Welcome to the U.S.-Ukraine Business Council

Document describes the position of the Foundation for Effective
Goverance of the directions, principles and goals for Ukrainian
economical reforms during 2008-2015.
Foundation for Effective Goverance, Kyiv, Ukraine, April 9, 2008


Introduction  3
Overview of the economic changes necessary for Ukraine  4
Basic elements for market economy  7
Improvement of business environment 27
Development of sectors - engines of growth  47

This document describes the position of the Effective Governance Foundation
of the directions, principles and goals for the Ukrainian economical reforms
during 2008 -2015.

The document is meant to serve as the basis for discussion by all stakeholders
and subsequent compilation of an integrated concept of economic
transformations required to achieve substantial improvement in the lives of
every Ukrainian citizen.

Over the past several years Ukraine enjoyed stable improvement of its
economic situation: robust GDP and income growth, falling levels of
government debt and a positive outlook on the national credit rating.

However there is a number of concerns: inflation is slipping out of control,
pension budget deficit has become chronic, labour productivity remains at
a level that is five times lower than that of the most developed countries.

Rising costs of production factors such as energy and wages, a worsening
demographic situation and depleting infrastructure could seriously undermine
Ukraine's competitiveness in the years ahead. Overall productivity must
increase in order to raise Ukraine's competitive strength and maintain its
economic pace.

However the productivity gains are impeded by a large number of outstanding
problems intrinsic for transitional economies. The formation of fundamental
markets, such as land, labour and capital, is still in progress. The
infrastructure is obsolete and investment for its upgrade is lacking.

Excessive share of state-owned enterprises depresses productivity  and
encourages corruption. Heavy taxation, outdated business legislation and
weak judicial system repels foreign investors and impedes the development
of domestic enterprises. Widespread corruption has long been a part of the
system and is perceived by the majority of the population as inevitable.

High energy dependence and low energy efficiency exacerbate the risks.
Demographic  trends if left unchecked can affect productivity and
competitiveness in the mid-term. For example, shrinking labor force and
falling level of qualification already produced deficit of high-skilled
personnel in some sectors. Education system lags economic realities in terms
of structure and quality of graduates.

To achieve stable economic growth these barriers must be overcome. Many
years of persistent work might be required to address each of the described
problems. The variety, number and scale of these barriers demands an
integrated comprehensive and harmonized program of reforms reaching beyond
the election cycles. Consistency in the implementation of the main reforms
that shall be followed up and handed over from one government to the next
will be the key factor for success.

In this Concept the Foundation presents the comprehensive program of reforms
required for Ukraine in the medium-term to lay the foundation for constant
economic growth. The purpose of the concept is to drive the economic
development, improve the welfare of all people and generate enough resources
to address social development issues.

While recognizing that the government role is twofold, firstly to "expand
the pie" by growing the economy and secondly to invest in social protection
and development, i.e. sharing the pie fairly, the Concept focuses on the
first aspect.  The other aspect will require additional reengineering of
existing frameworks, e.g. improving targeting and equity of social programs
as a mandatory precondition for mere volume boost.

While drawing up this Concept the Foundation aimed to put together all the
best practices accumulated by the Ukrainian research centers, institutions
and international organizations as well as integrating the experience gained
from reforms carried out in other countries. The Foundation pays tribute to
all who have contributed to the development of this Concept and to those
whose materials have been incorporated into this Concept.


The goal of the economic reforms described in the Concept is to provide
continuous economic growth, the only means to achieve a sustainable
improvement of human condition. In its turn the only way to achieve such
economic growth in Ukraine will be to increase productivity. The Concept
also aims to provide the conditions necessary for the development of higher
value added sectors so as to reduce dependence on the commodity markets.

Based on the analysis and pattern of economic problems in Ukraine the
Concept encapsulates three directions:

     (1) to secure basic elements of the market economy,
     (2) improve business environment,
     (3) develop the specific sectors - engines of growth.

[1] The main function of the State in relation to businesses is to establish
fundamental prerequisites for economic growth - the essential elements of
a functioning market economy such as effective foreign trade policy,
macro-economic stability, effective factor markets, infrastructure and
natural resources.

Without paying due attention to these questions and taking prompt action
these problems will, in the medium-term, become the main impediments to
progress. Sooner or later these factors will determine the scale and
strength of the economical development in Ukraine.

[2] The second important direction of the reforms is improving the business
environment, which consists of two complementary tasks: creating favourable
conditions and ensuring fair competition. The favorable environment will
enable capital and best practice inflows - precursors of productivity gains.
Fair competition, in turn, will create the necessary productivity pressure.

The task of creating a favorable environment will demand new tax policy and
business legislation, better protection of investors' rights, fair and
expedient judicial system and low administrative barriers. To ensure
competition the government will need to improve governance and regulation of
natural monopolies, reduce the hidden economy by lowering tax burden and
strengthening legal and institutional instruments of competition protection.

[3] The third important direction of reforms will be the development of sectors
that are strategically important and capable of becoming the "locomotives"
of growth. Experience of Eastern Europe and other developing countries shows
that robust retail and construction sectors can spur the rest of the
economy. Importantly, these two sectors alongside with the agricultural
sector in Ukraine are the biggest in terms of employment and the weakest in
terms of productivity.

