The education of Ukraine’s new rulers can be seen in their juggling of legitimate business interests and the equally obvious need to end illegal trade, apply tax burdens more evenly and bring the country’s legal framework, as well as commercial law enforcement, up to the standards needed for World Trade Organization (WTO) accession. The legal code of Ukraine was extensively modified, beginning in 2003, and conflicting laws and even opposing paradigms made understanding Ukraine’s commercial system difficult. The rules around SEZs were no exception.

Budget gap

Any hope of recreating the SEZ framework at a leisurely, painless tempo died as the enormity of the budget gap left by the previous administration became apparent. In the end, it is hoped that by the end of 2005, foreigners active in these zones will benefit from the reconstruction of the framework that they operate under. However, current uncertainty, exacerbated by poor PR management, has hurt the Ukrainian government’s image at home and abroad.

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In March, operators in Ukraine’s 11 SEZs and 72 PDTs had their tax privileges withdrawn. This was part of a blanket cancellation of the roughly 3000 company-specific and industry-targeted tax exemptions granted by prior administrations. The government made these changes by introducing them via the revised 2005 budget which, by necessity, was quickly sent through the Verkhovna Rada for passage by lawmakers within weeks of the new cabinet’s coming into power.

No warning

However, due to the urgent need to bring the budget in line with the new government’s findings, there was no time for public consultation. The revocation was announced with little warning.

“We’ve heard President Yushchenko state often that the rule of law will prevail in Ukraine now. However, these privileges were removed essentially by decree and without our input,” a foreign diplomat based in Kiev notes.

The European Business Association (EBA) vice-president, Jorge Intriago, points out that the administration has been in power for just over 100 days, and though it is well intentioned, has made mistakes. “Cancelling the benefits is one of those mistakes. Given Ukraine’s competitive advantages, those benefits might not have been necessary. But if the government grants those advantages, it should keep its word. They could enforce existing legislation instead and examine individual cases.”

Winds of change

Some cancellation was expected. As early as January 2003, then-President Leonid Kuchma attempted to close down what he called “semi-free criminal zones”. It was noted at the time that only two of the zones, in Yavoriv, near the Polish border, and Uzhhorod, near Hungary, were profitable.

Mr Kuchma’s attempt failed under domestic pressure, but the expectation of a change lingered. “We aren’t surprised that it’s happening, but we are about how it’s happening,” comments Ulrike Straka, commercial attaché at the Austrian embassy. “When they speak of the rule of law, they should understand that it means that legal changes which infringe upon personal or corporate rights need to be introduced gradually, not overnight, and certainly not retroactively.”

Poor PR

Mr Intriago sees the problem as one of necessity combined with poor PR. “One of the biggest differences between this government and the prior administration is that this one is willing to listen. Within two weeks of Mr Yushchenko’s coming to power, the vice-premier, Oleg Rybachuk, started a dialogue with us concerning changes that need to be made.”

The vice-prime minister for EU integration has drafted legislation to replace the SEZs with technology parks that will have the same basic function, but under legislation tailored to meet WTO standards. “The draft is comparable to EU norms. It is really well-written legislation,” Mr Intriago adds.

Despite Ukraine’s closer ties with the international business community, damaging communication errors still exist. Though the EBA has seen the draft and commented upon it, commercial sections of central European embassies in Kiev were unaware of any specifics.

Much of what has been doneto calm investors and governments has happened face to face. Mr Yushchenko and Mr Rybachuk visited Poland to discuss the issue with their counterparts in Warsaw, and the Polish embassy in Kiev has been involved in talks as well.

 

 

Polish pragmatism

“Our businessmen who are currently involved in Ukraine’s SEZs are being pragmatic,” says Zbigniew Szmuniewski of the commercial department of the Polish embassy in Kiev. “After we sent a note through diplomatic channels and the governments started talking, they understood that we would wait for the Ukrainian government to sort things out.”

Polish investors are in close communication and none are planning to withdraw from the market. “We have heard of a court case against the government being launched in Donetsk, however,” Mr Szmuniewski says.

It is recognised that something needs to be done quickly, and that trust in the new administration has been damaged. Mr Szmuniewski notes that as long as there is uncertainty regarding how the Ukrainian government will handle both the legislation itself and guarantees that the laws will stay in place, future Polish investors will wait.

WTO hopes

“Rebuilding confidence will be achieved mostly by WTO accession. If it happens at the end of 2005, as the new administration desires, then we should see a return to normalcy,” Mr Szmuniewski says. “With accession, the norms of relations between government and business will already be established on a clear level.” Talks regarding Ukraine’s preparedness for joining the WTO will be held in September.

Mr Intriago says that prompt passage of the new legislation regarding development zones will help as well. This could happen before the parliament closes its session at the end of June. “President Yushchenko has the support in the Verkhovna Rada at this time to get the law passed fairly quickly.”

Tax exemptions might well be restored after an analysis of each company. However, Mr Intriago thinks tax incentives should not be necessary to attract investment. “Given the comparative advantages that Ukraine possesses, development in its SEZs makes sense. Ukraine has a well-educated workforce right next to the EU and labour costs are low. The locations, especially in Yavoriv and Uzhhorod, are ideally situated. If the government wants to make them more attractive, cutting red tape and continuing to fight successfully against corruption will bring in more serious business than a tax break,” he says.

Influx of FDI

Given that only $1.5bn in foreign capital investment has made its way to Ukraine’s designated zones, the expected influx of $3bn to $4bn in total FDI in 2005 will be felt in these places. Mr Intriago feels that this alone will be a sign to investors that Ukraine’s time has come.

“There were a lot of great projects that were put on hold because the prior administration wasn’t interested in implementing what was needed. That changed 180 degrees within one week,” he says.

Mr Intriago also notes that news headlines aren’t a reliable indicator to potential investors of what is happening in the country. “The biggest problem we see with people coming to invest is a lack of preparation. People who do their homework do well here.”

In the case of Ukraine’s SEZs, the homework includes watching for two polls – the vote to pass Mr Rybachuk’s legislation bringing in EU-comparable designated areas and the vote that grants Ukraine WTO status.