Turning Point

Economic News

22 Jul 2010
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The mega foreign investment deal officially concluded last week in the banking sector - plus this week's privatisation of the country's biggest steel mill - could together mark a watershed in Ukraine's investment fortunes.

Investment has waned somewhat since the Orange revolution last year, despite President Viktor Yushchenko's best efforts to promote the country. Instead, foreign capital had so far largely shied away from Ukraine's perceived political risks.

One of the problems had been the post-revolution government's re-privatisation process, which most observers now agree undermined confidence in fundamental property rights.

The new administration led by Prime Minister Yurii Yekhanurov has therefore been explicit about its intention to end this ill-thought out process, with the re-privatisation campaign likely to end with this week's sale of the Kryvorizhstal steel plant.

The giant steel mill, which produces 7m tonnes per annum, was resold during a televised auction on October 25 to the world's biggest steel producer, Mittal, for a stunning $4.8bn. This is in stark contrast to the $800m it received during its initial privatisation, when it was sold to a company which included the son-in-law of the former president, Leonid Kuchma.

Meanwhile, the acquisition by Austria's Raiffeisen International Bank of a 93.5% stake in Aval - Ukraine's second largest bank - for a record sum of $1.028bn last week could not have come at a more auspicious moment.

Both the Kryvoriszhstal sale and the Raiffeisen acquisition are landmark deals in many people's minds, that should act together as a major declaration of confidence in Ukraine's economic potential, sending a clear message to investors that this market of 48m people is open for business.

As the largest financial intermediate in the country, analysts hope Raiffeisen will spur local investment activity in the real sector, and help to bridge the gap between the acute investment needs of the economy and the financial markets. Not unimportantly, it should also force other Ukrainian banks to raise their game.

In the short term, the most significant impact, market watchers say, will be felt in retail banking. Raiffeisen Bank CEO Herbert Smith told local media that the bank hopes to capitalise on Aval's almost 1400 retail outlets to ride the approaching wave in consumer finance.

However, some sceptics fear that the high price paid by Raiffeisen for Aval has dramatically raised the entry cost for other international banks looking to gain a foothold in one of the last virgin East European markets. Analysts maintain that the valuation of other major Ukrainian banks currently targeted by foreign buyers may increase threefold.

Nevertheless, others argue that this is a simple question of supply and demand and that despite the higher acquisition price, at least half of the Ukrainian banking sector will be in foreign hands by the end of 2006.

This is very good news, according to Denis Koplov, Chairman of Ineko Capital Partners, an investment company which is looking to attract strategic partners from abroad.

"Foreign-owned banks will provide the necessary financial infrastructure for the future entry of other Western capital," Koplov told OBG last week. Once the banking sector is sold off, other sectors will follow.

According to insiders, retail, IT, telecoms and construction are all being studied closely by foreign investors, with the real estate sector in Kiev probably one of the investment spots attracting the most interest.

Alexandr Shkarupa, manager of a Kiev-based property investment and development company, told OBG last week he has had a continuous stream of foreign visitors ever since the Orange revolution.

However, uncertainties mean many look but then prefer to wait. Shkarupa said only about 40% of those foreigners are serious about investing in Ukraine.

Yet according to a recent ranking produced by AT Kearney, Ukraine is the 3rd most attractive country for commercial property investments, offering high returns and short investment turnaround cycles.

But while analysts say that Kiev alone could absorb around $2-3bn of real estate investment per annum, the main problem is the absence of investment grade properties and a complicated legal system.

The best investors, according to both Shkarupa and Koplov, are Russian investors, who understand the local mentality and rely on their instincts rather than sophisticated due diligence processes.

Awash with excess liquidity from recently high oil prices and confident about Ukraine's development prospects, many Russian investors are rumoured to be buying up local companies and properties overnight and without much hesitation.

In real estate at least, Shkarupa argues, Russians will outpace other foreign investors, who are more risk averse and uncertain whether to jump or not to jump on the bandwagon.

Meanwhile, foreigners who do come to Ukraine prefer to enter with local partners.
The best form of investment, many Ukrainian entrepreneurs told OBG, is that of a joint-venture between local and foreign companies, with local actors absorbing the local risk and foreign investors bringing the intellectual know-how and higher quality standards.

Nevertheless, despite this locally approved joint-venture formula, Mittal Steel will be entering Ukraine on its own. According to some analysts, Mittal also defeated its main rival, Arcelor - the second largest steel group in the world - because Arcelor was in a consortium with a local partner, the Industrial Union of Donbas (IDS).

In the end, however, it was the stunningly high price which dictated the outcome. Undoubtedly, the re-privatisation will now go down as one of the most significant moments in post-Orange revolution history.

Meanwhile, analysts hope it will help to draw a line under the disruptive re-privatisation process. This will hopefully put Ukraine back on the track of fast economic growth and trigger significant flows of the foreign investment that many see still waiting outside Ukraine's gates.

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