A LOOK AT THE NUMBERS: Is foreign direct investment into Ukraine plummeting?

by Alexander J. Motyl

Among the many charges being made against the government of Viktor Yushchenko and Yulia Tymoshenko, one is especially serious. Foreign direct investment (FDI) is supposed to have fallen on their watch. Indeed, FDI is often said to have "plummeted." Use of that word conveys the impression that FDI was steadily rising over the last few years and that, thanks to their misguided policies, it is now in free fall. If true, the charge would imply that the orange government "squandered" its post-revolutionary legitimacy and "lost" an ideal opportunity to attract the foreign capital considered to be a precondition of Ukraine's economic revival.

As with so many of the charges made against the Orange government, this one is also vastly overstated. As one can see from the tables below, the data tell a rather more complicated story. (The data are available on the website of the State Statistics Committee of Ukraine, www.ukrstat.gov.ua.)

Table 1. Total Foreign Direct Investment (FDI) into Ukraine, 2003-2005

	2003 1/1	2003 4/1	2003 7/1	2003 10/1	2004 1/1	2004 4/1	2004 7/1	2004 10/1	2005 1/1	2005 4/1	2005 7/1
Total FDI, mil., US$	5339	5605	6038	6213	6658	6947	7325	7762	8354	8797	9061
Quarterly increase mil., US$		266	433	175	445	289	378	437	592	444	264
% increase		5.0	7.7	2.9	7.2	4.3	5.4	6.0	7.6	5.3	3.0

Table 1 shows overall FDI flows into Ukraine. Note that the volume of FDI (Row 1) has increased steadily for the last three years. The quarterly FDI increases (Row 2) are not spectacular, and we know Ukraine can do better, but at no time has the volume actually decreased.

Note as well that the rate of increase (Row 3) has hardly "plummeted" either. There is no obvious consistently upward secular trend in 2003-2004 to justify such an alarming word. The rate of increase did rise steadily in 2004, but it fluctuated in 2003. Since the last quarter of 2004, when the rate stood at 7.6 percent, it has fallen to 5.3 percent and 3.0 percent in 2005 - but it is clearly too soon to conclude that these two data points portend a free fall.

If, as the Orange government expects, Kryvorizhstal and several other plants will be privatized in the second half of 2005, the rate of increase will jump.

If, as seems to be the case, several foreign hotels will be built in Kyiv, the rate will rise as well. Will those investments be evidence of a "skyrocketing" trend? Alas, no. Ukraine will have to sustain improvement for a while, at least a year or two, for such an optimistic conclusion to hold.

But who's doing the investing, and what can those data tell us?

Table 2. FDI from Cyprus and the Virgin Islands, 2003-2005

	2003 1/1	2003 4/1	2003 7/1	2003 10/1	2004 1/1	2004 4/1	2004 7/1	2004 10/1	2005 1/1	2005 4/1	2005 7/1
Total FDI, mil., US$	940	901	1113	1019	1160	1342	1440	1568	1579	1800	1961
Quarterly increase mil., US$		-39	212	-93	141	182	98	128	12	221	161
% increase		-4.1	23.5	-8.4	13.8	15.7	7.3	8.9	0.7	14.0	9.0

Table 2 shows FDI flows from Cyprus and the Virgin Islands - both countries that serve as havens for illegally (and legally) acquired Ukrainian (and Russian) capital. These numbers tell a very different story from those in Table 1.

Ukrainian capitalists were anything but bullish about the Kuchma period. Their investments fluctuated wildly in 2003, and then went into decline in 2004. In contrast, Ukrainian FDI rose by 14.0 percent in the first quarter of 2005 and by a still healthy 9.0 percent in the second quarter. If we believe that Ukrainian capitalists, especially those whose gains were illegal, are both most knowledgeable about investment conditions in their country and most sensitive to risk, then we may want to conclude that the investment climate in Orange Ukraine has actually improved.

Table 3. FDI from Russia into Ukraine, 2003-2005

	2003 1/1	2003 4/1	2003 7/1	2003 10/1	2004 1/1	2004 4/1	2004 7/1	2004 10/1	2005 1/1	2005 4/1	2005 7/1
Total FDI, mil., US$	323	335	343	355	378	386	411	428	458	511	546
Quarterly increase mil., US$		12	8	12	23	8	25	17	30	54	35
% increase		3.8	2.4	3.5	6.4	2.2	6.4	4.2	6.9	11.7	6.8

As Table 3 shows, Russian investors would appear to agree that money can still be made in Orange Ukraine. Their volume of investments has increased in every quarter since early 2003, though erratically so. The rate of increase was low in 2003, went up and down throughout 2004, and has actually registered its most impressive gains in 2005. Since we may assume that island-based Russian investors, like their Ukrainian counterparts, know Ukraine and are sensitive to risk, their investment behavior may warrant the conclusion that the investment climate under the Yushchenko administration is hardly disastrous.

