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Country Commercial Guides for FY 2000: Ukraine Report prepared by U.S. Embassy Kiev Released July 1999 Note*

Chapter VII: Investment Climate

A. Openness to Foreign Investment

The Ukrainian government officially maintains that it is actively interested in creating a free market economy and openly seeks foreign investment. However, Ukraine is struggling through its transition, has been slow in implementing much-needed reforms, and has failed to establish an investment climate that encourages business and investment. In May, President Kuchma publicly stated a need for $ 40 billion in foreign investment over the next five years. However, many foreigners considering investing in Ukraine were waiting until after the presidential elections scheduled for October 1999.

According to the State Statistics Committee, annual inflow of foreign direct investment (FDI) in Ukraine did increase more than 21 percent from 1997 to $ 922 million in 1998. (One reason for the FDI increase in 1998 was the strategic agreement between the government of Ukraine and Korean Daewoo that led to investment in the Ukrainian Zaz plant.) However, the statistics committee reported that foreign direct investment in Ukraine fell by more than 42 percent during the first quarter of 1999 compared with the same period in 1998. While total cumulative foreign direct investment was more than $ 2.8 billion as of April 1, it remains low compared to others in the region. By comparison, Poland received more than $ 10 billion in foreign direct investment in 1998 alone.

Although the Ukrainian government wants foreign investment, it has had difficulty adopting and implementing legislation that would encourage it. It passed a Foreign Investment Law in April 1996, which guaranteed registered foreign investors equal treatment with local companies and possible special privileges for investors. Furthermore, the law provided certain protections, including general guarantees against expropriation, unhindered transfer of profits and post-tax revenues, and a ten-year guarantee against changes in legislation that affect these basic protections. However, certain of its provisions, in particular, a tax holiday, were subsequently suspended by Parliament, thus damping the inflow of foreign capital.

In May 1999, Parliament established government guarantees for investment protection and introduced a provision prohibiting changes in legislative regulations during the term of the investment; however, foreign investors are unsure what the law's actual impact will be. The U.S.-Ukraine Bilateral Investment Treaty, which took effect on November 16, 1996, provides further protection for U.S. investors. However, use of international arbitration under the treaty is regarded as a tool of last resort and is not very practical for solving everyday problems that businesses continually face.

In 1997, President Kuchma created a Foreign Investment Advisory Council to advise the President on trade and investment matters. The third annual meeting took place in May 1999, chaired by President Kuchma and attended by numerous high-level Ukrainian government officials and representatives of high-profile foreign companies. The Council raised a number of issues of concern to foreign investors in Ukraine, particularly tax problems. The President has also formed a Chamber of Independent Experts -- consisting of Ukrainian and foreign legal experts -- designed to serve as a non-binding arbitration forum capable of rendering an impartial opinion on dispute cases brought before it. The economic ministry also created a "hot line" for investors last year, although -- so far -- most of the callers have been Ukrainian.

Despite these efforts, a recent survey conducted by the International Finance Corporation (IFC) found that three-quarters of small businesses feel that government authorities have a hostile attitude towards entrepreneurial activity, and almost all reported that they receive no support from the government.

Ukrainian legislation restricts foreign participation to 49 percent or less in the charter capital of enterprises in certain sectors and in certain privatized "strategic" enterprises; foreign shares of TV and Radio broadcasting companies cannot exceed 30 percent. Ukraine's anti-monopoly law also requires that the establishment of a legal entity, mergers, and acquisitions be approved by the anti-monopoly committee if the investment fulfills certain criteria (e.g. acquiring a certain percentage of the voting rights in an enterprise). Nearly all equity investments, joint ventures with multiple participants, and share acquisitions require anti-monopoly committee approval, a lengthy and fairly costly undertaking.

Privatization officially started in 1992 with the establishment of the State Property Fund. Privatization met strong bureaucratic and parliamentary resistance and was suspended in 1994. A presidential decree in November 1994 instituted a new voucher-based mass privatization program (MPP). Prior to 1995, 1,200 medium- to large-enterprises were privatized through an employee lease-buyout program, whereby employees' leases were converted to ownership. Beginning in 1996, voucher sales began for medium- and large-industrial enterprises. Usually, 20 percent of the shares in an enterprise were sold on a preferential basis to employees, 20 percent were sold to the public in exchange for privatization certificates, and the remaining shares were then sold for cash. There was no restriction on foreign ownership. In a limited number of cases involving "strategic enterprises," the state retained 26-51 percent ownership.

