enter the WTO;

The budget for 2006 must takeinto account the high levels ofgovernment expenditure of the2005 budget whilst certain taxcuts need to be introduced.

UKRAINES PLACE IN THEWORLD

Voting for a European Ukraine, asopposed to a Ukraine continuing tolive in Russias shadow, was one of themost appealing factors for the count-less thousands of supporters of theOrange Revolution. Whilst fewUkrainians would have expected theircountry to enter the European Unionat any time in the foreseeable futureas a result of Viktor YushchenkosViktory in the presidential elections,his Viktory gave hope to the countlessthousands who believed that a new

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Ukraine could now possibly emerge: acountry embracing European politicaland institutional values, graduallymoving away from Soviet-style brandsof quasi-authoritarianism and eco-nomic centralism. Indeed, as hasbecome evident right from the outsetof the Yushchenko presidency, theconduct of his governments withWestern governments and institutionshas improved significantly comparedto the previous regime. Ukraines newpresident has stated that eventual EUmembership is amongst his top prior-ities and his administration appears tohave become far more committed tocloser Western integration than thatof his predecessor.

However, the key issue forUkraines government in promotingits European policy will be to do so ina manner that does not harm thecountrys mainstream, deeply rootedrelations with Russia. The two states,being part of the same country just15 years ago, remain inextricably tiedto one another in political, social,economic and military terms and anyconcerted attempts to disassemblesuch ties is potentially far more harm-ful than advantageous for both coun-tries. Furthermore, Ukraine belongsto certain CIS regional economicorganizations such as the CommonEconomic Space (CES), together withRussia, Belarus and Kazakhstan.Russia hopes to further develop CESwith Ukraines further commitment tothe alliance. Such ties could cause dif-ficulties for Ukraines efforts to moveclose to European institutions, since itwould make it harder for Ukraine toharmonize its laws and regulationswith those of the EU with the eventualhope of entering that body. From thisperspective, therefore, it is not sur-prising that President Yushchenkohas stated on several occasions duringthe year that Ukraine will adhere itscommitments to the CES, but as longas such commitments do not jeopar-

dize Ukraines efforts to move closerto the EU and the WTO.

Ukraine and the EU

As a result of an exchange ofdiplomatic cordialities and politicalgood-will between Kyiv and Europeanand North American capitals fol-lowing the Orange Revolution andUkraines political definition as aEuropean (as opposed to a Eurasianor post-Soviet) state became moreclearly pronounced. However, whileKyivs new political elite have statedthat Ukraine has set itself the goal ofstarting negotiations on associatemembership in 2007, no significantchange in EU-Ukrainian relations hasbeen taking place in 2005. The EU hasset the framework for developing therelationship between itself andUkraine on the basis of an Action Planit had already negotiated during theKuchma presidency, which calls onUkraine to implement a wide rangingseries of internal reforms aimed atbringing Ukraine institutionally closerto the EU. Although Ukraines newgovernment signed an agreement sig-nalling its acceptance of the generaldirection set out under the ActionPlan, as reported in a recent study onthe Enlarged EU and Ukraine by theStefan Batory Foundation (in Poland),Brussels gave President Yushchenkosgovernment a take-it-or-leave-itoption with no immediate scope forrenegotiation on the EUs positionover the main clauses of the Plan. Fur-thermore, given the vast institutionalgulf presently existing betweenUkraine and the mainstream EUstates, there are many scepticsamongst the latter in relation toUkraines EU aspirations.

The sentiment amongst the EUsUkrsceptics seems to be that relationsbetween Ukraine and the EU shouldbe developed on the basis of theEuropean Neighbourhood Policy,

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which offers the country no prospectof future membership. Either way, ifUkraine is to move closer downthe institutional path of becoming aEuropean state, rapid implementa-tion of the Action Plan, under thedirection of the Vice Prime Ministerresponsible for European Integration,is necessary. It is vital for the currentgovernment not too repeat theapproach of the Kuchma government,that is, to make pro-European decla-rations without implementing anygenuine reforms to make Ukraine EUcompatible. Ukraine and the EU aredue to conduct a first review of theimplementation of the Action Plan inearly 2006. Given the political crisisthat engulfed the country in Septem-ber and the majority of Kyivs politicalelites contemplation of the March2006 parliamentary elections, it is un-likely that the first review of the ActionPlan will move Ukraine any closer toEurope (institutionally) than its cur-rent position. Eventually, however,if Ukraine does make noticeableprogress in pursuing democratic andmarket oriented reform successfully,it is likely that the EU will offer thecountry at least a vaguely wordedlong-term prospect of significantlycloser relations and maybe even thehope of eventual membership.

