1. UKRAINE – EU INTEGRATION:
NEW DRIVER OF ECONOMIC GROWTH
(by Global Vision Advisory Services and One Baltic Group)
October 2013

2. Ukraine-EU Association Agreement economic consequences in brief
Ukraine and the EU are going to ratify an Association Agreement. The
consequences of this step for Ukrainian economy will be the following:
 Positive influence on Financial Account and domestic Lending
To intensify capital inflows Ukraine needs deep, but quick reforms
in banking sector and financial markets liberalization (esp. for
European banks).
 Longer-term positive effect on Foreign Direct Investments
To attract strategic investors Ukraine needs to reform the court
system to restore investors trust to the Courts and to local
authorities. Investor’s protection is the key issue to rise foreign
capital at rapid pace and repeat the success of Poland in early 1990s.
 Negative impact on Ukraine’s Trade Balance in the first 1-3 years after
ratification (depending of the Russian trade policy)
To minimize trade balance deterioration Ukraine needs currency
devaluation, improvements in standards of goods quality and detailed
plan for integration with the EU.
2

3. Higher risks of Ukraine’s economy are mainly overstated
There are a lot of speculations in press regarding higher risks of Ukrainian
economy these days. But the fears are predominantly overstated:
 Sovereign default
Association Agreement with the EU will significantly raise chances
for Ukraine’s government to receive stabilization loans from IMF and reopen external capital markets for Ukrainian debtors.
 Currency devaluation
Current exchange rate policy (peg to US dollar) is unjustified by
economic reasons. Hryvnia devaluation will be positive for Ukrainian
economy due to trade balance improvement and increase of Ukrainian
producers competitiveness.
 Collapse of trade with Russia
Recent Russia-Ukraine trade relations worsening is caused by
political, not economic reasons. So the full-scale trade war is not very
likely and won’t last for long even if it begins.
3

4. Association Agreement with the EU will reopen external capital
markets for Ukrainian banks and unfreeze domestic banking lending
 Association Agreement with the EU will create the necessary
condition for Ukraine to receive significant ($15-25 bn for several
years) stabilization loans from IMF and EU financial institutions.
 Stabilization loans will restore investors confidence in Ukraine’s
government as well as in Ukrainian banking system credibility and
reopen external capital markets for Ukrainian borrowers in private
sector.
 Association Agreement with the EU will also encourage European
financial institutions to invest in Ukrainian branches and to buy
local banks. It’s the only way to ease lending terms for local
borrowers.
 Lower capital costs and easier lending terms are needed to
increase capital inflows from the EU to Ukraine (primarily in form of
loans). That will improve Ukraine’s Balance of Payments, unfreeze
domestic banking lending and become the main driver of economic
growth in the forthcoming years.
4

5. Ukrainian banks lost $17.3 bn of foreign capital since mid’2008.
Financial capital from the EU are required to restore it.
Cumulative capital inflows to banks and non-financial
sector since 2000, $ mln
50000
40000
$17.3 bn outflow from
Ukraine banks
Cumulative inflows to Non-financial sector
Cumulative inflows to Banks
30000
20000
10000
0
2000-Q1
2001-Q1
2002-Q1
2003-Q1
2004-Q1
2005-Q1
2006-Q1
2007-Q1
2008-Q1
2009-Q1
2010-Q1
2011-Q1
2012-Q1
2013-Q1
-10000
Source: National Bank of Ukraine, Arbat Capital
5

6. After 2008 Ukrainian banks lost their ability of healthy credit
expansion
Ukraine domestic banking lending, $ mln
140
120
100
Pre-crisis rapid
expansion 70-80% p.a.
Post-crisis "new normal"
0-10% p.a.
80
Households
100
60
Non-financial corporations
Financial corporations
80
Government
40
Banking lending 12-months
growth rate, % (r.h.s.)
60
20
40
0
20
-20
0
Jan-06
-40
Jul-06
Jan-07
Jul-07
Jan-08
Jul-08
Jan-09
Jul-09
Jan-10
Jul-10
Jan-11
Jul-11
Jan-12
Jul-12
Jan-13
Jul-13
Source: National Bank of Ukraine, Arbat Capital
6