In 1998, the government planned to raise UAH 1.04 billion (approximately $ 270 million) through cash privatization, but eventually only raised UAH 340 million ($ 80 million). Through June 1999, the government has raised $ 62.5 million, largely through the hundreds of share packages offered on stock market exchanges. Too high an asking price for shares offered, the failure to offer majority shareholdings to investors, and onerous investment obligations accompanying the share packages are all contributing to low privatization revenue. Nevertheless, more than ninety percent of all medium and large enterprises have been privatized to date - 9,500 out of 10,000. These private enterprises account for 62 percent of Ukraine's industrial production and 50 percent of Ukraine's industrial employment.

To date, management/employee purchases remain the most popular form of privatization, with the majority of shares in medium and large enterprises held by employees and the public. However, most of these newly privatized enterprises are not easily restructured: their ownership is too diffuse; their shares are not actively traded in the secondary market, discouraging further investors from buying; and, in some cases, the government retains a 25 percent-plus-one block of shares, permitting it to block restructuring if it chooses. As a result, these enterprises continue to suffer from a lack of investment capital. Those few that are restructuring are among the most attractive firms, and they are just beginning the process.

As for foreign participation, investors can participate in public auctions, either as private investors or through investment funds; compensation certificate auctions, held monthly, which sell certificates introduced in 1996 to compensate Ukrainian citizens for the adverse effects of the hyper-inflation years; and tenders, one type involving only an up-front cash purchase of a share package in an enterprise, and a second type which also requires, in addition to the above, a commitment for further investment in the future. The privatization program also provides for commercial and non-commercial tenders, usually not closed to international investors, in which a strategic investor could buy a 25 percent (occasionally more) block of shares.

Foreign investors are not particularly discriminated against at any stage of the privatization process. The procedures for conducting tenders were designed to attract strategic investors (language in the 1999 privatization program implies equal treatment to all parties, especially foreign investment). The overall rules are the same for foreigners and locals. Cash auctions must go through a local institution, but it is not difficult to find a broker to represent foreign investors. From the start of the privatization process up to the purchase a level playing field exists. Although Ukraine's written privatization laws and regulations are not perfect, many believe that corporate governance issues (unfair treatment by company management toward all outside investors -- foreign and domestic -- who have not come to terms with management) are a major impediment to the success of privatization and enterprise restructuring in Ukraine.

In February 1999, Parliament adopted the 1999 Privatization Program. The program called for the privatization of 455 medium and large-scale enterprises, 5,500 small enterprises and 402 unfinished construction sites. Also, the privatization process for over 400 grain elevators had started by May 1999, with at least 70 percent of over 350 elevators being sold. Yields from the sale of state property were expected to bring UAH 800 million worth of receipts to the state budget. Land privatization continues to move slowly and will probably not be addressed this year. In addition, a number of enterprises remain on the Parliament's "negative" list, i. e. they can not be privatized.

An organization called the National Agency for Management of State Corporate Shares (NAMSCR) has been created by presidential degree, which has further complicated the privatization process. The State Property Fund has transferred state owned share packages to NAMSCR which auctions off the "management rights" of the enterprises. NAMSCR adds another level of bureaucracy and further complicates the privatization process. Rumors persist of the privatization of Ukrtelecom (the state telecom monopoly), but little progress has been made. Few expect great strides in privatization until after the presidential elections in October 1999.

Although the government has reduced many subsidies provided to state-owned industries, they still remain quite significant. For the most part, these subsidies appear not to be specifically designed to provide direct or indirect support for exports, but rather to maintain full employment and production. The government does not target export subsidies specifically to small business. In conjunction with its application to join the World Trade Organization, Ukraine is negotiating to join the WTO Subsidies Code.

B. Right to Private Ownership and Establishment

The Constitution of Ukraine (June 28, 1996) guarantees the right to private ownership, including the right to own land. In addition, Ukraine's law on ownership, which was one of the country's first major parliamentary measures, specifically recognizes private ownership and includes Ukrainian residents, foreign individuals, and foreign legal entities among those entities able to own property in Ukraine. Moreover, the law permits owners of property (including foreign investors and joint ventures) to use such property for commercial purposes, to lease property, and to keep the revenues, profits, and production derived from its use. The law on ownership does not, however, establish a comprehensive regime regulating the rights of ownership and the mechanisms for their transfer. Some difficulties have arisen over foreign acquisition of majority control of enterprises, with the government or the current management continuing to exercise effective control or veto power over company decisions.

