Will “investment nannies” improve the investment climate in Ukraine?

07-05-2021

In February this year, a law that effectively formalized the activities of investment managers, better known as “investment nannies”, came into force.

From January 1, 2022, investors implementing large projects in Ukraine will be able to receive state support under the terms of special investment agreements concluded with them.

The law establishes the maximum term of preferences — 15 years, and the project implementation period should not exceed 5 years.

Why should we have “nannies” for investors?

Political and economic stability are key factors in attracting long-term investment.

In Ukraine, the high level of corruption and the shadow economy deters potential investors, who prioritize transparency, predictability, and stability of the institutional environment.

Of course, Ukraine has some achievements in improving the investment climate, but there are still significant problems and barriers for investors. In the Doing Business-2020 rating, Ukraine ranked 64th among 190 countries, having strengthened its position in the protection of minority investors by +27 points during the year, but the ‘enforcing contracts’ and ‘paying taxes’ indices have decreased (-6 points and -11 points accordingly).

According to the Corruption Perceptions Index (CPI), in 2020, Ukraine ranked 117th among 180 countries, receiving only 33 points out of 100 possible. In 2021, the Index of Economic Freedom included Ukraine in the list of “mostly unfree” economies. As a result, we have the 126th position among 180 countries. At the same time, Ukraine gained only 35 points out of 100 possible in the investment freedom component.

The laws aimed at removing institutional barriers and creating investment incentives for potential investors should improve the situation.

At the same time, trying to cater to investors, we actually recognize that it will be difficult for businesses to work without a special intermediary solving problem with highly-placed officials.

This also confirms that state institutions in Ukraine are weak, and the current regulatory environment and regulatory framework are not always effective. Investment managers have to open the doors that should be open to everyone anyway. This is a really frank admission.

“Investment nanny’s” functions: support of investment projects or an additional intermediary?

“Investment nannies” will be authorized state investment managers, one of the main functions of which is to interact with public authorities and local self-government bodies regarding issues related to the support of generation and implementation of large-scale investment projects in Ukraine.

By creating an additional structure in the relationship between investors and the state, we simplify the communication process and reduce compliance risks. This is the main purpose of providing professional information and advice.

However, it is important to prevent a situation when such support turns into intermediation with additional informal costs for investors. Additionally, the new structure in the negotiation process may

be perceived as an attempt to strengthen state control, which may cause additional concerns among investors.

It would seem that an investor who invests at least 20 million euros can hire highly qualified lawyers to professionally represent his/her interests. If state institutions work effectively, that should be enough.

It is clear that the “investment nanny” idea with such a set of “services” is a response to the weakness of government institutions resulting in the lack of confidence in the state’s capacity to ensure the rights of any entity, including investors.

This is very clear evidence of the so-called transitive consciousness of Ukrainian society, which is characterized by its readiness to compromise on unfair rules of the game. However, admission of the problem is the first step towards solving it.

Why is it more important than ever to improve the investment climate?

Investment failure as a global trend in 2020

Back in the summer of 2020, when it was hard enough to estimate real economic losses from quarantine restrictions, experts from the United Nations Conference on Trade and Development (UNCTAD) estimated the COVID-19 pandemic challenges at $0.6 trillion in lost investment per year.

Although official statistics for 2020 have not yet been published, it is clear that the coronavirus crisis will lead to a sharp decline in global foreign direct investment flows by at least 40%, and for the first time since 2003, their amount will be less than $1 trillion.

But do not expect the capital flows to be resumed in 2021 because even according to optimistic forecasts, their amount will decrease by another 5-10%. Capital flows to transition economy countries and developing countries will be affected the most, as export industries suffer the largest investment decline. Accordingly, competition for capital will only increase in global markets, and the countries with the most favorable investment climate will benefit.

Investment needs and achievements of Ukraine

The importance of investments for ensuring sustainable economic growth can hardly be overestimated. The National Economic Strategy 2030 approved by the government on March 3, 2021, identifies the attraction of foreign direct investments as a key issue because the Ukrainian economy is systematically underfunded.

This is confirmed by statistics: as of the end of 2019, Ukraine has accumulated about $48.9 billion in foreign direct investment per 41.5 million people, while Poland — $236.5 billion per 38 million people, and Hungary with a population of 10 million — $97.8 billion.

