James Brooke, The Ukraine Business Journal, 16-18.08.2016
In a few days, Geoffrey R. Pyatt will depart Ukraine, completing the standard three year tenure of United States ambassadors here. But Amb.Pyatt’s time in Ukraine has been far from standard. It was marked by revolution, war, Ukraine’s U-turn to Europe, and a bitter, ongoing battle for free market reforms.
Early in August, Amb.Pyatt took time out from packing for his next post, Greece, to talk to James Brooke, editor in chief of the Ukraine Business Journal.
Focusing on the road ahead for Ukraine, the American envoy repeatedly returned to one theme: the next chapter for Ukraine will be economic. Foreign and domestic investment will be key to providing the jobs and development needed for Ukraine to succeed as a nation.
In three parts, the Ukraine Business Journal is posting edited and highlighted excerpts.
ON SECTORS ATTRACTIVE TO FOREIGN INVESTORS:
IT is now the 3rd largest component of GDP. Ukraine is one of the biggest IT countries in Europe now, with tremendous capacity. The challenge in the IT space is to continue to build the rule of law, the investment environment, so that Ukrainian technology entrepreneurs aren’t just focused on creating a good product, and then going public and moving to Silicon Valley as fast as possible. But to continue to develop here in Ukraine.
The interesting thing about IT in Ukraine is it’s geographically dispersed. There’s the Odesa IT story. There’s the Kharkiv IT story. There’s the Lviv IT story. There’s the Dnipro IT story.
The energy sector will continue to be an important one for American companies. Let’s not forget that in the Soviet Union, Ukraine was their Texas. It was the oil patch of the Soviet Union and the major source of oil and gas in the Soviet Union, until the Siberian fields came online in the 1970s and 1980s. In fact most of the development work in Siberia was done by Ukrainians, which is why you find Ukrainian gas and oil engineers today in Houston and across the United States, who got their training at the Ivano-Frankivsk Oil and Gas university. But it’s a sector that has been underinvested for 25 years of independence, largely because of poor policy framework. When I arrived, Ukraine was spending about 7%of GDP on the energy sector subsidies.
Prime Minister Groysman took a brave and important move in going to a full cost recovery model for energy, which created the incentives for Ukrainian companies to use energy more efficiently, removed the opportunities for corruption driven arbitrage that sucked out a lot of the entrepreneurial effort in this sector, and most importantly creates an incentive to produce and develop upstream opportunities here in Ukraine – suddenly it’s become economically attractive to be an oil and gas developer on Ukrainian soil so you’re starting to see international investment interest. I ran into a group from (Norway’s) Statoil just a couple weeks ago at the airport that was heading out to Western Ukraine. You’ve got real opportunities here and I think this is going to be a growth sector.
There is also the energy efficiency space. This is still one of the most energy inefficient industrial economies in the world, the most energy inefficient economy in all of Europe. Which means that all of the productivity gains we enjoyed in the United States in the 2000s are waiting to be had here through more efficient heating, more efficient compressors, more efficient water boiler, better insulation, majoring all of these steps – smart grids – all of these things I think are going to be part of the energy story in Ukraine over the next couple of years as well.
Ukraine still has a major commodity industry. The fate of Ukrainian steel, of Ukrainian iron ore is going to depend on what happens to global commodity prices. But this is a place where there are huge opportunities for value addition driven by what is today a very, very attractively priced labor market.
The good news is you now have Ukrainian energy policy makers, who are not just listening to (Dmytro) Firtash and other oligarchs, but are listening to the market. So when companies like JKX make the point that you just described (high gas royalty levels), I’m confident the Ukrainian system is listening to that. They will adapt and learn.
There were so many distortions three years ago in terms of this energy sector, they’ve got to sort of crank all of the price and market signals through the system. [I’m] very hopeful that they will take the next step this fall. Prime Minister Groysman has told me that he is totally committed to getting an energy regulator law through the Rada, as the Rada comes back this autumn. That will be an important step – creating a regulatory environment that is, again, not dominated by the incumbent oligarchic interests.
FOUR MONTH REPORT CARD ON PRIME MINISTER VOLODOMYR GROYSMAN?
We are very bullish on Prime Minister Groysman. First of all, we believe he is genuinely committed to the project of reform.