The land code of Ukraine, adopted in 1992, regulates the ownership, use and disposition of rights and interests in land. The Code was adopted four years before the Constitution (1996) and is inconsistent with it in some of its provisions. Although the Land Code facilitated widespread private ownership of residential and dacha plots, the right to own land is still subject to substantial limitation. Only citizens of Ukraine may own private land, and only for private residences or agricultural use. The land code does not permit legal entities -- regardless of whether they are Ukrainian companies or foreign entities -- to own land in Ukraine. (Ukrainian agricultural companies are exempt from this restriction). The land code also prohibits ownership of land by foreigners and only provides for their right to the use and lease of the land. Subsequent presidential decrees, including a January 1999 decree providing for the purchase of non-agricultural land by Ukrainian legal entities, have opened the way for private enterprises to own land. However, law firms have generally advised foreign investors not to conduct land transactions based on presidential decrees that contradict the land code and may be challenged in court.

In June 1999, President Kuchma issued a decree permitting mortgages of land and buildings, both private and commercial. However, banks are reticent to provide financial backing for the purchase of real or personal property. Another deterrent to bank lending is an underdeveloped legal system minimizing creditors' chances of seizing property. USAID has been instrumental in the creation of a pledge registry, the first of its kind in the former Soviet Union, which applies to individuals' obligations with regards to movable property and tax liens. Though rudimentary, the registry is nation wide, providing a more transparent lending market for personal property.

C. Protection of Property Rights

Ukraine has already established a comprehensive legislative system for the protection of intellectual property rights. As a successor state to the former Soviet Union, Ukraine is a member of the Universal Copyright Convention (May 1973), and the Convention establishing the World Intellectual Property Organization - WIPO (April 1970). After independence, Ukraine became a signatory to a number of key international agreements. In addition, Ukraine has laws On the Protection of Rights in Inventions and Utility Models (1993); On the Protection of Rights in Industrial Designs (1993); On the Protection of Rights in Marks for Goods and Services (1993); and On the Protection of Plant Variety Rights (1993). It has a number of draft laws ranging from the protection of geographic place names to the protection of software.

Although these intellectual property rights (IPR) laws are already in place, Ukraine was placed on the Special 301 Watch List in 1998 because copyright piracy in Ukraine is extensive and enforcement is minimal, causing substantial losses to U.S. industry. For example, it is estimated that 90% of all computer software in use in Ukraine is pirated. On May 1, 1999, Ukraine was moved to the Priority Watch List. Ukrainian legislation has inadequate criminal penalties for copyright piracy and none for infringement. In addition, pirate factories producing electronic media displaced from Bulgaria have found a home in Ukraine.

To address this problem, Ukraine is in the process of creating an anti-piracy committee with authority to conduct unannounced searches and to confiscate pirated goods. Administrative liability, in the form of fines and/or confiscation of products, equipment, and raw materials, may be sought in the event that an infringement of intellectual property rights is accompanied by unfair competition on the part of the infringer. However, fines are insignificant, and the law does not give the police or customs the authority to conduct seizure or ex parte searches. Compounding the situation, the judges understand little or nothing about IPR, should a case make it to court. Ukraine is attempting to remedy these shortcomings, but it admits this will take a long time.

Although Ukraine has taken some steps to improve its IPR regime in accordance with its two-year action plan to make its IPR legislation WTO-compliant, Ukraine still does not provide retroactive protection for sound recordings or for works created before 1973. Although the President signed the Phonogram Convention on January 1999, and Parliament has approved it for a first reading, Ukraine has not addressed the problem of retroactivity in a timely enough manner to satisfy U.S. industry concerns.

D. Performance Requirements/Incentives

There are no known cases of performance requirements being imposed on foreign investors in Ukraine. Ukraine modified its foreign investment law of 1996 and law of investment activity of 1992 several times, thereby removing certain tax breaks previously accorded foreign investors, equalizing tax treatment of foreign and domestic investors. The scope and the ability to make foreign investments was also strengthened. There are no tax breaks provided for in the new laws, but the foreign investor is granted a number of state guarantees, the most important being unhindered and immediate repatriation of profits and stable regulations for the time of the investment.

At the beginning of June 1999, President Kuchma issued several decrees providing certain tax benefits for foreign investors in the areas of finance and investment and submitted the provisions of the decrees to the Parliament as proposed laws. Foreign investors are still exempt from customs duties for any in-kind contribution imported into Ukraine for the company's charter fund. Some restrictions apply, however, and import duties must be paid if the enterprise sells, transfers, or otherwise disposes of the contributed property for any reason.

New categories of visas are emerging in conjunction with Ukraine's new machine readable visas, causing some confusion. Business people can no longer extend their visas while in Ukraine; they must return to their country of origin. Americans are exempt from having to return to the United States -- they can pick up a visa at any Ukrainian Embassy outside of Ukraine -- but they still have to leave Ukraine to renew. Most go to Poland, Germany or the Czech Republic.