Subsequently increased productivity in these sectors will free-up
considerable amount of workforce needed for other developing sectors of the
economy. The financial sector provides the financial backbone. Finally the
long-term development of the economy will require constant innovation and
emergence of new knowledge based sectors.

Industrial policy must focus on barrier removal to avoid creating
dependencies or distortions jeopardizing sustainability and competition of
the economy as a whole.  The main goal of the industrial policy will be to
ensure fair  competitive and enable inflow of the world's best business
practices to Ukraine.

Careful, limited in scope and time application of a wider range of
instruments to stimulate industrial economy might be applied in addition to
barrier removal, but only for nascent industries until they reach their
critical mass.

According to the international experience of large-scale economic
transformation success depends on the ability to prioritize tasks and focus
the resources. Stage by stage action allows the resources to be concentrated
for best impact. In this connection the proposed directions are divided into
three stages (please see the figures in the attachment) in accordance with their
impact potential as well as complexity and time intensity.

The ultimate goal of the efforts is to improve the living of the Ukrainian
citizens including establishing a broad level of successful middle class.

The goals and tasks set out in the Concept are ambitious. However successful
implementation of complex development  programs can be achieved if based
on well-coordinated work by all branches of power and monitoring by the civil
society. Work of such a scale under democracy was successful in the
countries whose citizens, authorities and politicians shared the
responsibility to achieve the agreed objectives.

To contribute to the implementation of the economic development program in
Ukraine the Foundation is prepared to work with public authorities civil
society on all levels.

This Foundation is urging country and its citizens to aim for economic
growth and start actual work on the improvement of the human condition in


Land and real estate markets

Ukrainian land and real estate markets are at the initial stage of
development. Currently, moratorium on sales of agricultural lands is in
effect, while supply and demand are misbalanced on agricultural land and
real estate markets (according to European Business Association, the gap
between supply and demand in some real estate categories is as high as 90%).

Development of land and real estate markets will encourage development of
other sectors, such as construction, agriculture and  retail, as well as
reduce potential corrupt practices. In addition, creation of land and real
estate market will ensure a possibility to engage additional resources into
the economic cycle.

Major issues in the field of Ukrainian land
and real estate are as follows:

   [1] No common national register of titles to land and real estate
   property and limitations thereon
   [2] Long and complicated procedure for transfer (sale) of title to land
   and real estate property and registration thereof
   [3] No free sale of agricultural lands
   [4] Limitations on purchasing farmland outside settlements for
   development and target use of non-agricultural land within the territory of
   settlements by certain categories of legal entities (e.g., legal entities
   with shareholders represented by foreign legal entities and individuals,
   Ukrainian representative offices of foreign companies)
   [5] Complex and non-transparent procedures for changing target use and
   purpose of land
   [6] Complex and non-transparent procedures for changing purpose of real
   estate property
   [7] Division of state and communal territories is yet to be finished
   [8] Complex and non-transparent procedure for sale of land and real
   estate property owned by the governmental and municipal agencies at
   different levels

Major targets in this field will be to achieve transparency of the land and
real estate market and ensure protection of rights of real estate property
owners. During 2008-2009 a common register of titles to land and real estate
property should be created, division of state and communal territories
finished, and in 2008 all constraints on sale of farmland and
non-agricultural lands should be cancelled.

A top priority step in the field of land and real estate property will be to
create a common register of titles to land and real estate. The register
should be available in electronic form and the information should be
publicly available. In order to facilitate the process of creating the
register, sufficient human and technical resources as well as funding should
be provided. The process should be finished in 2008-2009.

To simplify and accelerate the procedure for transfer (sale) of title to
real estate property and land and the registration thereof, a
'one-stop-shop' approach should be introduced in customer services
operations within a common agency dealing with registration of transactions
with land and real estate property. Also, the procedure should be implemented
in electronic format.

While creating a common register of titles to real estate property, the
following amendments to the Land Code should be developed and

   [1] Allow buying non-agricultural land both within and outside the
   territories of settlements for development and any target use by legal
   entities registered in Ukraine, whose shareholders are represented by
   foreign legal entities and individuals, including Ukrainian representative
   offices of foreign companies
   [2] Remove the moratorium on sale/purchase of agricultural land

The procedure for changing the purpose of land and real estate should be
simplified and accelerated, while it should be ensured that the process is
not biased. Clear and transparent criteria should be established (including
the exhaustive list of documents), which shall, if met, make it mandatory
for the state agency to make the decision on changing the target use of land
within certain purpose, a separate list of criteria should be created, which
shall, if met, oblige the state agency to change the land purpose and a
separate list of criteria should be created, which shall, if met, oblige the
state agency to change the real estate category.

Division of communal and state-owned territories should be completed by
the end of 2009.

The procedure for sale of state-owned and communal land plots and real
estate property owned by governmental and municipal agencies (region, city,
district, and other levels) should be simplified and unified, and equal
access should be provided for all the stakeholders. Open auctions for sale
of municipal land and real estate property may become a possible instrument
as one of the most transparent sales techniques.

A unified procedure for holding bids and organizing land auctions should be

During 2008-2009, the top priorities will be to create a unified national
register of titles to real estate property, to complete division of communal
and state-owned territories, and to cancel limitations on sale of
agricultural and non-agricultural lands in 2009.

Trade policy

In 2007 Ukraine had trade operations with 199 countries. The country's
foreign trade turnover was about 97% of the GDP (vs. about 44% in Russia).