Table 4. FDI from West (U.S., U.K., Netherlands, Germany, Switzerland, Austria) into Ukraine, 2003-2005

	2003 1/1	2003 4/1	2003 7/1	2003 10/1	2004 1/1	2004 4/1	2004 7/1	2004 10/1	2005 1/1	2005 4/1	2005 7/1
Total FDI, mil., US$	2603	2841	2876	3029	3238	3300	3518	3632	3986	4098	4110
Quarterly increase mil., US$		238	36	153	209	62	218	114	355	111	12
% increase		9.1	1.2	5.3	6.9	1.9	6.6	3.2	9.8	2.8	0.3

Unfortunately, Western investors may disagree. Their rate of FDI increase has fallen in 2005, reaching a piddling 0.3 percent in the second quarter. But, before we all start panicking, note two things. First, Western rates of increase have been tiny - 1.2 percent and 1.9 percent - in the past as well. Second, Western investments - both total quarterly volumes and quarterly rates - have fluctuated wildly since early 2003. The figures for 2005 may portend a secular trend or they may only represent a blip. It's too soon to tell.

Table 5. Total Volume and Percent of FDI per Quarter, 2003-2005

	2003 1/1	2003 4/1	2003 7/1	2003 10/1	2004 1/1	2004 4/1	2004 7/1	2004 10/1	2005 1/1	2005 4/1	2005 7/1
Total	5339	5605	6038	6213	6658	6947	7325	7762	8354	8797	9061
Cyprus/ V. Islands	940 17.6%	901 16.1%	1113 18.4%	1019 16.4%	1160 17.4%	1342 19.3%	1440 19.7%	1568 20.2%	1579 18.9%	1800 20.5%	1961 21.6%
Russia	323 6.0%	335 6.0%	343 5.7%	355 5.7%	378 5.7%	386 5.6%	411 5.6%	428 5.5%	458 5.5%	511 5.8%	546 6.0%
West	2603 48.8%	2841 50.7%	2876 47.6%	3029 48.8%	3238 48.6%	3300 47.5%	3518 48.0%	3632 46.8%	3986 47.7%	4098 46.6%	4110 45.4%

Finally, consider Table 5, which compares investment flows from Cyprus and the Virgin Islands, Russia and the West. Here we may see some secular trends. The Ukrainian share of total FDI appears to be growing since early 2003, while the Western share appears to be declining. That may be both good and bad news. It's good if you believe that Ukrainian capital has to be brought back home for the Ukrainian economy to function. It's bad if you believe that the West is indispensable to Ukraine's economic growth. Note, finally, that the Russian share of total FDI has fluctuated between 5.5 percent and 6.0 percent in this three-year period. If nothing else, that suggests that reports of an imminent Russian takeover of Ukraine's economy may be slightly exaggerated.

Conclusion

In sum, the data tell us that, while the volume of foreign direct investment has risen steadily since early 2003, it is simply too soon to conclude anything meaningful about the rate of increase of FDI under the orange government.

Should Ukraine be doing better? Of course. Could President Yushchenko and Prime Minister Tymoshenko have done better? Well, yes, and well, maybe not.

They could have done better because, as the conventional wisdom has it, they did enjoy widespread popularity and the Orange Revolution did generate a sense of euphoria about Ukraine's prospects. Those feelings of warmth and good will should have helped increase foreign, and especially Western, FDI.

But not necessarily. First of all, investors do not invest because they feel warm about countries. They invest because they think they can make a profit. Second, investors fear change - and orange Ukraine, simply by being a society in transition, was always going to be a changing society. Third, investors like certainty - both because it increases their chances of making a profit and because, in general, they lack knowledge about countries.

Small wonder, therefore, that Russians and Ukrainians, who know Ukraine, are far less skittish than Westerners about investing in Orange Ukraine. Let me suggest that Western investors would have been skittish about Orange Ukraine even if Mr. Yushchenko and Ms. Tymoshenko had held their hands and done absolutely everything just right.

One final point. As my last comment suggests, the willingness to invest is as much - if not more - a function of perception as of knowledge. If investors believe a place is worthy of investment, it is. That belief is only partly the product of a deep familiarity with a country or of the "objective" nature of a country's conditions or policies. Instead, that belief is as much, if not more, the product of "subjective" perceptions and, thus, of a country's image.

While the Yushchenko administration can, and should, make Ukraine more "objectively" attractive to Western investors, it has already made it more "subjectively" attractive. Its interactions with Western policy-makers, journalists, and media have placed Ukraine on the "mental map" of people in the West. After all, no one will invest in a country whose only claim to fame is Chornobyl.

Alexander J. Motyl is professor of political science at Rutgers University - Newark and an expert on Ukraine.

Copyright © The Ukrainian Weekly, October 2, 2005, No. 40, Vol. LXXIII

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