How to improve the inflow of the foreign investment in Ukraine?

Vadim Bizaev, a researcher at the Kyiv School of Economics who specializes in international investment projects of financial institutions, gave us some comments about mechanism of investment process of foreign countries and explain why Ukraine neglects its own investment potential.

Why do we need international financial institutions? 

 

In general, financial institutions are created to sustain worldwide development, fight with poverty and overcome inequality. These organizations offer loans, usually at very low interest rate, but under certain conditions of usage of these funds. We receive largest loans from International Bank for Reconstruction and Development (IBRD), European Bank for Reconstruction and Development (EBRD), European Investment Bank (EIB), The KfW (german state-owned bank for development).  

Frequently these loans are aimed to stabilize financial situation in country, in this case, there is no need for investor to choose in which sector of economy to invest, funds go forward to the budget and government of country decide how to use it properly for particular sector in economy. That kind of loans are in use in Ukraine.

 Sometimes money is given for investment project in certain area of economy. For example, last year we have kept an eye on the loans of World Bank that are offered to Healthcare industry and road quality improvement. That kind of financial support is very attractive for the country, because they are given at very low interest rate, far lower than those that could be generated by business, from bund issue etc. 

 

What benefits do international institutions derive from this investment policy? 

 

Every country seek for opportunities to attract investments. It is far more better in situation when investment is made by business – then it becomes the risk of a business which act like investor of particular industry of economy. However in our case, in Ukraine, we have not stable situation with following fields: economy, law, communication network and control system issue are main reasons that are misleading investor. In this case the only option for us are international financial funds. 

These huge pools of funds are formed by endowments from many countries from all over the world. For example, if we consider the World Bank, it includes approximately 187 countries, including Ukraine, and each country make its own contribution. The share of Ukraine is very negligible. The largest share corresponds to the USA, Japan, Germany, France, the Great Britain and Canada. Depending on the contribution, a country has impact on organisation`s decisions. Ukrane’s voting quota is less than 1%. For comparison – the USA have 16.39% of influence, Japan – 7,84%, Canada – 2,78%. 

 

What is complexity of investment projects?

 

Investment projects have a specific plan of realization and purpose. And that’s a point where difficulties are come up: 

 

  1. Investment projects are prepared by country and its specialists. And not always projects are well-calculated, with clearly defined benchmarks for confirming effectiveness of the invested funds. More cloud be seen from example of Healthcare case: the entire loan of the World Bank – 250 millions – is aimed to reform medical service in 8 Ukraine districts, each of district fulfilling its own object. But how we can define effectiveness of the usage of this funds? For this, there is already a need for properly spelled out benchmarks, which cannot always be measured by the available methodology for collecting statistics. 
  2. Significantly low stimulus to use all of funds. In most of  cases, allocated funds used in sectors of the economy, that have been stagned for decades, they are in poor conditions, and they are ignored, in terms of investments from government, for a very long period of time. And when it comes to management of financial resources, officials and workers does not know how to deal with them. How to purchase goods and services, how to determine the best proposition, and how to build strategy. That’s why allocated resources are used to cover holes in balance. Let’s take a look to investments in the development of assistance in the treatment of cardiovascular diseases. It is necessary to buy modern angiography, operating tables, supplies, but if there is no experience in this, a lot of time goes to acquire it.  
  3. Deficiency of our regulatory framework. And, as it follows, a lot of attention of law enforcement agencies. Officials scared to use these funds today , because tomorrow the prosecutor will come and say “you violated this and that”. That’s have it works in real conditions. Law enforcement agencies are just waiting for the customer to make a mistake. On the other hand, it is their job to do so, but it not always, these mistakes are deliberate and generally an offense. But you can always find some point in the rules of use of budget funds, for which an official can be prosecuted. 