High degree of transparency of Ukrainian economy increases the importance
of trade with neighboring countries, further liberalization of imports, and
improvement of exporters' access to international markets.

Further integration into international foreign trade practices requires
lowering tariff and, especially, non-tariff limitations, and simplifying
customs procedures. According to the World Bank's report entitled 'Doing
business 2008', the number of documents required to import goods to Ukraine
is twice as big, while the time that the import procedure generally takes is
4 times longer than the average time in OECD states. The other side of the
issue is bribery at customs and smuggling.

Access for certain Ukrainian goods to US and EU markets is still limited due
to the antidumping measures currently in effect. For instance, USA imposed
an anti-dumping duties of 90.33% on hot-rolled flat products; while EU
imposed a 29.26-33.25 euro per tonne duties on ammonium nitrate.

The major target of the Ukrainian foreign trade policy should be to ensure
for export industries favorable conditions of access to the markets of the
trade partner states. The above can only be achieved through further
integration of the Ukrainian economy into global trade system along with
opening the domestic market.

To achieve the above targets Ukraine will have to perform the following

   [1] Extend partner relations with EU (create a free trade area and
   implement the 'action plan')
   [2] Determine optimal format for commercial relations with CIS states
   (first of all, with the Russian Federation)
   [3] Complete the process of entering the World Trade Organization

Important tasks of Ukrainian foreign trade policy are still to develop
commercial relations with EU and CIS not only within the WTO, but also at
the regional level. Economy of these regions have opposite correlation with
prices on raw materials, therefore simultaneous liberalization of commercial
relations with them would ensure a possibility for Ukraine to diversify the
risks of cyclical recession in demand for Ukrainian exports at one of these
outlet markets.

The mid-term priority of foreign trade should be creation of the free trade
area with EU, which is already being negotiated. Free trade area will
primarily affect the issues of non-tariff limitations in the field of
movement of goods, services, capital and human resources [1]. That makes the
task of the negotiation team even more difficult, for the issues in question
are yet to be reviewed in detail in Ukraine.

In order to prepare the Ukraine's negotiation position, representatives of
the business and business associations should be involved to simulate the
impact of certain decisions on the country's economy in general. Negotiating
areas may be prioritized given the impact of the measures on trade,
difficulty in coordination of standpoints, and complexity of implementation.

No doubt, further efforts on implementation of Ukraine-EU 'action plan'
should be taken. The plan provides for such strategic partnership measures
as simplifying the procedure for customs clearing, and cooperation of
customs agencies, reducing technical trade barriers, increasing transparency
of state purchasing, etc.

At the same time, CIS states, most importantly Russia, are no less important
trade partners for Ukraine. Since a lot of agreements exist in CIS only in a
nominal way, their viability and necessity should be evaluated, and the
format for trade and economic cooperation with these states determined.

As the experience of the Common Economic Area shows, the area not actually
functioning, it is difficult to balance interests of many CIS states in a
single treaty, therefore it is reasonable to develop bilateral foreign trade
relations with CIS states. Ukraine should seek to keep the free trade regime
with CIS states, especially with Russia, extend the scope of application
thereof, and eliminate non-tariff trade limitations.

Entering the WTO will result in major export industries (metallurgy,
chemical industry) receiving wider access to their trade partners markets,
including through the use of the WTO dispute resolution procedures.
Industries targeting domestic market are not expected to experience
significantly reduced production, for the average weighted customs tariff
rate (about 6% for industrial products) will not be reduced significantly
after entering the WTO. Therefore, special measures to protect industries
are unlikely to be required.

However, certain sectors, especially food industry and agriculture, may have
to face significant reduction in headcount, caused by the need to improve
production performance[2]. Therefore, the WTO entering team must conduct
analysis on such sectors and come up with the measures to support movement
of workforce.

In the long-term horizon, entering the WTO will put Ukraine in a position,
where it will face new challenges. In particular, it concerns the issue of
protecting domestic manufacturers and consumers on the internal market from
unfair competitor practices, and providing the WTO trade policy data to
domestic manufacturers. Constant data sharing between state agencies and the
business should be a facility to make the required information available for
the chambers of commerce and industry and business associations.

The first step in execution of the tasks set should be ratifying the WTO
agreement by July 4. Also, national targets in development of regional
cooperation with EU and CIS states should be established. The obligations
assumed in areas of cooperation already coordinated with trade partners
should be carried out on time (for example, in Ukraine-EU 'action plan').


Macroeconomic stability is a major component of favorable business climate.
For example, high inflation rate increases risks and expenses of long-term
planning, as well as effective tax burden on enterprises, while the state's
low credit rating, being a proxy indicator of political and economic
stability of the country, increases the cost of borrowing, and hinders
direct investment.

Ukrainian macroeconomic landscape is uneven. On the one hand, state
debt [3] has been reduced in recent years, budget deficit reached moderate
levels [4], and the country's credit rating reached investment grade. On the
other hand, annualized inflation rate reached 22% [5] in February 2008
with government anti inflation efforts so far limited to mere administrative
price controls for certain goods showing little impact.

Increase in inflation rate is driven by a number of supply and demand
factors. Along with external factors like growth of costs for fuel and
foods, Ukrainian price index is significantly influenced by a number of
internal factors well within the reach of public policy.