However, we should note thatnotable progress was achieved withinthe context of Ukraine-EU relations atthe start of December (2005), whenBrussels said that it would accordUkraine the status of a market econ-omy. The move to recognize Ukraineas a market economy reflects furtheracknowledgement of Ukraines re-form program and is expected toenhance Ukrainian trade relationswith the 25 nation EU bloc. In partic-ular, recognising the country as a mar-ket economy will help Ukraines steelproducers gain access to Europeanmarkets without being subject to anti-dumping measures and thereby also

assist foreign investors operating inthe Ukrainian steel industry.

Ukraine and the WTO

Ukraines efforts to become a memberof the WTO have maintained a steadycourse after the Orange Revolutionand by July 2005 the country hadsigned 37 out of 50 WTO countrybilateral protocols. Before its summerrecess, the Ukrainian parliament hadpassed 8 of the 14 trade-related bills,including the key measure of intellec-tual property rights which could pavethe way for a bilateral trade agreementwith the United States. While somesocialist members of the parliamentseem to oppose Ukraine joining theWTO and other international organi-zations, overall, the country has beenmaking good progress towards WTOmembership during the year and itwould not be unrealistic to expectUkraine to become a member of theWTO by 2006, as the following com-ments from the BISNIS service ofthe US Department of Commercesuggest:

In order to achieve Ukraines goal ofaccession to the WTO, and ultimately EUmembership, a number of reforms need tobe implemented. Many of those reformsrequire Ukraine to bring existing economiclegislation (tax laws, customs laws, intel-lectual property laws) into conformity withWTO and EU standards. Some progress inthis direction was made in July 2005 withthe passage of legislation addressingpiracy and other legal obstacles to accession.Of the six laws passed in July, the most sig-nificant was one that strengthens intellec-tual property rights. Other key laws pushedthrough parliament ease restrictions onused car imports, stiffen environmentalstandards, lift requirements that half ofcomponents used by Ukrainian car manu-facturers be domestically sourced, and pavethe way for foreign auditors and life-insur-ers to operate in Ukraine. Three other newlaws, including one that will permit foreign

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banks to operate in Ukraine, are beingvoted on in September. The passage of newlegislation addressing piracy and otherissues, removal of SEZs, and re-privatiza-tion of Kryvorizhstal indicate that Presi-dent Yushchenko is making progress towardWTO and EU compliance, as well ascracking down on corruption. The slowpace of approval of economic reform legis-lation has largely stemmed from the reluc-tance of the Parliament's socialist faction,whose members reportedly oppose joiningWTO and other supranational organiza-tions. However, Most expect that Ukrainewill become a member of the WTO withinthe next year.

THE ENSUING REPORTIn the following sections of this report,the reader will benefit from the opin-ions of economic and political analysts,legal specialists and the foreigninvestor community on Ukrainesbusiness and investment environmentin the year following the Orange Rev-olution. The report is designed to bean analytical and updated compan-ion to Doing Business with Ukraine(3rd edition), published in December2004 by GMB Publishing Ltd. DoingBusiness with Ukraine is a compre-hensive resource with contributionsfrom more than 20 companies and in-dividuals who have first-hand exper-tise in Ukraine and provide in-depthanalysis pertaining to Ukrainian busi-ness legislation, the political system,economy, investment climate, taxa-tion regulations, sectoral analysis andregional overview. As a follow up tothe mainstream Doing Business withUkraine publication, the current

report is intended to bring interna-tional investors up-to-date with themajor developments in Ukrainianpolitics, economics and investment ayear after the Orange Revolution, andexamine the level of change in com-mercial legislation impacting on in-vestor strategies. It is designed to beread both independently, as well astandem with Doing Business withUkraine .

Raiffeisenbank Ukraine provides aninitial introduction to Ukrainespresent political and economic envi-ronment, demonstrating the manychallenges the country continues toface despite the positive internationalimage resulting from the Orange Rev-olution. The law firm of SayenkoKharenko presents a detailed legaldiscussion, focusing on the majoramendments which have taken placein Ukrainian business (and other rel-evant) legislation during 2005. Thereport then presents European Busi-ness Associations recommendationsto the foreign investor community inUkraine to further improve the busi-ness climate in the country, seeking tobuild on the initial optimism whichmany investors experienced as a resultof the change of government in Kievat the start of 2005. The Institute forReforms, a Kiev-based think tank,offers an outlook and ratings forinvestment opportunities in Ukrainesregions; and Dragon Capital high-lights the pros and cons of doing busi-ness in the new Ukraine based on theirexperience and which mirrors theperspective of many companies whichare themselves engaged in the processof doing business.