E. Transparency of the Regulatory System

In June 1999, Ukraine's finance minister submitted the government's first comprehensive tax code to parliament. In the meantime, businesses continue to cite Ukraine's tax regime -- with its hodge-podge of regulations, frequent legislative changes and sheer number of different taxes -- as hindering the development of their enterprises. Not only has the Ukrainian government changed tax laws frequently, making compliance difficult, but also retroactively. The fines imposed by the state tax authority are among the highest in the world.

Most troubling for foreign investors had been a regulation known as "Kartoteka II," which allows tax authorities to freeze the bank account of any entity that they believe to owe taxes -- without prior judicial proceedings. In a flurry of last minute decrees signed shortly before the president's economic decree power expired on June 28, the president signed a number of tax-related decrees, including one that requires a court ruling before tax authorities may freeze a bank account. However, parliament may amend the decrees before they take effect.

Several legislative changes aimed at reducing the number of inspections and simplifying business licensing and registration procedures for enterprises were introduced in late 1997 and 1998. Previously, any government monitoring entity had the power to inspect any enterprise, at any time, for almost any reason and without prior notice. Inspection by state bodies had been identified by the IFC survey as a major impediment to business operation; the average small business reported that it faced 78 inspections in 1997. A 1998 presidential decree restricted entities authorized to conduct financial inspections to one planned inspection per year and required at least ten days notice. While the average number of inspections of small businesses did drop to 13 in 1998, the decrease was more likely explained as a shift in focus toward large businesses, which reported an increase in the number of inspections, than the law, which went into effect in September.

Other laws reduced the steps required to register a business and the number of licensed activities. Ukraine reduced the overall number of licensed business activities in late 1997 from 112 to 42, although many still consider this lower number to be excessive. (As of April 1999, the number of licensed business activities increased to 51, not including six securities-related activities). The same survey reported that the time to begin operations in Ukraine had been reduced from 30 days in 1997 to 14 days in 1998. Still, various ministries and state bodies continue to require a number of other license-like permits. The bureaucratic procedures for obtaining various permits, licenses, etc., are complex and unpredictable, burdensome and duplicative; they create confusion, significantly raise the cost of doing business in Ukraine, provide opportunities for corruption, and drive much activity into the burgeoning shadow economy.

Although there have been some improvements, foreign investors still regard Ukraine's production certification system as one of the most serious obstacles to trade, investment, and ongoing business, and many consider Ukraine's system to be far more difficult than Russia's. Ukraine's domestic production standards and certification requirements apply equally to domestically produced and imported products. Product testing and certification generally relate to technical, safety, and environmental standards, as well as efficacy standards with regard to pharmaceutical and veterinary products. At a minimum, imports to Ukraine are required to meet the certification standards of their country of origin. In cases where Ukrainian standards are not established, country of origin standards may prevail.

The numerous certification bodies around Ukraine effectively operate as independent entities, often with monopolistic positions. Furthermore, these agencies work on a private profit basis, retaining 80 percent of the profits derived from certification fees and returning only 20 percent to the state. Pricing rules exist, but they are too vague to be enforced, and the State Standards Committee (the central governing body) does not have proper supervision over the various bodies. Much of the legislative and interpretive work is left to different agencies, with little or no coordination. For many products, multiple agencies are involved in the certification process, and often multiple certificates are required. Local, regional and municipal authorities often require additional documentation beyond that required by central agencies.

The existing system of rules and norms, based on Soviet practice, encourages rigid formality, inflexibility, and an absence of justice in the procedures. Under these rules, extremely wide powers are given to the certification bodies, with little control over, or responsibility for, decisions taken, permitting the introduction or modification of procedures without proper consideration of the applicant's rights. The applicant has few means to appeal against an unfavorable decision, further aggravated by limited access to existing procedures, norms and rules.

U.S. businesses in Ukraine repeatedly complain that there is a lack of clear regulations, the system is not transparent, the registration schemes are unfeasible for mass trade, the requirements are constantly changing and unevenly enforced, there is a lack of procedural flexibility, the import license procedures are overly complex and lengthy, and the certification and licensing fees are inordinately high. While the law may stipulate formal equality of treatment of both national and foreign companies, U.S. businesses are left with a very strong impression that the laws are not applied equally and that, in fact, there is a discrimination against foreign companies.

There is much discussion of regulatory reform, but to date little concrete progress (the only cited instance is the lowering of the number of licensed business activities). At present, there are no effective mechanisms to resolve business dispute cases. On occasion, disputes over international business arrangements have been settled only after President Kuchma or other national leaders have become involved and a special law or decree enacted to cover the business arrangement.