The largest portion of inflationary pressure firstly comes from growing
money supply, in the absence of capital inflow sterilization and within a
framework of a fixed foreign exchange rate and softening budgetary
policy [6]. Secondly, from increasing cost of imports driven by the dollar
pegg induced depreciation of hryvna.

Thirdly, from slow growth of labour productivity, especially in sectors
dominated by state-owned enterprises or distorted by a substantial number
of unreformed natural monopolies.

The situation is aggravated by the fact that some levers of monetary policy
like interest rates are no longer effective in the conditions of high
inflation rate and wide spread practice of lending from abroad.

Another factor is the insufficient independence of the National Bank of
Ukraine [7] characterized by weak statutory protection of the Chairman from
political pressure, possibility of government authorities to influence the
NBU monetary policy through the members of NBU Board and weak
financial independence of the NBU.

In this situation reducing inflation is an equally urgent and difficult
public policy task. The coordinated price stability policy should aim at
achieving gradual reduction of inflation to a stable level of about 10% by
2012, and 5-7% by 2015.

This will require using all available existing fiscal and monetary policy
tools as well as introducing the new ones. The state should use the
following levers:

   [1] Ensure complete institutional independence of the National Bank of
   Ukraine and all-round implementation of monetary policy tools
   [2] Increase fiscal discipline
   [3] Introduce floating hryvna exchange rate within a certain corridor
   [4] Introduce better supervision and control of risks posed by
   aggressive consumer lending practices in the banking sector
   [5] Increase labour productivity through de-regulation of the most
   low-performing industries, like agriculture, reform of natural monopolies
   and continued privatization

A new law on the National Bank of Ukraine should be passed, securing central
bank's independent of any governmental or private sector influence or
lobbying and making price stability the overriding goal of NBU's mandate.
The degree of NBU independence should increase by means extending the term
in office and raising dismissal criteria [8] of the Chairman of NBU and the
members of NBU Board.

The new law should also prohibit them from taking part in politics, being
members of the parliament or the government. The new Central Bank profits
distribution mechanism should secure its financial independence.

Stricter fiscal discipline should result in reduced public spending. The
public spending in excess of 54% of GDP reached excessive value[9] for the
current development stage of Ukraine, especially given that the spending
structure is skewed towards short-term consumption[10]. The government
should therefore limit the growth of public transfers while increasing the
investment share of the budget.

In order to reduce relative volume of transfers, pension reform should be
implemented.  In the short term horizon, Ukraine should avoid introducing
any new budgetary spending feeding consumption, in the absence of adequate
recurring funding sources. Ukraine should give up the practices of funding
investment initiatives from nonrecurring income, for example, pension and
social transfer increases must not be funded by privatization income. The
overall growth rate of public spending should not exceed the economic growth

A more flexible exchange rate managed within a certain NBU set range could
somewhat level the inflationary pressure resulting from capital inflows and
appreciation of imports. This action is required even though it may produce
negative temporary impact on competitive power of Ukrainian exporters.

Active growth of consumer loans [11] creates additional inflationary
pressure by substantially increasing the already fast-growing per capita
income. For example, in 2006 the growth of consumer loans accounted for 30%
of the growth in total household consumption. Experience of some East
European countries [12] shows that excessive growth of bank loans used for
consumption and investment in real estate does not increase long-term
potential of the economy nor provides for the repayment of the loans in the
future. At the same time, loan portfolio quality is often highly cyclical,
which creates volatility risks during the slower growth periods.

Given the above risks, preventive actions should be taken, including
introduction of monitoring and effective control of the volume and quality
of the consumer loan portfolio, as well as its influence on further
misbalance between supply and demand in Ukrainian economy.

In the long term, inflation can only be sustainable slowed by rising
productivity, ideally at rates exceeding the wage growth rate. Productivity
gains occur at the enterprise level, but the state may facilitate this
process by ensuring fair competition (it will create pressure to increase
production performance) and enabling better access to best practice (for
example, by creating favorable conditions for direct foreign investments or
encouraging domestic investment in modernization). In the mid-term horizon,
the focus of efforts of the state should shift towards privatization and
reform of natural monopolies - a notable source of inflation.

Given the above, the top priority steps for inflation control should be as

   [1] Develop a new NBU law to increase its independence and ability to
   conduct efficient monetary policy
   [2] Introduce a floating hryvna rate, probably, in combination with
   limited actions for temporary and targeted support of export industries
   most affected by the shift in cost
   [3] Publicly assume obligations to immediately (before compiling the
   2009 budget) and gradually reduce the budget deficit, while reducing
   relative volume of non-investment expenditure in proportion to GDP.


Ambitious economic growth targets will require maximum efficiency of using
the resources available in the economy. Global experience shows that
state-owned companies lag behind the comparable private sector companies
in productivity, costs and performance indicators.

State share in Ukrainian GDP is now 37%[13], which is higher than that in
most developed countries worldwide (in Canada, England, Italy - about 15%,
in USA and Germany - about 20%, in Poland - 25%). High share of state-owned
property and indefinite nature of the privatization process both slow down
the denationalization process and encourage corrupt practices, which result
from the contest for access to administration of state-owned companies.

Thus, major targets of privatization are increasing asset management
performance and reducing corrupt practices. Ukraine should further follow
the avenue of reducing the number of state-owned enterprises, where state
ownership is not critical for national security, through transparent and
predictable privatization process.