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2.THE POLITICAL AND ECONOMIC

ENVIRONMENT IN UKRAINEYevgen Zinovyev, Macroeconomics and Industries Expert

Raiffeisen Bank Ukraine

THE POLITICALENVIRONMENT

ith the benefit of confidence,guaranteed by the OrangeRevolution, the team of

Viktor Yushchenko had to use thischance to launch a series of demo-cratic reforms. Confrontations amongmembers of the team and businessand political lobbying were the mainimpediments to launching reformsand achieving political and economicstability in the country. The populistpolicy of increasing social paymentsand unfavourable external factorstriggered two-digit inflation in the

W

first half of 2005. Non-market instru-ments of dealing with the problemsreceived a negative feedback frombusiness and society. The policy ofcontrolling inflation led to financialinstability and significant slowdown ineconomic growth (in January - August2005, GDP growth amounted to only2.8 percent yoy).

The popularity of Viktor Yush-chenko has been declining gradually:according to a recent poll (September2005) 68 per cent of Ukrainians fullyor partially supports the presidentcompared with 73 per cent in June.The percentage of people not sup-porting the president increased from21 per cent in June to 26 per centin September. This tendency is

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explained by the fact that the govern-ment deceived the expectationsformed after the Orange Revolution.

The government of Yulia Tymos-henko discredited itself by launchingre-privatization in favour of somebusiness groups. In this situation theonly decision that the president couldtake was to dismiss the government. Itwas difficult decision, because ViktorYushchenko had to choose betweenthe possibility of reanimating the situ-ation in the country against the risk ofcreating a serious new opponent inJulia Tymoshenko in the upcomingparliamentary elections.

In September the Verkhovna Radaendorsed Yuriy Yekhanurov as PrimeMinister at the second attempt with289 votes (he needed at least 226 votesto be appointed). This support is theresult of an agreement between ViktorYushchenko and Viktor Yanukovych,his main rival in the last presidentialelections (all 50 members of theUkraines Regions Party headed byViktor Yanukovych voted for Yekha-nurov). This agreement took shape ina memorandum guaranteeing honestand clear elections and cessation ofpolitical repressions and re-privatiza-tion. The President also agreedwith constitutional reform limitingPresidential powers effective fromJanuary 1, 2006.

The new government is supposed tobe fully qualified technically (the maincriterion for appointing new ministerswill be their professional qualities, butnot their political orientation) andrather free of influence from any busi-ness groups or political parties. YuriyYekhanurov was the optimal candi-date for everybody. As a representa-tive of the Eastern region he couldbalance the situation and eliminatethe gap between Eastern and Westernparts of Ukraine. Yekhanurov is loyalto the president and had alreadyworked with Viktor Yushchenko. Heis supposed to stop re-privatizationand reanimate democratic reforms.The optimism of European andAmerican analysts about the newPrime Minister will certainly acceler-ate Ukraines joining the WTO. TheRussian establishment preferencefor Yuriy Yekhanurov over YuliaTymoshenko will help to reanimaterelations with Russia and stop the gaswar between Russia and Ukraine.

THE ECONOMICENVIRONMENT

Political instability and an unfavor-able external environment negativelyaffected the macroeconomic situation

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in Ukraine: the pace of growth of realGDP in January August declined to2.8 per cent compared with the sameperiod of 2004, while the growth rateof industrial production in January August amounted to3.5 per cent com-pared with the same period of 2004.

The major reasons for slowdown ingrowth are the falling off in invest-ments and the unfavourable externalsituation on the metal and oil markets.of the decline in investment activitymay be explained by the followingfactors:

fear of re-privatization causedthe owners of privatized enter-prises to postpone capital invest-ments;

growing political risks at the endof 2004 and the beginning of2005 caused foreign investorsto postpone investments inUkraine;

government investments de-clined as a result of increasingsocial expenditures;

increased tax pressure caused adecline in the disposal income ofenterprises, and, as a result, adecline in investments

Taking into account the exportorientation of Ukraines economy, the

development of Ukraines majorindustries is driven by global eco-nomic conditions: high demand formetallurgical products in 2004 stimu-lated development of the Ukrainianmetallurgical sector (exports accountfor 75% of metallurgy output), whilefalling demand in 2005 caused a slow-down in the metallurgical sector and,as a result, the slow down of economicgrowth in Ukraine. One more un-favorable external factor is the con-version of China into a net exporter ofmetal products that led automaticallyto a 76 per cent decline in the exportsof Ukraines metal products to Chinain the first half of 2005 compared withthe same period of 2004.

In 2005 agriculture remains a sig-nificant positive contributor towardsGDP growth. The expected grain har-vest is 41 million tons (the same as in2004), while the harvest of sunflowerseeds is projected as 3.5 million tons(10 per cent higher than in 2004).