F. Corruption

Corruption pervades all levels of government, according to press reports and foreign business complaints. Recognizing the problem, President Kuchma issued a decree in April 1997 establishing a national program against corruption, but its results are yet to be seen. Some corrupt acts have been criminally prosecuted, but many more that have been exposed have resulted in little or no action. The recent prosecution of some high-profile politicians has raised the question of "selective justice." Many anticorruption campaigns appear to be politically or economically motivated.

Corruption also permeates much of Ukraine's civil service and regulatory system. Conflict of interest is a poorly developed concept, and many officials and bureaucrats retain their commercial interests while in power. Corruption can also be institutional to the extent that certain government entities may own or have close ties to businesses that compete with those that they regulate. Government entities also use means that are off the balance sheet to pay for operations and expenses not funded by the state budget. A complicated and non-transparent regulatory system has also encouraged petty corruption at all levels of government. A professional administrative class is developing slowly, due in part to the low salaries of such professionals.

G. Labor

Ukraine has a well-educated and skilled labor force, with a nearly 100 percent literacy rate (98.6 percent). Although the official unemployment level is low (four percent as of June 1, 1999), most experts agree that: (1) reported unemployment is understated, (2) underemployment at state enterprises continues, and (3) employment in the informal sector accounts for a growing, but difficult to measure, share of the total labor force.

Wages in Ukraine remain very low by Western standards. The nominal average monthly wage in Ukraine in 1998 was 153.50 hryvnia, 7.2 percent more than in 1997. However, because consumer prices have grown more rapidly than the nominal average wage, real wages in 1998 were actually 12.9 percent less than in 1997, and real wages in 1997 were 2.4 percent less than in 1996. Because of the devaluation of the hryvnia in 1998, the average monthly wage converted to U.S. dollars fell from $76.9 in 1997 to $62.7 in 1998. (By comparison, in Russia the average monthly wage converted to U.S. dollars fell from $164.3 in 1997 to $112.8 in 1998). Many Ukrainians are forced to work second and third unofficial jobs to make ends meet, thereby making up a vast portion of the shadow economy. A 1998 report by the Harvard Institute for International Development suggested that the size of the informal economy is in excess of 70 percent of Ukraine's official GDP. (Most experts agree that the percentage is well over 50 percent.)

Slow movement on privatization and unwillingness of larger enterprises to reduce staff has negatively affected the labor market's ability to respond to new market conditions. A significant part of the Ukrainian labor force has migrated to the shadow economy, taking up service jobs such as taxi drivers, waiters, and traders to ensure economic survival. The last few years have seen an increase in wage arrears, in some cases by as much as a year-and-a-half. Plant managers continue to see employment of their work force as a key priority, and foreign investors may encounter resistance in trimming a project's work force to an efficient level. A further complication in business arrangements is the Ukrainian enterprise's continuing responsibility for housing and much of the other social infrastructure sustaining their workers. This social burden can become a real issue in business negotiations.

Ukraine's industrial inheritance from the former Soviet Union, particularly its military-industrial complex, has produced excellent specialists, engineers, and programmers. However, these specialties rarely were commercialized in the Soviet command economy, leaving many Ukrainians poorly equipped for the demands of dynamic, information-based commerce. Homo Sovieticus, or Soviet man, has left a distinct impression on Ukraine's working-age population. The Soviet command-administrative system discouraged creativity and entrepreneurial spirit, inhibiting the growth of business in Ukraine. Ukrainian workers, in the blue-collar and white-collar sectors, more often than not respond to "top-down" management practices. Indeed, one of Ukraine's most important goals will be to re-train entire generations of its workers in order to compete in the fast-paced world of high-technology production and modern management methods and practices.

H. Efficiency of Capital Markets and Portfolio Investment

Legal, regulatory, and accounting systems are not transparent enough and are not fully consistent with international norms. The reform process is advancing in these areas, especially in the banking sector; but, such systems in Ukraine remain underdeveloped. Ukraine has not generally adopted international accounting standards outside of the banking sector, requiring many foreign investors to keep double entry books, one entry with Ukrainian accounting standards and one entry following international standards for use by the parent company. Parliament did pass the first reading of the "Law on Accounting and Financial Accountability" in June 1999, but it is not expected to come into effect this year. Accounting firms expect that producing two different sets of accounts will still be necessary after the law is passed, although the differences between the two should be less. The day-to-day working of the security market lags behind international standards and also behind the progress achieved in the Ukrainian banking sector.