This will not only ensure the opportunity to increase economic performance,
but will also provide the state with additional funds to conduct structural
reforms, and will reduce political tension in the contest for administration
of state property. Major targets of privatization are to update the
privatization program, develop, approve and implement industry-specific
privatization concepts, and decrease the share of state sector in GDP to the
level of Poland - 25% -  by 2015.

This task creates a number of issues to be resolved by the Government:
determine privatization targets of the state for each industry, establish
criteria to classify a certain industry or assets as not subjects to
privatization, choose a privatization technique, establish standard
privatizing process, perform privatization at the reasonable market cost,
and determine whether pre-sale preparation is required. Appropriate laws
should be developed to accelerate and simplify the privatization process
and to clearly document the authority and responsibility of state agencies
dealing with privatization.

In order for the privatization to be a success a clear hierarchy of state
privatization targets by each industry is required. Industry privatization
concepts should include state targets (economic, social) and the program
for associated industry liberalization as well as for changing regulatory
environment that should be aligned with the above targets.

The regulation system should create equal competitive conditions for
privatized and non-privatized companies within the sector, including, for
example, cancellation of preferences and subsidies to the state-owned

The list of enterprises that are not subject to privatization should be
reduced to the minimum and include only enterprises that are critical for
national security (for example, nuclear electric power station) and
enterprises, the state ownership whereof ensures equal access to critical
assets (for example, airports). The criteria for classifying an enterprise
as non-eligible for privatization should be clear and without a possibility
of violent interpretation. The list of enterprises that are not subject for
privatization should not, for instance, include sports facilities, salt and
bread production industries. The list of non-eligible for privatization
enterprises should not be easy to change within a short timeframe to ensure
that the process is irreversible.

In case of privatization, mixed sales, being a sale of substantially all
(controlling interest) the shares to a strategic investor with further
public offering on a local market, ensure both high income and target
shareholder structure, as well as development of the stock market.

The common approach to the privatization process is to use a standard, as
specific as possible, and simple process that is common for everyone, and
minimum limitations to ensure equal participation of all the stakeholders in
the process. Selective and complex privatization pattern increases the risk
of 'asset milking' significantly. Eligibility requirements should be minimal
for the buyers. Among other things, requirements for consumption/supply of
products to a special enterprise , as well as that of experience of
operations in Ukraine, should be discarded.

No limitations available on the purchase of assets by foreign entities and
individuals will result in significant increase in the fiscal receipts and
the degree of administration performance at the privatized enterprise.
Post-privatization requirements for the investors should be simplified and
minimized. For example, the requirement to support social infrastructure
facilities after privatization, as well as that of the level of salary,
should be cancelled.

Operational restructuring conducted by the state prior to privatization
aiming at assets value increase is generally inefficient. Restructuring of
state-owned enterprises should focus on reducing debt and excessive
workforce, as well as taking social infrastructure facilities off the
balance, rather than on investments.

For the Ukrainian privatization process to be a success, the following
actions should be taken: update privatization program, develop, approve and
implement industry-specific privatization concepts that establish clear
targets and govern the new denationalization process.

Capital markets

Law "On Securities and Stock Exchange" came into force over 15 years ago
but Ukraine's stock market has yet to achieve the aspired level of development.
For example, the level of securities market capitalization as % of GDP in
Ukraine is 5 times lower than it is in Germany, 6 times lower than it is in
Russia, and 14 times lower than it is in Great Britain. Ukraine falls behind
Eastern Europe countries and Russia significantly by ratio between shares
trading and GDP[14].

Key reasons for the problems are associated with a number of closely
interrelated factors: a small share of freely traded securities of each
individual company, lack of issuers, lack of confidence, and low liquidity
level. Reasons of medium importance include poor information transparency,
regulatory gaps, and vague role of non-government organizations that control
the market. Reasons of modest importance include high risks associated with
activities of existing financial institutions.

Underdeveloped capital markets pose difficulties for economic development of
Ukraine. For example, on the one hand, due to unavailability of access to
any non-bank financing source within Ukraine, many companies are always
imposed to increased insolvency risk in case of cash flow disruptions as
well as currency exchange risk in case of substantial share of foreign
currency borrowings. In addition, such companies are unable to manage risks
due to lack of hedging instruments.

On the other hand, individuals suffer lack of investment opportunities which
causes reduced share of savings and overheated real estate market which is
the most popular and available means to invest private savings.

Mid-term development of capital markets should aim at achievement of average
indicators observed in such neighboring countries with developed capital
markets as Russia, Hungary, and Poland with regard to stock market
capitalization (ratio between capitalization volume and GDP) and liquidity
(ratio between trading on the organized market and capitalization) [15].

Urgency of measures aimed at capital market improvement is underlined by
experience of developing markets, particularly, Latin America markets, which
showed clearly that it is almost impossible to cease outflow of capital and
issuers from underdeveloped markets to regional and global trading floors in
some period of time.

For this reason, the government should immediately undertake an active role
in development of national capital markets by five areas of activity, that
   [1] Enable availability and choice of financial instruments
   [2] Encourage market activity
   [3] Improve capital market infrastructure and remove barriers for
   investors and capital users
   [4] Improve regulation and control over capital markets
   [5] Improve investor rights protection

The first step to improve availability and enhance choice of financial
instruments should include development of government securities market
considered to be a driver for liquidity facilitating creation of a long-term
interest rate curve which is crucial for functioning of any affective
capital market. This requires a sufficient issue volume, a market mechanism
to determine interest rates, concentration of liquidity within a limited
number of large issues, and an exact offering process (a regular issue
calendar, issue regardless of state funds deficiency, and a system of
primary dealers).

