Ukraine Focuses on Improving Investment Climate, Developing Stock Market

THE RESULTS OF THE PAST 12 MONTHS

In 2011 the Government of Ukraine set focus on macro stability, conservative fi scal policy, GDP growth and infrastructure spending. These priorities have been adequately realised. GDP recorded 5.2% growth last year, one of the highest rates in the region. The targets laid down in the budget suggest GDP growth of 3.9% this year, and the Government is determined to reach that level. Even taking into account our more conservative expectation of 2.2% for this year, Ukraine remains one of the fastest growing economies in the region. Infl ation is down to 3% and the budget defi cit has been halved from 8.7% in 2009 to 4.3% last year. This year the Government expects a budget defi cit of 2.5%, slightly more optimistic than our forecasts.

Regarding infrastructure, four brand new airports and stadiums are ready, and progress on other infrastructure projects has been impressive compared to previous years.

As for reforms, they were slower in 2011 than in 2010. However one of the most politically diffi cult measures, Pension Reform, was approved and came to effect in October of last year. And grain export restrictions - a hotly debated issue this time last year - have been lifted.

NEW GOVERNMENT PRIORITIES

For 2012, the Government will focus on improving the country’s investment climate. Among the most important objectives are protection of creditors’ rights (currently the largest problem for banks that prevents faster lending growth), transfer pricing (the respective law is being drafted), deregulation of the construction sector, and simplifi cation of tax rules.

Recent appointments in the Government give investors hope that the reform program needed to improve the investment climate in Ukraine will be resumed.

Focus on the stock market

Among the priorities of the Government is the development of a well-functioning stock market worthy of the size of the Ukrainian economy. The measures include the introduction of double-listings - placement on Ukrainian stock exchanges of foreign holdings based on Ukrainian assets. This will allow Ukrainian investors access to leading domestic agricultural and steel enterprises.

UKRAINE COMPARED TO GLOBAL CAPITAL MARKETS

Being a frontier market Ukraine usually suffers from low liquidity and underperforms during times of global uncertainty but always more than catches up when situation stabilises.

It can be seen from dynamics of Ukrainian stock market index, the KPDragon: during last 5 years Ukraine has been an absolute leader in performance, either among the best or worst.

Ukrainian stock market’s annual performance (based on KP-Dragon index) in 2007-2011

Note: KP Dragon is a MC weighted index of top 20 most liquid Ukrainian stocks listed on LSE (50%), WSE (34%) and UX (16%). Largest sectors are agriculture (50%), Metals & Mining (22.6%), Oil & Gas (14.6%), machine building (6.2%), energy, banking.

DEBT MARKETS

Last year Ukraine’s corporate and municipal issuers placed $2.6bn worth of bonds, historic record. This comes on top of $3.4bn issued by sovereign. Issuers used window in February-July to tap the market.

Given high quality of issuers, average yield decreased to pre-crisis 2007 level – 8.9%. Debt servicing remained reliable despite sharp tightening in global credit markets after August. All repayments were made on time and there were no restructurings last year.

Ukrainian Eurobonds fully participated in the September global sell-off but the recovery has been lagging since then. EM indices such as SOVX CEEMEA and EMBI have recovered 68% and 90% of the drop, respectively, while Ukraine has recovered only 40% of the Summer-2011 drop. The main reasons for this underperformance were delays in renegotiating the gas deal with Gazprom and resuming IMF program. If macro issues start being resolved, we see clear room for yields compression and catchup with global EM universe.

STOCK MARKET DEVELOPMENT AND CORPORATE GOVERNANCE

Measures aimed at the development of Ukrainian stock market cover the following areas:

Regulatory framework - The government plans to present new legislative proposals within a month to foster development of the domestic stock market. The government is also seeking to improve coordination with the NBU in this area to quicker enact necessary measures to allowing dual listing of Ukrainian companies whose shares are currently traded on European exchanges.

Corporate governance - Only a handful of Ukrainian listed companies comply with corporate governance best practices and the government is working on legislation to strengthen requirements in this fi eld, particularly what concerns curbing transfer pricing, instituting mandatory share buyouts and other measures to provide adequate protection for minority shareholders.

Pension reform - The government is focused on bringing untaxed wages (an est. UAH 150bn p.a.) out of the shadow economy, which should allow to make the state Pension Fund balanced as early as 2013 and pave the way for launching a second tier of the pension system as a source of long-term domestic funding.

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We hope that the Ukrainian leadership’s interest in the investment climate in general and in the Ukrainian stock market in particular will signifi cantly improve the situation with capital infl ows into the country. The new team in the Government is targeting quick wins that should improve business environment.