 

All of these obstacles work in opposite direction. They stop investment. Projects are typically several years long, and you have to do every year to improve your performance in five years. And every obstacle affects the term, and the international financial institution looks at the pace of use of funds. In real life, it is often the case that three of the five planned years of the project have passed, with 20% of the funds used and 80% remaining. The International Finance Organization says: “We can give you more money, but you haven’t used it yet.” And Ukraine needs that money. And very often such projects are closed. At half, at 20, at 5 percent. If it is, for example, road construction, a 500 million $ project, we have spent 80 million, done design documentation, started construction. But it is further revealed that during the preparation phase of the project, they did not discuss with the public and did not learn in advance that the next site should pass through the territory which the local authority refuses to provide for construction. And all, the project stops, often for years.

 

Institutions have charitable goals. What is the point to invest in other countries?  

 

In global sense they have their own intentions. Firstly, if we talk about neighbouring countries to them, it is clear, that creating stabile democratic environment around, is important, so that countries do not “slip” into third world category, there will be no usurpation of power, or no migration flow from there. Secondly, to get money is not easy task, but with the return of a corresponding percentage, if we talk about loans. There is a lot of free money in the world, and the desire to invest somewhere to get some return on your investment after a while. But investors should have a guarantee of their money back.

 

Does Ukraine repay its loans? 

 

We have never had a default – so, yes. 

 

Nowadays, its often heard, that default and refusal to cooperate with IMF will be more beneficial for Ukraine. Is it true?

 

In comparison with alternative possibilities to get money, IMF and other IFI provides less expensive financial resources. If there is exists any other opportunity for us then please, we will analyse it. But the truth is, there is no other possible option, that would be more beneficial for us. The IMF does not want us to necessarily raise tariffs or “oppress” our population by raising the retirement age. They want us to have stability in budget balance, a smaller Pension Fund deficit, and so on. If we find another way to close the “holes” in the budget, the IMF will not mind.

 

So we can conclude that IMF is a friend for Ukraine? 

 

Of course. I don’t think any modern economist can say the opposite.

 

If there are any successful investment projects in Ukraine?

 

There are projects that have well ending, though i don’t think they used 100% of funds. Let’s take for example, our medical project. It is oriented on eight districts. Lviv is the only one district in which everything is completed in time and all funds were used. A lot depends on the local team that is engaged in the project and, of course, presence of the appropriate motivation, experience, knowledge.

 

What is investment itself? We are given money and distribute it properly. How? Either by injecting these funds into the general state budget, or by carrying out purchases of goods and services in the framework of developed investment projects. The World Bank and EBRD projects are reinsured knowing the level of corruption risks in developing countries and have developed procurement rules. And all the purchases of such investment credit projects occur behind them.

This rules specifies what the experience of the company should be, how many suppliers it should have for the tender. For example, Prozorro rules requires that tender can be arranged only if there are at least two suppliers who are submitted their propositions, on contrast World Bank rules admits one suppliers if application is timely and the technical documentation meets the standards of at least three available suppliers on the market. With the advent of the Prozorro system, the World Bank has already allowed certain types of purchases through it.

 

Do suppliers have to be Ukrainian or foreign suppliers are also allowed? And in case of foreign investments, it follows that one country get investments, but another pays off?  

 

Yes, it is. We have a competitive, global market and all anti-competitive measures can only be within the framework of WTO rules. That’s the reason why international purchases are interesting because foreign suppliers, manufacturers can come and give a price lower than available in certain country.

For example, manufacturers of large modern medical equipment came here for the same medical project. We made a comparison: similar equipment purchased from other customers through Prozorro and equipment purchased from pilot areas for World Bank credit. The difference is often 20-30 and up to 50%. Purchases throw World Bank rules was cheaper. Because these are purchases simultaneously for large lots of goods and directly from the supplier.