In the first half of 2005 imports grewby 26 per cent, while exports grewonly 9.1 per cent. The high growthrate of imports is explained by thefollowing factors:

the rising costs of Russian oil dueto high international prices andincreased duties by Russia;

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oil crises in May which causedincreased imports of oil;

introduction of the programmestop the smuggling that in-creased official imports.

The result of this tendency wasa sharp decline in the trade balanceto USD 1.94 billion, which is morethan a two-fold decline comparedwith USD 3.99 billion for the sameperiod of 2004. The commoditybalance has been negative for fivemonths with the lowest value in June(USD 413.2 million).

The government of Yulia Tymos-henko declared inflation targeting asits main strategic goal. Instruments,chosen for achieving this goal, were

the revaluation of hryvna revaluationand loose monetary policy. This strat-egy of controlling inflation was highlycriticized by economists, because thesource of inflation in Ukraine is anexpansionary fiscal policy: increasedsocial payments lead to increase ofprices, because of the inability ofUkrainian enterprises to increase out-put in the short-term. Loose monetarypolicy does not fully compensate foran expansionary fiscal policy, but itcauses the liquidity of the bankingsystem to deteriorate. As a result,Ukrainian banks began to increaseinterest rates and limit credit activityto decrease the demand for creditfacilities.

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3.UKRAINIAN LAWS: RECENT

DEVELOPMENTSVladimir Sayenko and Partners, Kyiv

INTRODUCTIONhe Presidential elections of2004 marked a revolutionarychange in the mentality of

Ukrainian people who realized thattheir will and their vote can actuallychange the country. The change ofGovernment has had a positive impacton the attitude of state authorities tobusinesses. Many burdensome admin-istrative acts were abolished at theinitiative of the new President. Someof the unreasonable legal require-ments were interpreted more liberallyby the administrative bodies and statecourts. The registration of new busi-nesses was simplified by the introduc-tion of the one-window registrationprocedure.

The Ukrainian Parliament also con-tributed towards the development ofthe new legal system by adopting theCode of Administrative Justice, thelaw on Private International Law,the amended VAT law, etc. Certainlaws were amended to remove restric-tions on financial services provided byforeign companies, which was one ofthe requirements for Ukraine's acces-sion to the WTO. Although not all ofthe changes can be characterized asunambiguously positive and non-con-troversial, they can be viewed as a stepforward towards the establishment of

Tthe rule of law and the developmentof the legal and democratic state.

At the same time, these legislativechanges do not reflect the expecta-tions of the business communityfor major changes which are longawaited. Despite all the promises, theBusiness Code of Ukraine was notabolished, or even amended to re-move the inconsistencies with the CivilCode of Ukraine. A lot of importantlegislative acts have not been adopted,as expected. These include the draftlaws on Joint Stock Companies, onSecurities and Stock Market, on Cur-rency Regulation, on Real Estate Tax,the Tax Code and many other legi-slative acts that could improve thebusiness climate in Ukraine.

The explanation for this passivenessby Members of Parliament can beexplained by the distribution of polit-ical forces in the Ukrainian Parlia-ment. After the election of PresidentYushchenko, many of his alliesobtained senior positions in the Gov-ernment and had to give up their seatsin the Parliament. Even though manyof the remaining Members of theParliament are no longer in a strongopposition to the democratic forcessupporting the new President, manyinitiatives of the Government do notreceive support from Parliament.In view of the forthcoming Parlia-mentary elections the development of

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commercial legislation does not ap-pear to be a priority for Ukrainianpoliticians in view of the comingParliamentary elections.

ANTITRUST/COMPETITIONLAW

The Anti-monopoly Committee ofUkraine (the AMC), which is a statebody with special status created tosupervize compliance with Ukrainiancompetition laws, continues to in-crease its powers. On May 31, 2005,the Parliament of Ukraine adoptedthe Law On Amending Certain Leg-islative Acts of Ukraine RegardingStrengthening the Legal Protection ofEconomic Competition (the Compe-tition Law Amendments), broadenedthe powers of the AMC to control con-centrations and combat concertedpractices.

Expanded definition of anti-competitive concerted practices

The Competition Law Amendmentsexpanded the definition of anti-competitive concerted practices tocover actions, which led or may lead toprevention, elimination, or restrictionof competition, provided that marketanalysis performed by the AMCdemonstrates absence of objectivereasons for such actions. In otherwords, the AMC received a legitimatepossibility to define the anti-competi-tive concerted practices and imposefines for such practices on the basis ofpure price monitoring without directevidence, as was previously required.Effectively, this allows the AMC toimpose a fine on two undertakingsthat increased their prices at the sametime and failed to persuade the AMCthat the reasons for such increase wereobjective. Combined with the quasi-

judicial functions of the AMC toconsider cases, adopt binding deci-sions, and impose fines, the AMC nowhas a very powerful weapon and it isnot yet clear whether it will be usedproperly.