In June 1991, the Parliament of the then Ukrainian Soviet Socialist Republic approved a Law on Securities and the Stock Market, which marked the birth of a Ukrainian capital market. The Law outlined the existence of the following types of securities: stocks (registered, bearer, preferred, and common), government securities, general obligations/bonds, corporate bonds, savings certificates, and promissory notes. Later decrees and amendments adopted from 1991 to 1995 added bond coupons, loan certificates, bank orders, savings books, and privatization certificates. In June 1995 the State Securities and Stock Market Commission was established, having administrative and disciplinary powers over issuers, investment funds, brokers and trading activities. A law on a depository system, regulating financial infrastructure and trading institutions was added in December 1997.

Almost 95 percent of the reported secondary market activity is conducted through the nationwide electronic trading system for the self-regulatory organization or "PFTS" (The Ukrainian Broker/Dealer Association and Over-the-Counter Trading System). Other markets exist, including the Ukrainian Stock Exchange, the Donetsk Exchange and the Crimean Stock Exchange, but most trading (about 75 percent) is not reported to any licensed market (PFTS or exchange). Ukraine's stock market was negatively impacted by the Russian financial crisis in 1998, experiencing sharp declines in trading volumes and overall market capitalization. Investors continue to face numerous problems, including low market confidence, incompatible accounting standards, lack of accurate company information, and inadequate protection of minority shareholders' rights. To date, an effective portfolio investment regulatory system has not been established. USAID was involved with the creation of a law on collective investments, which is awaiting its first reading in Parliament.

The Ukrainian banking sector is in the early stages of development. Nevertheless, in contrast to many other sectors of the Ukrainian economy, there has been real progress in structural reform over the last several years. Development of sound market-oriented banking system has been an important area of emphasis of international assistance, including from the U.S. As of April 1999, there were 211 banks registered in Ukraine. The National Bank of Ukraine (NBU) has both the supervisory and monetary powers of a central bank.

All Ukrainian banks formally converted to international accounting standards on January 1, 1998. The National Bank has passed a number of new regulations, such as loan-loss provisioning, loan classification and lending to insiders and related parties, which are in line with Western practice. Foreign licensed banks may carry out all the same activities as domestic banks and there is no ceiling on their participation in the banking system.

However, there are also important deficiencies. The legal infrastructure is sadly deficient. For several years, the parliament has held up passage of vital laws that would give the National Bank the authority it needs to deal with banks in trouble. In fact, NBU Governor Viktor Yushchenko complained that a new Law On the National Bank of Ukraine, passed in spring 1999, strips the NBU of the right and means to punish banks for not meeting mandatory reserve requirements. Given the tenuous economic environment and the still continuing directed lending by banks at the government's behest, there is a large overhang of problem loans. For some of the larger banks in Ukraine, the problem is acute. The National Bank, together with the IMF, has identified a group of the largest seven banks in the country as a primary source of systemic risk. Together with 35 foreign bank inspectors (from eight countries, including the U.S.), full-scope supervisory exams were completed at the end of 1998. The National Bank has signed agreements with each of these banks on measures to rectify identified weaknesses. Now, together with foreign technical assistance, a two-year upgrading is starting for this group of largest banks.

Problems still persist. Although a number of measures were introduced to make it easier to identify bad loans and avoid possible crises, many banks still have a large number of bad loans. They continue to lack sufficient resources to provide credit, and so are not a major source of investment funds. Loans that are made are short-term and at high interest.

Ukrainian financial markets do not seem to have such complex "cross-shareholding" and "stable shareholder" arrangements as are found in Asian markets. However, foreign investment through mergers and acquisitions is restricted in Ukraine, but for other reasons such as underdeveloped legislation and unfair treatment toward minority shareholders by company insiders.

The lack of rights extended to minority shareholders creates obstacles in attempting to change ownership. Examples of shareholder rights abuses include the following: limited disclosure, capital restructuring without shareholders' consent, and voting fraud.

Ukraine continues to remain a cash economy, but a few banks have started issuing credit cards (Visa and MasterCard) and a number of local businesses have begun accepting credit cards. In addition, a number of automatic teller machines have appeared throughout the country.

I. Conversion and Transfer Policies

The April 1996 foreign investment law guarantees foreign investors the "unhindered transfer" of profits, revenues, and other proceeds in foreign currency after covering taxes and other mandatory payments. Ukraine's new currency, the hryvnia, was introduced in 1996 and is traded in Ukraine against the U.S. dollar and other currencies at a rate of roughly four hryvnia to the dollar, as of June 1999. The hryvnia had stayed within the 1.95-2.25 UAH/dollar range before the 1998 financial crisis. Since the beginning of 1999, the value of the hryvnia has fallen about 13 percent and was expected to continue its gradual depreciation during the year.