 

We need to understand, that in Ukraine we do not produce modern equipment. The construction works are purchased from our contractors, but in the road sector we still 5-10 years ago did not have enough modern equipment for good roads. That is why in the first stage in the market won a foreign contractor who had the latest equipment and really made quality. But they also hired subcontractors: used our employees, our supplies. They just provided their machines and equipment. And if we talk about the purchase of equipment, Ukraine does not produce it. Exactly there are foreign manufacturers and it is very effective alternative, when they come directly and there is no do “one-day firms” in this chain.

 

How we can improve investments in our country?

 

We must show that we can use money honestly. And make us trust. International financial institutions have no precautions or claims that there is a fact of stealing money from purchases, because they follow the rules of these organizations, which reduces the possibility of theft. It can be, and probably is, somewhere there. But not massively. There are caveats that money is not used because there is not yet enough institutional capacity in the ministries, departments, local authorities to properly procure, determine investment / development priorities, assess the economic feasibility of various measures. This can only be remedied by improving education for these beneficiaries. For example, the rules for the procurement process. Ministries often do not have a person who understands these rules. So, it can be more efficient if public authorities hire private-sector professionals who are familiar with it. But in the private sector there are not enough specialists with up-to-date education, and here is lack of experience. So they need to improve their knowledge too.

 

Has Ukraine started to use investments more efficient in the last 5-10 years? 

 

After the Euromaidan, Ukraine’s attractiveness and investments in it have increased significantly. Investors want to invest money here, but they do it carefully. There is an increase in interest, but is there a percentage increase in the use of incoming money? It is, but it could be better.

 

Which ministry is a leader in terms of investments?

 

There are leaders in the number of investment projects involved. These are the Minregionbud and the Ministry of Infrastructure. Funding Leader – The Ministry of Healthcare. It uses money not worser, but often better than others.

 

Are there any disadvantages of investments?

 

Недоліки – це те, що не створюється інституційна пам’ять втілення цих інвестицій. В кожному міністерстві ситуативно збираються різні команди, вони щось роблять, розробляють, прораховують. Ці команди через плинність кадрів та відсутність мотивації часто йдуть: хтось в бізнес, хтось в інші місця. Варто створити організаційну структуру, яка матиме інституційну пам’ять та аналізуватиме дії що відбувалося і до чого це призвело, щоб на п’ять-десять-двадцять років наперед був план дій та можна було на цифрах розуміти яка буде ефективність від теперішніх інвестиції. Цього зараз взагалі немає. 

Disadvantages are that the institutional memory of the implementation of these investments is not built up. In each ministry different teams gather together, they do something, develop, calculate. These teams often go because of staff turnover and lack of motivation: someone in business, someone elsewhere. It is worth creating an organizational structure that will have the institutional memory and analyze the actions that have taken place and what has led to this, a plan of action for five, ten or twenty years ahead and to figure out in numbers what the effectiveness of the current investment will be. There is none at all.

 

Maybe it makes sense to create some separate body? 

 

Yes, it should be a such body. If we speak globally, it is like a centralized investment organization or it may be the Ministry of Economy. For investment, it is important to have a layer of professionals who understand the process, control it, and assist local authorities. For me, now it is an interesting idea to unite the Ministry of Economy and the Ministry of Finance, because the decision to attract investment seems to be developed and adopted by the Ministry of Economy, and the money still goes with the agreement of the Ministry of Finance.

 

Recently, Vladimir Zelensky appealed to businesses to invest in Ukraine. Do these stories work, or do we just have to show a stable result and the investment will come?

 

Calls without action are baseless. It will be effective to correct that all investor complaints over the past years have been linked to law enforcement pressure and conflicts of law, and no guarantees of property rights protection. The business does not feel free because of this. Everyone knows that a law enforcement officer is assigned to each department, and he keeps track of everything that’s going on. They also follow the actions of the business and try to obtain unreasonable benefits whenever possible. The law enforcement system and the reform of the judiciary are needed to protect property rights. As long as property rights are not protected in Ukraine, and law enforcement officers are “frighten business” there will be no improvement.