This legislative change can beviewed as an urgent response to thesudden increases of petrol prices inUkraine that occurred in spring 2005.At that time the government accuseda number of large oil companies of fix-ing petrol prices, but the AMC couldnot collect the necessary evidence andreact quickly to this problem.

Increased scope of concentrationsrequiring clearance from the AMC

The Competition Law Amendmentsintroduced another criterion for con-centrations requiring clearance fromthe AMC. Previously, such clearancewas required only if the asset valueor sales turnover of the parties tothe concentration exceeded certainthresholds. Now AMCs clearance isalso required for any concentrationirrespective of the asset value or salesturnover of the parties to the concen-tration, if the market share of any ofthe parties to the concentration orthe combined market share of the par-ties to the concentration (includingrelated entities) exceeds 35 per centon any goods market and the con-centration takes place on this or onadjacent goods market.

Expanded list of related entities

The broad notion of related entities(persons connected by a control rela-tionship to use the exact languageof the law) has been expanded furtherto clearly cover close relatives of anindividual: husband and wife, parentsand their children, brothers and/orsisters. This will allow competitionlaws to combat the common practices

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of certain businessmen who used theirrelatives to avoid competition lawrequirements and at the same time tomaintain an actual control over theirbusinesses.

Simplified procedure for thecalculation of fines

Most fines for violation of Ukrainiancompetition laws are calculated as apercentage of the violators grossincome. For example, failure to obtainclearance for a concentration may leadto a fine of up to 5 percent of the grossincome. If the amount of the grossincome is not known, then the AMCshould, under the applicable laws,impose a fixed fine of up to 170,000Ukrainian hryvnias (currently ap-prox. EUR 27,000) for each suchviolation. Very often the AMC couldnot get the undertakings to providethis information and had to use thefixed fine, even if the information onthe gross income was actually availablepublicly from other sources.

The Competition Law Amendmentsnow allow the AMC to determine therevenue of the undertaking on thebasis of the so-called administrativeinformation, i.e. the official docu-mented information which is col-lected, used, and kept by state bodies,for example the state tax authorities orthe State Commission on Securitiesand Stock Exchange (the SecuritiesCommission). Under the applicablelaws, these state bodies are obliged toprovide the AMC with such informa-tion at its request.

Confidential treatment of tippees

As a result of the Competition LawAmendments, the AMC gained thelegal authority to keep confiden-tial the information regarding an un-

dertaking that was engaged jointlywith other undertakings in anti-competitive concerted practices andwas the first to notify the AMC of suchaction (thetippee). Special confiden-tial treatment can now be granted bythe AMC at the request of the tippee.Together with the previously existingrule permitting the AMC to relieve atippee from liability for anticompeti-tive concerted practices, this proce-dure allows the AMC to be moreeffective in investigating concertedpractices.

Exemptions from the filing require-ment clarified

Ukrainian competition laws containan exemption from general filingrequirement for concentrations in-volving securities brokers and otherintermediaries. Instead of the usualprior approval from the AMC, suchtransactions only need to be notifiedafter the closing. Recently, the AMC,jointly with the Securities Commis-sion, adopted the recommendationsin which this exemption was clarified.Thus, no prior approval is requiredfor concentrations where the acquireris an undertaking primarily engagedin financial transactions or transac-tions with securities and the sharespurchased in a concentration areresold within one year. In order tobenefit from the exemption, theacquirer cannot participate in themanagement of the target undertak-ing during this period. In its recom-mendations, the AMC provided theorder for notification of such transac-tion, the criteria for determiningwhether the acquirer's primary activi-ties fall within the stated exemptionfor financial or securities transactionsand some guidelines on the level ofparticipation in the managementof the target that would not bepermitted.

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LAWUkrainian corporate law did notundergo any major changes in 2005.Revolutionary changes in corporatelaws occurred about two years ago,when the Civil Code of Ukraine andthe Commercial Code of Ukrainewere adopted. Both Codes enteredinto force on January 1, 2004 and itwas obvious that they both required alot of work. In fact, the CommercialCode was often characterized by prac-titioners as an impediment to thedevelopment of a market-orientedUkrainian legal system. In 2005 somerepresentatives of the new govern-ment declared their intension toabolish the Commercial Code, whilemoving some of the useful conceptsfrom the Commercial Code into theCivil Code. This intention has not yetbeen implemented. The most notice-able event in 2005 was the introduc-tion of the one window or one-stopregistration of companies. At the sametime, the role of the courts andadministrative agencies in providingguidelines on important issues arisingout of application of corporate lawshas increased.