7. Ukraine’s economic growth became very sensitive to capital flows.
Lack of funding in 2011-2013 is the main reason of today’s crisis.
Ukraine capital inflows/outflows, $ mln
8000
20
6000
15
10
4000
5
2000
0
0
2000-Q1
2001-Q1
2002-Q1
2003-Q1
2004-Q1
2005-Q1
2006-Q1
2007-Q1
2008-Q1
2009-Q1
2010-Q1
2011-Q1
2012-Q1
2013-Q1-5
-2000
-10
Non-financial sector
-4000
Banks
-15
Government
Real GDP growth, % yoy (r.h.s.)
-6000
-20
-8000
-25
Source: National Bank of Ukraine, Arbat Capital
7

8. Association Agreement with the EU will increase foreign direct
investments to Ukraine, but mostly in longer-term
 More than 40% of current foreign direct investments to Ukraine
are made by Ukrainian investors through European entities
(mainly Cyprus)
 Weak macroeconomic picture, poor legal system, severe
corruption and rumors about forthcoming state default are main
obstacles that withhold foreign investors from investing to
Ukraine
 Association Agreement with the EU can improve only economic
aspects of Ukraine’s investment climate, that is not enough.
Further reforms are required to strengthen investors confidence
and boost foreign direct investments
 Nevertheless, closer Ukraine and the EU economic integration
after Agreement ratification should result in modest foreign capital
inflows from main Ukraine’s trade partners
(Italy, Germany, Poland)
8

9. Foreign direct investments grew almost tenfold over last ten years.
2011-2013 stagnation is a result of weak banks and lack of confidence.
Foreign direct investments to Ukraine in 2002-2013
60
Foreign Direct Investments, mln. USD
50
40
30
20
10
0
Source: State statistics services of Ukraine, Arbat Capital
9

10. Cyprus, Germany and Netherlands are accounted for 2/3 of total
Foreign Direct Investments from the EU to Ukraine
Main EU contributors of foreign direct investments to
Ukraine*
2.1%
2.4%
1.3%
1.6%
1.1%
2.9%
Cyprus
3.7%
40.2%
4.1%
Germany
Netherlands
Austria
6.0%
United Kingdom
France
7.9%
Sweden
Italy
Poland
Hungary
Luxembourg
12.0%
Greece
14.7%
* % of total foreign direct investments from EU to Ukraine
Other EU states
Source: State statistics services of Ukraine, Arbat Capital
10

11. Financial services, real estate, trade and production of metals
consumed nearly 70% of cumulated FDI from the EU to Ukraine
Industrial structure of foreign direct investments from
the EU to Ukraine*
Financial
1.7%
2.6% 2.1%
Real estate
3.0%
1.8% 1.6%
29.6%
Production of metals and metal products
Trade
3.4%
Transport and communication
3.6%
4.8%
Food industry
Chemical industry
Production and distribution of electricity, gas
and water
Mining
5.7%
10.1%
Production of other mineral products
16.1%
Engineering
Construction
13.9%
Agriculture
Others
* % of total foreign direct investments from EU to Ukraine
Source: State statistics services of Ukraine, Arbat Capital
11

12. Nearly 70% of total FDI to Ukraine are made only in three regions:
City of Kyiv, Dnipropetrovsk oblast and Donetsk oblast
Regional structure of foreign direct investments from
the EU to Ukraine*
City of Kyiv
10.6%
Dnipropetrovsk oblast
1.9%
2.0%
2.7%
3.0%
3.0%
Donetsk oblast
Kharkiv oblast
47.7%
Kyiv oblast
Lviv oblast
3.4%
Odesa oblast
4.0%
Autonomous Republic of Crimea
Zaporizhya oblast
5.9%
Poltava oblast
15.9%
* % of total foreign direct investments from EU to Ukraine
Other regions
Source: State statistics services of Ukraine, Arbat Capital
12

13. Association Agreement with the EU may have negative impact on
Ukraine’s trade balance. What is the right strategy to minimize it?
 Association Agreement with the EU means no import tariffs for
Ukrainian manufactured goods (including metals) and higher
quotes for Ukrainian agriculture products in Europe that will
boost Ukraine-EU export
 The same time the Agreement implies no import tariffs for EU
manufactured goods in Ukraine that will result in Ukraine-EU
import rise and hurt seriously domestic producers in a number
of industries
 The positive effect of the Agreement for Ukraine’s trade balance
is at risk, as export increase will be negated by import growth
 Moreover, conventions with the EU carries significant risk of
trade relations with Russia worsening, while CIS is a #1 export
market for Ukrainian producers
WINNING STRATEGY: To motivate moving of production
facilities to Ukraine from the EU countries and Russia.
13

