Privileged treatment for enterprises with foreign investment in Ukraine has caused considerable losses to the budget and has assumed a scope dangerous to the nation’s economic security.
The National Security and Defense Council session last Thursday seized on a sizable nerve center of financial interests, judging by the pressure from lobbies on the eve of the session and its repercussions.
However, the very fact that the President dared to take this step (moreover, the Council met in the presence of media people), inspires hope that this long-standing problem will at last be dealt with.
Ukraine badly needs investment today. At the same time, how can one distinguish between “pure” investment that works for the national interest and an offshore pseudo-investment that only destabilizes the Ukrainian market? What kind of legislative and administrative barriers should there be to approve projects aimed at stepping up industrial output, creating jobs, and promoting Ukrainian trademarks, while dropping middleman schemes disguised as investments? How can we strike a balance between the investment requirement and budget revenue targets? These points are dealt with in the commentary of Yevhen MARCHUK, Secretary of the National Security and Defense Council.
“”The oil products market has begun to form monopolistic structures which in fact already control over half this market. For example, data for the first twenty days of January show that several structures control almost 85% and about 60% of the diesel fuel and gasoline markets, respectively. Joint ventures have turned upside down the legislative norms which envision protection of foreign investment.
“So the problem of improving state regulation of foreign-invested enterprises can only be solved on the basis of a rational balance between the interests of the state and the investor.
“The question is not in whether or not foreign investments in the Ukrainian economy are necessary but in the different forms of economic mimicry displayed by enterprises with foreign investment toward flaws in our legislation and the system of state oversight of their economic activity.
“In practice, these norms are used to protect of a few enterprises with foreign investment. The situation has been reduced to absurdity, for their investments are below $50 and are often presented in the shape of telephones or fax machines, while these firms’ turnovers on the oil products market reach hundreds of millions of hryvnias.
“In addition to having foreign investment privileges, these businesses were registered (on purpose) in villages enjoying the status of radiation-contaminated areas, which gives still more privileges. For example, the Bison Company is registered in a village near Shostka (Sumy oblast) and the Torh Imeks Joint Venture in the village of Manevychi in Volyn. These juridical addresses do not mean that the firms really work there. There are in fact no representatives of theirs in those areas. They only receive double insurance in order to retain their privileges, such as exemption from VAT, excises, and customs.
“Owing to such privileges, these firms became monopolists on the domestic market of oil products, as well as meat products, poultry, and confectioneries. They have practically pushed out their rivals, and even ruined Ukrainian chicken farming. The import of so-called chicken drumsticks blocked the sales of such domestic items on our market.
“Thus granting privileges to enterprises with foreign investment gave impetus not only to monopolization of the domestic market and elimination of the competitive environment but also caused serious warping of the legal standards regarding the protection of foreign investment. The spring sowing is around the corner, when fuel supply becomes a very acute problem for Ukraine. Taking into account this and also the problem of price making (we know from last year’s experience what difficulties came up due to faults in state regulation), as well as preliminary assessment of this problem and all the above-mentioned considerations, the National Security and Defense Council was forced to put this question on the agenda.
“Why does this and no other body have to look into this problem? It seems to be the job of the legislative, executive, judicial branches, and the Constitutional Court. The Prosecutor General requested the Supreme Court last year to comment on some norms of the legislation in force, so that all know where the law begins and ends. This was caused, among other things, by the fact that joint ventures filed complaints about the attempts of prosecutors and arbitration courts to curtail their activities to common pleas courts, and the latter handed down rulings in favor of these enterprises. Formally, their conclusions were correct. The question is whether they took into account all the facts. For the ruling of the Novozavodsky district court in Chernihiv (June 1998) about the Aktyv subsidiary of ARI Ltd. led to a situation when this entity, mostly engaged in oil products, has failed to pay, since August 1998, UAH 480 million in customs duties, UAH 168 million in excise duties, UAH 678 million in VAT, and about UAH 75 million in other taxes, so in general this ruling helped the firm evade paying UAH 1,401 million to the budget. The Liutnia, Bison, Fianit, its subsidiary Viktor, and Olympic Ltd. companies failed to pay UAH 855.7, UAH 146.5 million, UAH 186 million, UAH 146 million, and UAH 162 million respectively.
“Numerous firms that take advantage of these privileges are in fact subsidiaries of two or three companies, such as Burtex and ARI: they have mushroomed almost all over Ukraine. The Kyivsky district court in Kharkiv handed down a ruling over the suit of the Liutnia firm, as a result of which the budget lost of UAH 855 million. 28 rulings of this kind by first-instance courts have caused the state to fall short of 3 billion 43 million 837.5 thousand hryvnias. The whole country bore witness to this juridical nonsense. The point is that the law provides for protection of foreign investment, which usually means a trouble-free gaining and appropriation of profits, but in this case something completely different happened. For such firms usually made their investments in the shape of low-cost equipment that was used for their own needs and did not help create new jobs.
“Verkhovna Rada is also to blame for this situation because each time the Cabinet, prosecutors or even the President raised such a point (and they did more than once) it passed a far from best decision.