Improved Procedure for the StateRegistration of Companies

In July 2005 the one window regis-tration of companies finally began tooperate in Ukraine. This simplifiedprocedure was introduced by the Lawof Ukraine On the State Registrationof Legal Entities and IndividualEntrepreneurs, effective from July 1,2004, which it took the governmentabout a year to implement it.

The one window registrationmeans that after submission of one setof documents to the state registrar thecompany will be registered not onlyat the United State Register of Legal

Entities and Individual Entre-preneurs, but also with a number ofother state authorities required bylaw:

the State Tax Administration; the State Pension Fund; the Social Security Fund for the

Temporarily Disabled; the Social Security Fund for

Employment-Related Accidentsand Professional Diseases and

the Social Security Fund for Un-employment.

In the past, the newly registeredcompany had to apply directly to eachof the listed authorities according toseparate bureaucratic rules and prac-tices established by each authority,which hampered the start of a busi-ness in Ukraine. Now the state regis-trars transfer necessary data to theseauthorities and the company receivesdocuments confirming the registra-tions with each of these authoritiestogether the companys State Regis-tration Certificate or shortly after-wards. The whole process should takethree business days, but sometimescan take about a week.

The one window registration is alsosupposed to cover registration at thestate statistics authority, but this re-quirement has not yet been imple-mented. Some additional steps, likeobtaining a permission to produce acorporate seal, are still required afterregistration and before the companycan open a bank account or enter intoa contract.

Simplified Registration of theCompanys Location

The location (address) of a companyor another legal entity is an importantelement of the corporate status inUkraine. Most registrations andfilings must be made by the company

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in the administrative district where itis located. A company that is not actu-ally located at the address where itis registered may be liquidated by acourt order at the request of govern-mental authorities. In the past, manycompanies could not register theirchange of location in a timely manner,because such change also required achange in the charter of the companythat could not be made promptly (forexample, because the law requires a45-days advance notice for any meet-ing of the shareholders of a joint-stockcompany that is authorized to amendthe charter, or because changes to thecharter could not be adopted due tothe absence of a quorum).

Some of these problems wereresolved by the Law of UkraineNo. 2452-IV of 3 March 2005, which:

(1) introduced a clear definition ofthe location of a company: thelocation of a legal entity is thelocation of the body or personthat is authorized to act on itsbehalf pursuant to the founda-tion documents of the legalentity or by law;

(2) simplified the procedure forregistration of a change of loca-tion in the Unified State Registerby removing the requirementfor submission of amendedfoundation documents; and

(3) removed the requirement tostate the location of the companyin its foundation documentsfrom many legislative acts.

At the same time, Article 4 of theLaw of Ukraine On Business Compa-nies has not been amended and con-tinues to require that the formationdocuments of a company should con-tain information on its location. Mostpractitioners agree that this require-ment should be complied with untilthe inconsistency is resolved.

Clarified Procedure for SigningFormation Documents

In 2005, the State Committee ofUkraine on the Issues of RegulatoryPolicy and Entrepreneurship hasissued a number of letters clarifyingthe procedure for the signing ofchanges to the charter of the com-pany. For example, for a joint stockcompany changes to the charter maybe signed by the chairman of the gen-eral meeting of shareholders thatapproved such changes. Previously,certain state registrars insisted on hav-ing the signature of each shareholderof a company on the amended char-ter. This created a problem if a minor-ity shareholder refused to sign theamended charter properly approvedby the majority of shareholders inaccordance with all applicable proce-dures. Even though clarifications ofthe State Committee of Ukraine onthe Issues of Regulatory Policy andEntrepreneurship are not legal acts,they are usually followed by stateregistrars.

Clarified Procedure for the Disposal ofShares in a Closed Joint Stock

Company

For a number of years Ukrainianlawyers debated the right of share-holders to dispose of their shares in aclosed joint stock company irrespec-tive of the limitations contained in thecompany's charter. The court practiceon this issue was inconsistent.

In May 2005, the ConstitutionalCourt of Ukraine made a definitiveruling stating that the charter of aclosed joint stock company may pro-vide for priority rights of other share-holders and such rights must beobserved. More importantly, the Con-stitutional Court of Ukraine observed

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that the right of shareholders to selltheir shares is not absolute. Thismarks an end to a lengthy theoreticaldiscussion that was echoed in a num-ber of other areas of law.