14. However Ukraine’s trade balance deterioration won’t be
terrible, esp. if Ukraine has a plan of devaluation
 Russia will decrease import of Ukrainian agricultural products
and foodstuff, but not very significantly. In case of economic
stagnation in Russia, the population will boost demand for
relatively cheap Ukrainian food products. So a new trade
agreement between Russia and Ukraine is a matter of time.
 Russia will continue to import machines & equipments from
Ukraine due to well-established processing chains (e.g. aircraft
or nuclear power industry). This will keep roughly $7 bn of
Ukrainian export to Russia unchanged.
 Coming 2014 year will be a real challenge for Ukraine as GDP
will decline and Ukrainian Hryvnia will be devalued with high
probability to defend local producers and local markets.
14

15. Europe is accounted for 25-30% of Ukraine export and 30-40% of
Ukraine import. Russia takes 35-40% and 40-45% respectively.
Ukraine goods export / import structure
100
25.9
26.9
27.0
25.3
27.6
33.9
36.4
38.3
36.8
35.9
35.0
40.2
36.6
34.8
37.9
36.5
25.1
20.9
23.1
22.2
26.8
28.9
39.2
43.3
44.0
45.0
40.7
34.0
EXPORT, %
36.0
31.8
32.9
30.0
29.5
26.2
31.3
33.0
37.8
35.6
34.1
37.8
36.9
34.1
32.2
14.5
80
14.2
17.8
17.9
19.8
47.1
44.8
42.2
39.7
60
26.2
40
20
IMPORT, %
0
20
40
50.0
51.3
60
80
35.5
34.5
35.1
37.3
38.0
35.6
35.7
32.9
32.8
32.5
37.2
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
Jan-Jun'13
100
Europe
CIS
Other regions
Source: State statistics services of Ukraine, Arbat Capital
15

16. Ukraine exports to the EU two main groups of goods: 1) base metals
& mineral raw materials and 2) agricultural products & foodstuffs
Geographical pattern of Ukraine's export to the EU
13.5%
16.2%
3.3%
3.3%
3.4%
15.2%
3.4%
3.9%
5.1%
10.5%
5.8%
6.7%
9.9%
Italy
Poland
Hungary
Germany
Spain
Netherlands
Czech Republic
France
Romania
Bulgaria
Austria
United Kingdom
Other EU states
Source: State Statistics Service of Ukraine, Arbat Capital
Commodity pattern of Ukraine's export to the EU
4.7%
2.5%1.4%
4.0%
6.0%
9.6%
11.1%
13.7%
Base metals and metal products
Agricultural products
Mineral raw materials
Machines & Equipments
Foodstuffs
Chemicals
Light industry products
Wood & paper products
19.3%
Other industrial products
Transport vehicles
16
Source: State Statistics Service of Ukraine, Arbat Capital
27.9%

17. Ukraine imports from the EU mostly engineering products
(machines, equipments, transport vehicles) and chemicals products
Main EU importers of Ukraine's goods
13.0%
25.8%
2.5%
2.7%
2.9%
3.2%
3.4%
3.7%
14.6%
3.9%
4.2%
5.1%
7.2%
7.7%
Germany
Poland
Italy
France
Hungary
United Kingdom
Netherlands
Czech Republic
Switzerland
Spain
Lithuania
Austria
Romania
Other EU states
Source: State Statistics Service of Ukraine, Arbat Capital
Commodity pattern of Ukraine's import from the EU
5.4% 3.2%
5.6%
Chemicals
Machines & Equipments
Transport vehicles
Agricultural products
Mineral raw materials
Other industrial products
Base metals and metal products
Wood & paper products
19.6%
Foodstuffs
Light industry products
17
Source: State Statistics Service of Ukraine, Arbat Capital
26.3%
5.8%
6.8%
8.1%
8.3%
11.0%

18. Contacts
One Baltic Group Limited
Global Vision Advisory Services Ltd
GVAS, Room 207
Mortlake Business Centre
20 Mortlake High Street
London
SW14 8JN
UK
18