It's important to know how active he has been in traveling. Part of the job of any political leader in a democracy like Ukraine is to explain to people why tough measures have to be taken. He’s been to Odessa he’s been to Lviv he’s been to Kharkov. Those are all important opportunities to make the government’s case as to why reform.
As Prime Minister Groysman likes to say: “These are things that Ukraine should have done 25 years ago.” This is absolutely true. The problems in Ukraine’s economy are a residue of the fact that when Ukraine achieved independence there was not sufficient urgency on the project of reform.
The best illustration of that is right next door in Poland – a country that’s pretty much the same size as Ukraine, that had almost exactly the same GDP as Ukraine when they both achieved independence. Twenty five years later, Poland is three times richer than Ukraine because it went through this process of radical reform which Prime Minister Groysman, his advisers, people like (Eastern European reform architects) Leszek Balcerowicz and Ivan Mikloš, are committed now to achieve.
We are doing everything we can to support him, support his agenda of reform. That was a clear message when he (Groysman) was in Washington (in July), seeing Vice President Biden and pretty much everybody else in the US government. And it’s a message that we’re going to continue.
IS A RELATIVELY STABLE DOLLAR/HRYVNIA EXCHANGE RATE LEADING TO COMPLACENCY ON THE REFORM FRONT?
Fear of Putin helps. As Prime Minister Groysman likes to say: ‘Fear is a good motivator.’
I think Ukraine understands today the agenda of reform is not optional. Exchange rate stability is an important accomplishment, especially for business. I remember what it was like in the winter – early spring of 2015 when you’re at wild gyrations, the exchange rate was in the 40s for a couple of weeks there.
One of the most important reforms that nobody knows about is the reform that’s happened in the National bank, where [Bank Governor Valeriya] Hontareva has been a courageous and successful reformer.
The fact is she has closed more than a third of Ukrainian financial institutions, and the system did not wobble. The fact is she has done so much to clean up problems of related party lending, non-transparent bookkeeping, bogus accounts.
There is still work that has to be done in this area but it is a dramatically improved situation from what it was two and a half years ago -- and Gonterevna deserves a lot of credit. As I said, it’s the biggest reform that nobody knows about, because it’s not visible the way energy sector reform or the patrol police or these other things are.
There was a real risk in the spring of 2016, and the Ukrainian system was threatening itself with cannibalism. The feuding that was going on between Narodniy front [People's Front], the BPP, the sense was that: “Oh! We’ve seen this all before! It’s Ukrainian politicians putting their own parochial interests ahead of the nation’s interests.”
I think if that process had deteriorated further, it could have been fatal for the kind of support that we’ve been providing.
But, as often is the case, Ukraine walked up to the precipice -- and then made the right decision. Prime Minister Yatseniuk deserves a lot of credit for the decision he made to surrender his office, and then, equally importantly, for his clear signals of support of Prime Minister Groysman.
Former Prime Minister Yatseniuk sees Groysman’s success as being important to the protection of his legacy and certainly the collaboration between Narodniy front and BPP and the Rada is essential to moving ahead the reform agenda that still need to be accomplished, including the energy sector, the Constitutional reforms, and the judiciary, which were important steps forward in the area where there is still the greatest deficit of reform -- and that’s rule of law, of justice.
Ukrainians should recognize is a very strong bipartisan Republican and Democratic party commitment in the United States, standing with the Ukrainian people, supporting Ukraine, doing the hard work of reform.
Like Vice President Biden keeps saying: “You keep reforming, we’ll keep supporting.”
But it is conditional, and it’s conditioned on a demonstrated Ukrainian commitment to sustaining and caring for the process of reform.
IMF AND CONDITIONALITY FOR DISBURSING MONEY TO UKRAINE IN 2016?
For the United States, it's very important the IMF sticks to its guns, sticks to its principles. I think it would have been unfortunate if the IMF, in the face of incomplete fulfillment of the standby requirements, watered down its conditionality.
In this regard, there are a lot of Ukrainian reformers who support that position. Senor Ukrainians, at the top levels of the government who have said to me: “Ambassador, please make sure that the United States and our other international friends don’t go soft on these conditions, because that’s what empowers us to break the old mafias, to challenge the oligarchs, to build a new Ukraine.”