How much foreign investment does Ukraine need?

According to the Methodical Recommendations for Calculating the Level of Economic Security of Ukraine, the investment attraction level, at which the ratio of net annual growth of foreign direct investment to GDP is 6%, is a satisfactory level for investment and innovation security (the optimal rate is 7%). However, since 2007, net FDI inflows to Ukraine have not exceeded 6%.

To ensure sustainable economic growth, it is necessary to focus on increasing value added, and this requires the creation of new production facilities at enterprises or the renewal of existing ones, and hence significant capital investment. However, the data of the State Statistics Service show that capital investments have decreased by almost 40% over the past year. In general, in Ukraine, there is a tendency to reduce investment in fixed assets from 4.5% in 2009 to 0.4% in 2020 at the expense of foreign investors.

The dynamics of attracting fixed capital investments at the expense of bank loans and other loans also decline: from 17.9% in 2011 to 7% in 2020.

Thus, the formation of a favorable institutional environment aimed at stimulating investment activities is extremely important for Ukraine, although the relevant law was adopted with significant delay.

Protection of national interests

The idea of creating a specialized institution that would take care of investors is not new. For example, in Lithuania, a government agency “Invest Lithuania” was established at the Ministry of Economy and Innovation to stimulate the inflow of foreign investment in 2010.

The agency provides free consultations and assistance to companies wishing to do business in Lithuania. Its activities cover three main areas: investment assistance, project management, and support. I emphasize that “Invest Lithuania” is focused on foreign investors.

The Ukrainian analogue — UkraineInvest — was established in 2016. The organization’s activity is also aimed at promoting the attraction of foreign capital.

At the same time, the creation of preferences for foreign investors has certain threats.

For example, in Poland, in the pre-EU accession period, the provision of income tax benefits to foreign investors, in particular a reduction of the rate to 5%, stimulated significant capital inflows, but most of the industry sector moved to the ownership of foreign multinational enterprises.

In Hungary, as a result of extremely favorable foreign capital laws (The 1988 Law on Investment by Foreigners) that allowed foreign investors to own 100% of the company and did not impose any restrictions on the capital repatriation, in 1997, more than 60% of the country’s banks came under the control of foreign investors.

And if the external capital accounted for only 24.1% in the total capital of enterprises in 1989, it was already 85% in 2000.

The advantage of the new Ukrainian legislation is the lack of preferences for foreign capital, as state support for investment projects is provided to create a favorable environment for attracting significant, both domestic and foreign, investments in Ukraine.

Thus, market competition is not distorted, there are no incentives for the development of round-tripping operations and withdrawal of capital by Ukrainian residents for further investment in the economy of Ukraine, but with preferences.

Preventive measures on the use of a certain category of shadow schemes are also welcome, as offshore companies cannot apply.

Moreover, the new legislation provides for the analysis of not only economic and financial indicators but also social effects and environmental consequences of the investment project. This complies with the implementation of the sustainable development concept to attract and intensify responsible investments.

Conclusions

The strong government intervention in the market mechanism of the investment process can certainly be harmful. The introduction of any investment incentives can lead to market imbalances and shift the competitive balance.

However, staying away from the global trend of improving the investment climate means losing the competition for capital in international financial markets.

The possibility to receive certain tax preferences and state support in other forms is an effective tool to stimulate investment activities. The main provisions of the law will be gradually adapted to the new challenges and features of the country’s socio-economic development.

In particular, the focus will be shifted to supporting other areas with the highest priority and using an up-to-date set of regulatory tools at a different level over time.

In addition, it is important to remember that the adoption of a single law that provides benefits to a particular category of investors will not immediately create a favorable investment climate in the country. However, this is the first step towards investors.

It is quite obvious that it is unlikely to be possible to encourage investors with the help of “investment nannies”. In the process of generation and implementation of investment projects, the authorized institution plays a minimal role in the formation of a favorable investment climate.

However, provided that the principles of support (instead of intermediation) are followed, the state investment manager will be an additional bonus, although not a significant factor.

Today, the main challenge for Ukraine is not the adoption of law useful for the economy and society, but its effective implementation for the benefit of citizens. After all, it is worth remembering that even the best initiative can be distorted if used in the context of the interests of certain stakeholder groups.

Source: Economichna Pravda

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