Another important lever may include encouraging of share issues and
increased percentage of freely traded shares achieved by improvement of
listing requirements, for example, introduction of simplified listing
standards to cerate additional categories of share market. In addition, it
is necessary to use Initial Public Offering (IPO) instrument and free
trading of shares for privatization of large state-owned assets.

 Encouragement of market activity will require attraction of foreign players
to the market, establishment of new market players in Ukraine (for example,
pension funds), and elimination of restrictions for investment instruments.
Attraction of foreign players will require alignment of requirements to
licensing and reporting with international standards, liberalization of
capital transfer rules, more thorough investor rights protection, and
development of capital market infrastructure. Establishment of new market
player segments is determined mainly by introduction of the second (savings)
level of the pension system. Elimination of restrictions for investment
instruments includes liberalization of rules for obligatory instrumental
diversification of investment fund portfolios[16].

In terms of infrastructure, the key requirement for capital market
development is consolidation of exchanges and depositaries. It is also
important to start implementing paperless securities, and determine the role
of a centralized depositary which would keep records on all securities by

It is impossible to increase activity of stock market, and particularly,
attract foreign players without improved protection of investor rights.
Today, Ukraine is the only state within CIS where there is no law "On
Joint-Stock Companies" in place, though, joint-stock companies comprise
about one third of the total number of actual players in the economy.

Therefore, law "On Joint-Stock Companies" should be approved without delay
to protect rights of shareholders and set requirements to transparency of
companies in line with European standards. It is also required to refine
legislation to strengthen control over standards of disclosing financial
information and requirements to stock market players.

An important link to development of an effective stock market should include
a single state regulatory agency[17] responsible for elabouration of
appropriate legislation, infrastructure development, control and
methodological support for market players and transactions made in the stock
market. In order to improve performance of supervisory functions, the
government should introduce a new financing mechanism where the regulator is
funded by mandatory contributions from the market players, in proportion to
their asset volume (a common practice in many EU countries).

Natural gas and electricity markets

Natural gas market
Ukraine's economy is one of the world's most natural gas-intensive: the
share of natural gas in Ukraine's power consumption structure is about
41% [18]. Only one quarter of the 86 billion cubic meters of natural gas
[19] consumed in Ukraine annually is produced in the country, the rest comes
from Russia, Turkmenistan, Uzbekistan and Kazakhstan (the proportions
vary from to year). Imported natural gas is transported to Ukraine through
pipelines owned by Gazprom.

On the other hand, about 70% of the natural gas supplied to the European
Union and some CIS countries from Russia is transported via pipelines owned
by Ukrainian.

Ukraine's major problems with the natural gas market:

   [1] Lack of independence of the natural gas industry:
   -       all pipelines enter Ukraine from Russian territory
   -       Ukraine's own law hampers development of domestic natural gas
   .       companies that undertake gas field exploration have no guarantees
           for right of gas production in fields they have explored (two licenses
   .       restrictions set on companies with 50% Ukrainian government
           ownership stake, they can only sell gas produced in Ukraine for
           consumption by domestic enterprises at fixed prices that are below
   .       continuous increase of tax rates on natural gas production in
   .       export quotas for natural gas produced in Ukraine.

   [2] Instability of the natural gas sector.

In the recent years import contracts for natural gas have been re-formulated
ever year. Frequent changes in political expediencies bring along risks
associated with change of rules in the natural gas industry.

   [3] Unclear and fragmented legal base for the natural gas sector
results in the lack of transparency and contributes to corruption

   [4] Risk of a price shock in the next 1-2 years

Turkmenistan (the main source of Ukrainian natural gas imports) declared
transition to a formal method for calculating gas price for Ukraine starting
in 2009.  As per expert assessments, use of the formula will result in the
price of about $300 US for 1 cubic meter of natural gas imported to Ukraine
in 2009. Given 41% of the natural gas share in Ukraine's total energy
consumption such increase in price may pose a threat of an economic crisis.

   [5] Low efficiency of Ukraine's natural gas transportation system

Primary indications of that are high process costs and losses (deterioration
of the trunk and distribution pipeline infrastructure) which amounted to
about 8% of total consumption in 2006 (including unauthorized gas take-off
within Ukraine borders), and low efficiency of the natural gas consumption:
in 2006 only 43% of the households had gas meters.

   [6] Making business and the state, not households pay for consumed gas
Regional heating enterprises and households pay for the natural gas at rates
that do not cover costs, while natural gas rates for industrial enterprises
are 3 times as much as the rates set for households (as of early 2008).

   [7] Payment defaults
In 2007 the default level by all categories of consumers was13.3%, with
defaults by TeploKommunEnergo of 19%.

The main development goal for the natural gas market should be reducing
Ukraine's natural gas dependence and attracting sufficient investments in
the infrastructure to ensure sectors security and high performance.

It is imperative to increase independence of Ukraine's natural
gas system.