There are currently no limitations on the frequency of repatriation of earnings. In general, foreign exchange is rapidly available at market-determined rates, and investors can convert their earnings into foreign currency through commercial bank, which purchases foreign currency for the investor at the Interbank market. Commercial banks can trade foreign currency between each other or participate in electronic currency trading at the Ukrainian Interbank Currency Exchange (UICEX). Due to the August 1998 financial crisis, the National Bank of Ukraine (NBU) put into place a number of capital controls. Investors should be aware that such regulations change regularly and the NBU is often forced to protect thin foreign currency reserves. However, since this spring there has been a liberalizing of the foreign exchange market and the Embassy purchases local currency at the commercial rate from a variety of local commercial banks.

J. Expropriation and Compensation

Since gaining its independence in 1991, the government of Ukraine has not engaged in any known acts of expropriation of foreign investments or property. Under the 1996 law on foreign investment, a qualified foreign investor is provided guarantees against nationalization, except in cases of national emergencies, accidents, or epidemics. Insufficient time has passed to judge the adequacy of this law in cases where compensation was due. However, some incidents with foreign investors have caused concern. For example, in one case, after the government reorganized the state Television and Broadcasting Company, the successor television company unilaterally abrogated a 10-year contract with its U.S. business partner. In another case, the government reorganized a state-owned agricultural company shortly after an American investor received an arbitration award against it. The assets were transferred to a newly established entity, and the state-owned company went bankrupt.

K. Dispute Settlement, Including Enforcement of Foreign Arbitral Awards

As the number of foreign investments has grown, so too has the incidence of disputes. The Embassy has been involved in numerous advocacy cases on behalf of American investors who have been the victims of a variety of abuses, including overzealous tax collection, sudden and drastic tariff hikes, abrogation of valid contracts and licenses, and outright corruption.

At the heart of the current disputes is the lack of transparency in Ukraine's business environment, the problem of authority (or lack thereof), and non-implementation of court decisions. Ukrainian laws and regulations are vague and open to considerable leeway in interpretation, providing ample corruption opportunities for officials at every bureaucratic layer. Xenophobic attitudes, especially at the regional level, also play a role as foreign investors are all too often seen as competitors of local firms and their government "sponsors."

The Embassy and U.S. businesses recognize that key high-level Ukrainian government officials in Kyiv are aware of the problems and are sensitive to the needs of foreign companies. The difficulty lies in the relative independence of action of the middle levels of the bureaucracy. There are simply too many officials, both in the various layers of government and at the enterprise level, who have a strong, vested interest in the status quo.

In the early days of independence, many foreign investors became mired in a common type of investment dispute. In these cases, American firms that operated for several years in joint ventures with a Ukrainian firm experienced difficulties once the JV started to show a profit. After it became clear that the firm had established itself on the Ukrainian market, the Ukrainian partner attempted -- through various illegal or semi-legal means -- to force out the American partner. The Ukrainian partner continued operations using the JV company name, product brand names, logo, and other intellectual property, sometimes resorting to threats of physical violence toward the former partner if the partner did not "go away." The number of such cases reported to the Embassy has declined recently, although other embassies in Ukraine continue to report that some of their investors have had similar experiences.

In February 1994, Ukraine enacted an international commercial arbitration law. The law parallels commercial arbitration laws set forth by the United Nations Commission on International Trade Law and is therefore in accordance with international standards. The law covers a wide range of international commercial transactions, reflects the principles of equality and fair treatment of parties, provides for a supportive relationship between the courts and arbitration tribunals, and includes basic provisions for the functioning of arbitration proceedings where the parties themselves have not made necessary provisions. According to Ukraine's law on foreign investment, disputes between U.S. investors and the state are to be considered by Ukrainian courts of arbitration. Ukraine is also a member of the New York Convention of 1958 on the recognition and enforcement of foreign arbitration awards. Some parties have been able to enforce foreign arbitration awards in Ukraine, although there has not been universal success.

The draft Civil Code is being readied for its second reading in parliament. The Civil Code is of fundamental importance, governing all commercial relationships in Ukraine. A special committee of the Parliament, headed by Deputy Speaker Victor Medvechuk, has been established to prepare the draft Civil Code for its second reading. The current bankruptcy law was enacted in 1992 and provides for the liquidation of enterprises. A revised law on bankruptcy, providing for debtor-led financial restructuring and reorganization as well as tax forgiveness, is being prepared for its second reading in parliament. The revised bankruptcy law goes well beyond current law and will be considered one of the most progressive bankruptcy laws in the former Soviet Union if enacted.