“As the privileged entities, having huge funds, have established their own lobby in Parliament, every parliamentary hearing ended up not in favor of the state. On the contrary, the positions of these entities were only strengthened. Although none of these farms invested in production and infrastructure, practically all of them acted as traders and intermediaries. But the parliamentary lobby still keeps its options open.
“Simultaneously the true big investors working on the Ukrainian market ask for no privileges. Addressing the President after his inauguration in November, the largest investors operating in Ukraine — Coca- Cola, Motorola, John Deere, Citibank, and others (27 all in all) — asked to only that they be granted equal conditions with our domestic economic entities. Moreover, European legislation does not in fact envision any privileges or concessions for investors. It is in Ukraine that this unique situation was created. The original good idea was to create as favorable conditions as possible to attract investors. But this resulted in serious problems, including some for foreign investors. For instance, some foreign, including Russian, firms which would like to sell oil products in Ukraine refuse to enter our market because they will a priori be non-competitive due to the activities of privileged firms (which can manipulate prices at their discretion). Paradoxically, the law which is supposed to protect foreign investors willing to work on our fuel market does not in reality allow them to do so, for the market has been captured by monopolistic monsters who took advantage of their privileged treatment.
“Hence the question of privileges also relates to the judiciary (the Supreme Court convened a plenary session last Friday to discuss this issue). Verkhovna Rada should not duck these problems, nor should the executive bodies, particularly local state administrations which register such firms. For it is very easy to make sure that the firm operating several hundred million dollars and registered in a village near Shostka is almost a monopoly fuel supplier but does not have in this village any office or other facility and, hence, is illegitimate. The governmental bodies, as the phrase goes, came unstuck here, let alone such agencies as customs which constantly monitor all imports and excise duty payments. The customs authorities has already raised this problem, but still there are no apparent results. While the share of goods subject to excise was 59% of the total imports of joint ventures and their imports accounted for 52% of all Ukrainian imports in 1999, only for the first twenty days of this year the share of the excise-dutiable goods imported by the privileged joint ventures made up 64% of all imports of such goods. This testifies to the monopoly status of these entities on the market. Only for the first twenty days of this year, which also included a long Christmas vacation, they failed to pay, due to privileges, UAH 22 million to the budget. Their import of ethyl alcohol and butter accounted for UAH 237 million and UAH 5 million respectively. Thus this is a major and comprehensive problem to be tackled by all branches of state power.
“Having huge money and access to the media and politicians, these entities formed their lobby in Parliament. They also have links to the government. For example, Minister of the Economy Serhiy Tyhypko told the National Security and Defense Council session they hinted they might complicate the situation on the eve of the spring sowing. In other words, the state is now in a virtual trap, having allowed two or three petrochemical monopolists to get so strong that they can even blackmail the government by threatening suspension of supplies, which would cause difficulties in agriculture. They even exert political pressure on this country’s leadership. In this way imperfect legislation has also led to political consequences. Naturally, all these negative phenomena should be countered. This is why we held a National Security and Defense Council session last Thursday. We are going to create the best possible conditions for genuine investors who willingly come to Ukraine and see to it that they do not suffer from the monopolists. We are going to shatter monopolies on these and other markets.
“To offset the unfair use of privileges, which is fraught with market monopolization in some fields, floods the market with substandard products, and endangers the environment, it is advisable to set in motion the levers anti-monopoly and ecological laws, the quality control system, etc. Clearly, these are tactical measures. We should simultaneously plan strategic measures based on a balance between the interests of the state and potential investors. It necessary in this connection to work out in the near future the basic guidelines for Ukraine’s long-term investment policy. This policy should lay down the main state priorities in the sphere of investment, the methods of influencing investment processes and management, informational and banking instruments of investment promotion, the system of investment risk insurance, etc. We must urgently work out and offer economic regulators to restrict the import of goods already being produced in Ukraine or the production of which can be quickly launched in this country and at the same time encourage the import of critical and high-technology items, tighten restrictions on the export of unprocessed raw materials, offer a system of privileges for domestic and foreign investors aimed at the development of national competitive high- technology industrial production (strategic investors) by granting them certain privileges for exporting such products.
“Foreign investors currently working honestly and seriously in Ukraine have nothing to fear. The debate on and solution to this problem in the Council will only improve their performance, especially on the markets mentioned. Speculations that might emerge about this, e.g., claims that we are launching an offensive against investment, is nothing but a defense mechanism of the few privileged firms. For these firms have turned the right to privileges for enterprises with foreign investment, a truly noble idea, into a mockery of the law and budget of Ukraine. As a result, the state has lost about UAH 10 billion of nonpayment to the budget. We can argue for a long time whether or not this was done in compliance with the law, but the fact still remains: tough competition has been created on some domestic markets, the state has incurred tremendous losses and been put at the mercy of a few monopoly structures on the petrochemicals market. This is a fact to be reckoned with, at least for the time being. But this cannot continue. The President has instructed law enforcement bodies to check what kind of figures stand behind all these facts. Thus the exploration of this question still goes on”.