   [1] Stimulate exploration and development of new gas fields in Ukraine:

- clearly define the  process and terms and conditions of new field
exploration in Ukraine and invite investors (both Ukrainian and foreign) for
exploration of new fields
-  provide legal guarantees of the production rights for the companies
that explored the field
-  lift restrictions on the sale of the natural gas produced in Ukraine
only for domestic consumption at fixed rates that are below
-  increase efficiency of the natural gas consumption by businesses and
by TeploKommunEnergo, including through investments in new technologies to
increase coefficient of gas combustion efficiency
-   stop continuous increase in taxes on gas production in Ukraine
-   lift the quotas on export of natural gas produced in Ukraine

   [2] Continue lobbying efforts for construction of the "White Flow"
natural gas pipeline from Turkmenistan through Azerbaijan and Georgia laid
on the floor of the Black Sea. The actual potential of the project, its time
of completion and risks should be assessed.

   [3] Evaluate feasibility of building a natural gas liquefaction  plant
on the coast of Crimea, which will enable Ukraine to import liquefied
natural gas from Iran (an agreement for potential co-operation is already
signed by Iran) or from Georgia

It is imperative to achieve predictability of the natural gas market in
Ukraine: a long-term gas supply contract with Russia needs to be signed;
that will stipulate clear mechanisms of delivery, the rules of price
determination/calculation, and will secure guarantees of compliance by both

It is imperative to pass an integrated law "On the Natural Gas Market" in
Ukraine that will clearly stipulate the rights and obligations of all market
participants, the scheme of transferring gas on all stages from the moment
it reaches Ukraine to the end user. It will regulate the process of using
gas storages, stipulate regulator's and supervisory bodies' authority. A
regulatory body should be independent from the executive branch. The head of
the regulatory body should be appointed by the President or the Rada, rather
than by the Cabinet.

A program of preparation of Ukraine's transition to market prices for
natural gas should be developed and adopted. The program should be based on
the long-term development strategy of Ukraine's natural gas market. However,
it should be primarily focused on measures aimed at ensuring predictability,
accountability and minimal adverse effects of the transition process to the
market prices.

In order to increase efficiency and improve safety of Ukraine's natural gas
system, it is necessary to invest in upgrade of the gas transmission
infrastructure, starting with residential housing and important public
facilities (schools, kindergartens). It is imperative to install gas meters
in 100% of all businesses and households by the end of 2009 to ensure
efficient use of natural gas. According to Naftogaz, Ukraine's assessment,
installation of meters in households would save 8-10 billion cubic meters of
gas, which is around 10% of all natural gas consumed by Ukraine per annum.

The efforts against payment defaults need to be organized in a clear and
transparent manner. The law (for example law "On the Natural Gas Market")
should stipulate a step-by-step process of rates change on all levels,
secure payment deadlines, and define the penalties for failure to pay. It is
necessary to identify the categories of facilities that cannot be cut off
from gas supply even in the event of default (for example schools,
orphanages), entities that will be required to pay off their debts, payment
deadlines. In the event any other facilities fail to pay for natural gas,
all penalties provided for by the law should be strictly implemented, up to
cutting off the gas supply and initiating bankruptcy proceedings against the
defaulting enterprises.

The process of gradual increase in natural gas rates for general public to
the breakeven level should be predictable and expected. The time line and
the amount of the rates increase should be clearly defined, and the
population should be widely informed. Rather than receiving subsidies
through administrative areas natural gas enterprises (on the province and
county level), the disadvantaged categories of the population should receive
them from the budget allocations through the social security agencies.

The top priority measure should be development and passing of the Law "On
the Natural Gas Market" in Ukraine.

Electric power market

Electricity production and consumption has been growing in Ukraine since
2000. Of 195 TW of electricity produced by Ukraine in 2007, about 90% were
produced by thermal and nuclear power plants (43% by thermal and 47% by
nuclear plants) and 5.2% by hydro power plants. Renewable energy sources
(wind, sun) only amounted to less than 1% of total production. As of 2007
the thermal plants were used only to 27-30% of their total power generating
capacity, while 8.8 TW or 4.5 of total electricity produced was exported.

Main problems of Ukraine's electric power market:

   [1] Low efficiency of Ukraine's electric power system
Both low efficiency of power generation (first of all by thermal plants) and
high in-process losses (caused by obsolete and deteriorated transmission
and distribution grid) testify to that, as well as low efficiency of
electric power use. The in-process losses of power in 2007 were 12.6%
which is twice the losses in the developed countries.

   [2] Risk of failure to meet the demands of the growing economy for
electric power.

Despite the fact that Ukraine has sufficient capacity for generating
additional power at thermal plants, these capacities are obsolete and
unreliable, their remaining useful life being 5-7 years (thermal plants
produce 43% of total electricity). The old, deteriorated grid of
cross-country and public supply power lines will not be able to ensure safe
transmission of large volumes of power (especially in the cities) to meet
the needs of the growing economy.

   [3] Tariffs for households do not cover even basic expenditures.
In 2007 electric power rates for the general public only covered 50% of the
costs. It results in the reduction of the funds, which are scarce as it is,
available for investing in the sector. Raising the rates for the public to
the economically feasible level will stimulate reduced consumption,
introduction of energy saving measures, and will also allow for the increase
in investment in the sector by the power supply companies.

The main development goal for Ukraine's electric power market should be
ensuring sufficient investment in the energy sector, reduction of GDP's
energy-output ratio and improved efficiency of Ukraine's electric power
system, including through twofold reduction of the in-process energy losses
to 5-6% (developed countries level).