The good news is, as a practical matter, Ukraine doesn’t need the IMF disbursement today. Their exchange rate is stable, their reserves are solid, the confidence is still there, and the IMF has been very careful to package the delay of its disbursement in a way that at the senior most level on down has signaled to continue confidence in Ukraine, but also continued tough love on the principles attached to conditionality.
Let me answer it this way, I don’t do domestic politics. I’m not going to talk about our election campaign. I’m not going to talk about what our candidates said.
That being said, Ukrainians are vitally interested in what happens in our democracy. There is no more important international partner for Ukraine today than the United States of America. President Poroshenko is extremely generous in characterizing his appreciation to the government and people of the United States. He’s also quite consistent about recognizing that Ukraine's central support from the United States rests on two pillars - both the White House, the executive branch, and the Congress, where there has been a strong bipartisan support.
When I had a farewell lunch with President Poroshenko, we were talking about what will remain for me one of the most memorable moments of my three years in this job. It was sitting in the House gallery as President Poroshenko spoke to a joint session of our Congress. This is the highest honor that our democracy can offer to a visiting head of state. [This came] with an emphatic welcome from the members of our Congress and a very clear message that the Ukrainian struggle to build a democratic European society should be understood as part of a shared democratic heritage with the United States has spent the last 240 years developing.”
ARE FOREIGN INVESTORS STARTING TO MOVE ON OPPORTUNITIES IN UKRAINE?
The most interesting data point for me, you know, is [US-based agrobusiness] Bunge, because you don't do a $180 million project overnight.
The Bunge CEO was here about a month ago for the inauguration for the new plant down in Nikolaev. He described the debate that went on inside his board in 2014, when they had to decide whether or not to go ahead with this project. You can imagine board members of a publicly traded company like that saying: “Ukraine! You must be crazy - don’t you watch CNN?”
But in fact the project has been completed. It's a complete success from the company's standpoint, and it has generated many new jobs. It has generated lots of economic activity. But it also has been good for the American investors, for the American company.
THAT'S A BIG PART OF THE STORY. DON'T GET CONFUSED ABOUT THE OPPORTUNITIES THAT ARE PRESENT HERE.
This is a big European country, a continental country and the violence that the Kremlin has managed to unleash on the south-east corner of Ukraine is isolated at this point. And it's not going to go any further, barring major invasion by President Putin, which I don’t think he’s prepared to do right now.
This means you’ve got enormous opportunities in the 95% of the country that is not facing Russian intervention. And, again, because the economic picture has changed so dramatically in the recent years.
Remember, again, when I got here three years ago, about 50% of Ukraine’s exports were with Russia. The Ukrainians were forced to go cold turkey on that relationship, largely because of these politically motivated embargoes and restrictions that the Russian government has imposed.
But the really striking thing is how nimble and flexible the Ukrainian economy has proven to be in finding new markets and finding new outlets. That's a reflection of the resiliency of this place, but also the fact that this is still a relatively new economic story.
As you said, this sort of an economic frontier, where you can do a lot of new and interesting things, whether in agriculture, agro industry, electronics car parts, metallurgy, informatics. All these things leverage Ukraine's established record. In addition, you have a highly literate, well trained, hardworking, and, at least for now, very inexpensive work force.
WHAT ARE THE CHANCES THE APPEAL OF THE WEST WILL FADE, AND UKRAINE WILL DEFAULT BACK TO LOOKING EAST?
I think Ukraine’s made its choice. I’ve not met a single Ukrainian that said: “Gee, I really wish my kid could go to school in St. Petersburg.”
Ukrainians are not attracted to the model of corrupt, oligarch dominated, Kremlin-subordinated business that the Eurasian customs union represents.
Ukrainians have chosen Europe. They have chosen the association agreements. They have chosen rule of law, the model that comes with being part of the European family.
My own view is that that this process is now irreversible. The issue is how quickly is Ukraine able to move down the road of implementing these standards, and how quickly does the market respond.
THE GOOD NEWS IS THAT THE IRON STRAIGHT JACKET OF EUROPEAN RULES ACTUALLY WORKS TO UKRAINE'S ADVANTAGE.
For instance in the energy sector, again there are powerful vested interests who would be perfectly happy to have this system operate exactly the same way it’s operated for 25 years, because there are people who have gotten very rich off of that.