New Guidelines from the SupremeCourt of Ukraine

At the very end of 2004, the SupremeCourt of Ukraine issued detailedguidelines on the application ofthe Law of Ukraine On BusinessCompanies (the Guidelines). TheGuidelines deal primarily with issuesthat arise out of the operation of jointstock companies and resolve a lot ofambiguities in Ukrainian corporatelaw. In particular, the SupremeCourt of Ukraine has confirmed thefollowing:

The charter of a joint stock com-pany may be declared invalid bya court, and the state registra-tion of the company may becancelled, if the charter does notcontain all the mandatory infor-mation prescribed by law.

The shareholders of the com-pany, as well as to other persons,including state bodies have theright to challenge decisions ofthe general meetings of share-holders and other corporatebodies, if the rights of suchpersons are violated by thesedecisions.

A court order (injunction)prohibiting a conduct of thegeneral meeting of shareholdersamounts to interference in thebusiness activity of the jointstock company and may result inviolation of the rights of othershareholders to manage thecompany.

By law, the decisions belongingto the exclusive authority of ageneral meeting of shareholders

may not be delegated to otherbodies of the company, irrespec-tive of the provisions of thecompanys charter.

A violation of the procedure forconvening the general meetingof shareholders, including theprior notice requirement, is oneof the grounds for declaringinvalid the decisions adopted atsuch a meeting. At the sametime, the decision of the generalmeeting of shareholders shouldnot be declared invalid if theshareholder who was not prop-erly notified is present at themeeting.

The employment agreementconcluded between a companyand its CEO cannot limit theauthority of the CEO providedby the companys charter.

The supervisory board of a jointstock company may consist onlyof the company's shareholders.A legal entity elected into thesupervisory board may partici-pate in this corporate bodythrough its authorized repre-sentative.

FINANCIAL SERVICESIn 2005 accession to the WTO becamea priority goal of Ukrainian economicand foreign policy. As one of its WTOaccession efforts Ukraine has under-taken to liberalize its financial servicesmarket. In particular, the set of draftlaws submitted to the Parliament ofUkraine (Verkhovna Rada) includedamendments to the current laws thatwere supposed to ensure free access ofnon-residents to such discriminativeareas as banking, insurance and auditservices. However, due to strong op-position from local financial institu-tions, only two of the laws have beenpassed by the Parliament so far.

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Abolition of Ukrainian citizenshiprequirement for auditors

On 6 July 2005 the Law On AuditActivities and the Business Code ofUkraine were amended to allow for-eign individuals to render audit ser-vices subject to the receipt by them ofa Ukrainian certificate confirmingtheir qualifications.

Abolition of restrictions for branchesof foreign insurance companies

On 7 July 2005 the Law On Insur-ance was amended to allow foreigninsurance companies operate inUkraine through their branches, totake effect in five years after Ukraineaccedes to the WTO. In order to setup a branch in Ukraine an insurancecompany shall be registered in a coun-try that meets certain criteria (cooper-ates with FATF; has an informationexchange memorandum signed withthe competent authority in Ukraine;exercises state supervision over insur-ance services; has concluded a doubletaxation treaty with Ukraine; is notconsidered an offshore territory; hasauthorized Ukrainian insurance com-panies to open their branches in itsterritory).

Moreover, the foreign insurancecompany shall place a guarantee de-posit equivalent to the amount of itsauthorized capital with a solvent bankin Ukraine; shall grant an irrevocableundertaking in writing to comply un-conditionally with any claims arisingout of its activity in Ukraine, and itsfinancial stability rating shall meet therequirements set by the competentauthority in Ukraine. Branches of for-eign insurance companies shall alsokeep their reserves in Ukraine. If anyinsurance claims arising in Ukrainecannot be satisfied with the assets ofthe branch and its guarantee deposit,

these claims shall be satisfied by theparent company.

Abolition of restrictions for branchesof foreign banks expected soon

While the Law On Insurance wasamended (although with delayedeffect), the amendments to the LawOn Banks and Banking providingfor the access of branches of foreignbanks to the Ukrainian market onterms similar to those for insurancecompanies, were overturned by theParliament. However, given the im-portance of WTO accession forUkraine and pressure on the part ofthe President, it is expected that aftercertain redrafting this amendmentwill still be passed by Parliament, sub-ject to a delayed date for coming intoforce.

INTELLECTUAL PROPERTY

Liability for IP laws has tightenedsignificantly

In order to comply with requirementsfor WTO accession, the UkrainianParliament adopted the Law OnAmendments to Certain Laws ofUkraine (Regarding the Restructur-ing of Operations Related to Manu-facture, Exports and Imports of Disksfor Laser Reading Systems, Equip-ment and Raw Materials for TheirProduction) of 6 July 2005, No. 2734-IV, which enhanced the protection forcopyrightable products distributed onoptical media, restructured the con-trol mechanism over the productionand sale of laser discs (CDs and DVDs)and imposed additional penalties forviolation of the existing requirements.