Unfortunately, in spite of the positive formal character of these laws and measures, dispute settlement remains weak in Ukraine. Most U.S. businesses avoid the court system because the local and national court systems are burdensome and highly unpredictable. Some investors have reported instances in which the Ukrainian judicial system appeared subject to considerable political interference and/or suffered from corruption and inefficiency. Even when firms receive favorable rulings from Ukrainian courts, the country's judicial system lacks the mechanism necessary to enforce court judgments in their favor. As was reported in the U.S. State Department's 1998 report on human rights, the authority and independence of Ukraine's judicial system are "undermined by the poor record of compliance with court decisions in civil cases." One partially successful method used for the settlement of investment disputes has been Embassy appeal for intervention at the highest levels of government -- clearly not a viable long-term solution.

L. Political Violence

Political demonstrations and disagreements in Ukraine rarely involve violence and are generally resolved peacefully.

M. Bilateral Investment Agreements

The Bilateral Investment Treaty between the United States and Ukraine entered into force on November 16, 1996. The following countries have also signed bilateral investment agreements with Ukraine: Canada (1994), France (1994), Germany (1993), Italy (1993), Bulgaria (1994), the Czech Republic (1994), Hungary (1995), Poland (1993), Slovakia (1994), Armenia (1994), Estonia (1995), Georgia (1995), Kazakhstan (1994), Kyrgyzstan (1993), Lithuania (1994), Moldova (1995), Uzbekistan (1993), the People's Republic of China (1992), Cuba (1995), Egypt (1992), Greece (1994), Israel (1995), and Mongolia (1992). The agreement with China has a five-year term. All of the others have a term of ten or more years. Ukraine has also entered into bilateral treaties with Azerbaijan, Belarus, Russia, and Turkmenistan. These treaties cover customs duties, but not VAT or excise tax, with the exception of the treaty with Belarus. In December 1997, Russia and Ukraine agreed to a mutual exemption on value-added tax. Ukrainian exports to Russia were expected to increase 20-25 percent as a result.

N. OPIC and Other Investment Insurance Programs

Overseas Private Investment Corporation:

The Overseas Private Investment Corporation (OPIC) currently provides financing for projects in Ukraine and offers insurance to U.S. investors against the risks of expropriation and political violence in Ukraine. The U.S.-Ukraine OPIC Agreement was signed in Washington on May 6, 1992. Since January 1994, OPIC has approved investment insurance totaling more than $ 133 million for seven projects in Ukraine.

Export-Import Bank:

The U.S. Export-Import Bank is operating in Ukraine. In spring 1992, the Export-Import Bank reached an agreement with the Export-Import Bank of Ukraine to support transactions involving the export of U.S. goods to Ukraine. Since then, the Export-Import Bank has financed U.S. exports of agricultural machinery to Ukraine.

Multilateral Investment Guarantee Agency:

The Multilateral Investment Guarantee Agency (MIGA) is an independent member of the World Bank Group, which provides guarantees against political risk to foreign investors in connection with new investment in developing member countries. Forms of investment which can be covered by MIGA include equity, loans, loan guarantees, and loans made by financial institutions (as long as MIGA is also insuring part of the foreign equity in the project enterprise). Certain non-equity direct investments may also be eligible, such as technical and management contracts and franchising and licensing agreements.

O. Capital Outflow Policy

It is estimated that $10-20 billion of Ukrainian capital has been hidden abroad since 1991. Ukraine's investment policy has been heavily focused on capital inflow - attracting foreign investment and recapturing Ukrainian capital currently banked abroad.

P. Major Foreign Investors As of June 1999, major foreign investments made in Ukraine were channeled into: (a) telecommunications - Utel (a long-distance and international telephone services joint venture with foreign shareholders AT&T (USA), PTT Telecom (Netherlands), and Deutsche Bundespost Telecom (Germany)) and the UMC joint venture (with contributions from PTT Telecom, Deutsche Bundespost Telecom, and Telecom Denmark (Denmark)); (b) tobacco - R.J. Reynolds, Philip Morris, and Reemstma; (c) soft drinks - Coca-Cola and PepsiCo; (d) food processing - Cargill, Kraft Jacobs Suchard; (e) consumer goods - Procter & Gamble; (f) detergents - SC Johnson; (g) electric power - ABB (Swiss-Swedish-US), Westinghouse-Siemens (Germany, USA), Northland Power (Canada); (h) oil & gas - JV Poltava Petroleum Company (JKX Oil & Gas (UK)), JV Eurogas Ukraine (Eurogas (USA), RWE-DEA (Germany)), USENCO (USA), JV UkrCarpatOil (Carpatsky Petroleum Corp. (USA)); (i) agribusiness - Cargill Ukraine; and (j) fast food - McDonald's.