But as a practical matter, it's an economic dead end. So Ukraine has chosen the European model, the third energy package, European Union standards. All these things provide both a road map, but also a straightjacket in the sense that Ukraine needs to move towards unbundling of Naftogaz. It needs to move towards transparent regulation.
These are all part of the standards that the European Union brings. In exchange, Ukraine gets the protection of being part of the European energy system.
WILL AMERICAN INVESTORS SEE MORE FINANCING ASSISTANCE FROM OPIC, THE OVERSEAS PRIVATE INVESTMENT CORPORATION THAT IS THE US GOVERNMENT'S DEVELOPMENT FINANCE INSTITUTION?
I was with [OPIC President] Elizabeth Littlefield in March, when I was in the United States. She’s very interested in further potentials here. We’ve got some interesting projects that are coming down the pipeline from OPIC.
FUTURE OF UKRAINE'S OLIGARCHS?
You know all of these guys, all of Ukraine's big oligarchic bosses -- Kolomoisky, Akhmetov, Pinchuk, Kurchenko - they’re all trying to figure out where their economic future lies.
They recognize that the model that most of them built their empires on has exhausted itself. That is to say nobody else is going to make himself into a billionaire by buying distressed Soviet era assets and flipping them. That model’s done.
Ukraine is moving towards a system with greater transparency, with an environment of regulation and law, which is trying to apply equally to everybody -- whether your last name is Okhmeter or Shevchenko.
It's a system which is going to create opportunities for new economic players to come to the forefront, outside of these giant economic groups, theseoligarchicgroups that have so dominated the system.
The one oligarchic player who clearly has a red card as far as the US government is concerned right now is [Dmytro] Firtash. He’s an indicted criminal in the United States. That hasn’t changed. And it won’t. The Department of Justice and the FBI are looking actively to have him face justice in a US court.
I'm not going to speak to visa status or legal status of any of these other players.
We do hope that all of them will recognize that the environment has changed, the rules have changed. Everybody has to pay their taxes, everybody has to accept the regulatory oversight of the NBU [Central Bank], the energy regulator, and, probably the most damaging or destructive aspect of the old oligarchic business model - the idea that if you were going to be a successful oligarch there was a whole package that went with that.
You had your media outlets who were part of your political tool kit. You owned members of the Rada. In order to look after your interests you had certain people who worked in key ministries who worked for you. Those days need to end.
The government in Ukraine needs to serve the interests, not of any particular group or family, but of the Ukrainian people. One of Viktor Yanukovich’s legacies was that he was so greedy and he so concentrated the leverage of the state to further his own financial and familial interests, that he basically broke that old oligarchic model.
Now something new started to grow up underneath it. It's not going to happen from one day to the next. We had to work through these issues in the United States in the early 1900s. It's going to take Ukraine time.
But Ukraine has advantages. It has help, including powerful friends like the United States. And it has the roadmap that’s provided by the association [with Europe].
PRIVATIZATIONS ON THE HORIZON?
I strongly support the approach that Prime Minister Groysman has taken which is that privatization needs to be transparent. He said in the case of the Odessa plant that there needed to be at least two bidders, and one of them needed to be a legitimate foreign operator.
These are good principles. Under the circumstances, I think it was just as well that the tender was aborted. He signaled very clearly to us, to me, his intentions to move forward with privatization as quickly as possible.
He has tasked Ihor Bilous, the head of the State Property Fund to develop an approach that finds the right price and deals with some of the issues that deterred at least the key American potential bidder. None are more important that the dead-overhang of Firtash, because of Firtash´s legal status in the United States.
They need to find a way to somehow insulate against the Firtash debt, so that any international company, particularly any American company that picks up the Odessa plant, does not find that it comes with a poison pill.
That's certainly the intention of Prime Minister Groysman and he made it very clear to us that he doesn't want it to stop with the Odessa plant, but he want to look at all of the areas where the government is presently involved.
I agree with former Economy Minister [Aivaras] Abromavicius on the idea that these privatizations are important, first and foremost, not as revenue measures but as anticorruption measures. Because as long as you have these entities in the hands of the state in Ukraine, as in many other countries where you have large state owned enterprises, they tend to attract corrupt interests within the government and from outside.
Ambassador Pyatt leaves Ukraine at the end of this week. Under his watch most would agree that Ukraine has become a better place. Thank you for you have done to help Ukraine down what is a long and difficult road.