The main state bodies in chargeof implementing state policy in thisarea are the State Department of

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Intellectual Property, the Ministry ofEconomy, customs and other author-ities. Their major weapon againstcopyright infringers is an inspection, ascheduled or unscheduled visit of stateauthorities to verify compliance withapplicable laws. Scheduled inspec-tions are undertaken not more thanonce per year. The period for advancenotice to the company about a sched-uled inspection was reduced from tendays to five days. Unscheduled raidsare performed without any advancenotice. Representatives of copyrightand neighbouring rights holders maynow assist at inspections.

If a license for manufacturing, im-portation and exportation of laserdisks is revoked, following at least twosubsequent registered violations oflicense terms, the company mayobtain a new license not earlier than5 years after the revocation (this rep-resents a significant increase from thepreviously stipulated term of oneyear). Furthermore, if the cost of ille-gally produced laser disks, equipmentand/or raw materials reaches thethreshold of UAH 2,620 (approxi-mately US $520), the infringer will besubject to criminal liability. If the costof illegal goods exceeds UAH 13,100(approximately US $2,590), the in-fringer may serve a term of up to fiveyears in prison. It is worth noting thatpreviously the threshold for criminalliability was UAH 393,000 (approxi-mately US $77,820).

Following the adoption of this Law,the US have lifted their sanctionsimposed on $75 million worth ofUkrainian exports to the US inJanuary 2002 for the failure of theGovernment of Ukraine to enact andimplement adequate optical disc me-dia licensing legislation. As a furtherstep, the US are conducting a Special301 Out-of-Cycle Review to focus onUkraines intellectual property rightsenforcement and consider Ukrainesstatus as a Priority Foreign Country.

Procedure for acknowledgement ofwell-known trademarks has been put

in place

Implementing the Paris Conventionof 20 March 1883 for the Protectionof Industrial Property, Ukraine hasdeveloped procedures for the recog-nition of well-known trademarks,which may be used to defend againstunfair competitors in Ukraine. Forthis purpose, on 15 April 2005 theMinistry of Education and Science ofUkraine adopted the Regulation onthe Acknowledgement of Trademarkas Well-Known in Ukraine by theChamber of Appeals of the StateDepartment of Intellectual Property,No. 228. Applications for acknowl-edgement of well-known trademarksshall be considered by the Chamber ofAppeals based on the trademarksfame in a certain consumer sector,geographical area, its value, promo-tion and acknowledgement etc.

The Ukrainian Parliament hasattempted to introduce a law on the

transfer of technologies

On 6 September 2005 the Parliamentof Ukraine approved the draft LawOn the State Regulation of Activitiesin the Sphere of Transfer ofTechnologies (the TechnologiesLaw) aimed at creating a favorableenvironment for the development ofcommercial science in Ukraine. Thedraft Technologies Law purported toestablish a monitoring mechanismover the import of technologies toUkraine under certain state-financedcontracts, provided for a fair remu-neration to the creators of technolo-gies based on the income derivedfrom using their inventions and

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introduced certain measures protect-ing Ukrainian science.

However, the protective provisionsof the Technologies Law, namely therule that the transfer of technologiesinto Ukraine may not obstruct the useof concurrent Ukrainian inventions,and the contemplated funding ofthe transfer of technologies by theState through limited tax relief, wereattacked by the President of Ukraineas falling short of WTO requirementsand, hence, jeopardizing Ukrainesaccession to this organization. Forthese reasons, the President refused tosign the Technologies Law and sent itback to the Parliament for reconsider-ation.

PRIVATE INTERNATIONAL LAWOne of the most significant 2005developments in Ukrainian law is theadoption of the Act On Private Inter-national Law (Conflict of Laws) (CLA)on 23 June 2005.1 Initially conceivedas a part of the new Civil Code(adopted in 2003), the conflict of lawselement mysteriously disappearedfrom the draft code during the pro-longed parliamentary debate. As aresult, for more than a year, since theCivil Code came into effect, Ukrainelived with little conflict of laws regula-tion. The relevant rules outlined inthe old (Soviet) Civil Code were lostwhen it was replaced with the newcode.

The CLA brings long awaited orderto the area of law vital to the develop-ment of international social and eco-nomic contacts of Ukraine and itsresidents. It effectively ends the Sovietregulation aimed at limiting any cross-border contacts and, cons