Large capital investments are in order to ensure safe and uninterrupted
performance of Ukraine's electric power system under conditions of  growing
demand and consumption as well as to improve the system's efficiency. It is
imperative to update the existing generating capacities of the thermal
plants and the deteriorated grid of cross-country and public supply power
lines (for example replace old low voltage cables with the high voltage

Privatization of the generating capacities of the thermal plants with
clearly defined investment responsibilities can be an effective mechanism of
attracting sufficient investment to the sector. The rates need to be raised
to the economically feasible level in order to ensure normal levels of
investment into power generation, transmission and distribution.

The process of gradual electricity rates increase for the general public to
the break-even level should be predictable and expected. Timelines and rate
increase amounts should be clearly defined, and the population should be
widely informed. Rather than receiving subsidies through Regional
Electricity Providers (on the province level), the disadvantaged categories
of the population should receive them from the state budget allocations
through the social security agencies.

Attracting sufficient investment to the electric power sector through
continued privatization of the thermal power plants' generating capacities
and electricity rates increase to the economically feasible levels should be
Ukraine's top priority.

Electric Power Market

Starting in 2000, the production and supply of electricity in Ukraine grew
up. Out of 195 terawatts of electric power produced in Ukraine in 2007,
about 80% was produced at thermal and nuclear power plants (43% at thermal
power plants and 47% at nuclear power plants) and 5.2 % at hydro power
stations. Renewable energy sources (wind, solar) produce less than 1% of the
total electric power.

In 2007, the thermal generating facilities utilization rate was 27-30%; 8.8
TW or 4.5% of all generated power was exported.

Fundamental problems in the energy market in Ukraine:

   [1] Low efficiency of the power supply system in Ukraine.
This is seen in the low efficiency of power generation (especially at
combined heat and power plants), as well as in a high rate of process losses
(due to outdated and worn power transmission and distribution grid), and the
low efficiency of electricity utilization. Process loses in 2007 were 12.6%,
which is twice as much as in developed countries.

   [2]  The risk of inability to satisfy the growing economy's electric
power demand.

Even though Ukraine has sufficient capacity to generate additional electric
power, these capacities are obsolete and their remaining service life is 5-7
years (about 43% of all energy is produced at heat power plants), and the
old worn network of power transmission and distribution lines won't be able
to ensure safe transmission of higher amount of power (especially in cities)
in order to cover the demand of the growing economy.

   [3] The tariff set for households does not cover the costs
In 2007, electricity tariffs for the residents only covered costs by 50%,
which will result in further decrease of already insufficient resources for
the sector. Bringing gas tariffs for the population to a market-based level
will stimulate reduction in consumption, result in implementation of
energy-saving measures, and also would allow increasing power generating
companies' investment in the infrastructure.

The main aim of development of the electric power market in Ukraine should
become ensuring a sufficient level of investment in the energy sector,
lowering its share of the GDP and raising the efficiency of the power supply
systems of Ukraine, including the gain that can be obtained through
reduction of process losses by half by 2015 - to 5-6% (the level achieved in
developed countries).

In order to ensure the safe and uninterrupted operation of the Ukraine's
power supply systems by increasing the volume of supplied electric power,
and also to increase efficiency of the Ukrainian power systems, large
capital investments should be made.

It is necessary to renovate existing generating thermal electricity stations
as well as the worn out transmission and distribution grid (for example,
replace old low-voltage distribution networks with high-voltage ones).
Privatization of thermal generation capacities with clearly defined
investment obligations could be an effective mechanism for achieving a
necessary level of investment in the energy sector. In order to ensure a
necessary scope of investment in generation, transmission and distribution
it is necessary to raise tariffs to a market-based level.

The process of gradually raising the tariff level of power generation for
the population to the level where costs are covered should be predictable
and expected, it is necessary to establish a clear timetable and degree of
the increase in rates and widely inform the population about them.
Disadvantaged groups of the population ought to receive subsidies, not from
Oblenergo, but through purposeful actions by State Bodies for Social

In the power industry ensuring a sufficient level of investment into the
sector by continuing privatization of generating thermal capacities and
increasing tariffs to a market-based level should become a priority.

Transport infrastructure

Transport infrastructure and transportation services constitute the basis of
modern economy and a connecting link for all sectors. Nowadays in Ukraine
serious issues exist in development of this sector. First of all it is the
absence of institutional environment for development of market relations in
the sector (absence of competition and equal transparent rules of the game
in the market). As a result sufficient level of investments in the sector
can not be achieved. This leads to poor quality of roads, railway tracks and
other transport infrastructure, depreciation of key assets, as well as low
quality of transportation services[20].

The main objective of the reform is improvement of transport infrastructure
and transportation services quality by increasing investments and
incentivising competition. By the year 2015 cumulative investments in
private and public transportation must increase several times compared to
2007 level.

Considerable differences exist among the sectors of transportation branch
that range in gravity of problems and needs for reforms. Unnecessary state
interference is seen in the railway sector. State monopoly for
infrastructure and transportation services, lack of transparency in
organization and management, including cross-subsidies of passenger and
suburban transportation services at the expense of freight transportation,
result in low efficiency of this sector.

It is important to separate railway transportation management from politics,
detach non-core and service units, allow opportunity for the private
transport operators to offer services using existing government
infrastructure, and eliminate cross-subsidies in the sector.

First, financial and operational activities of the railways must be separate
from political realm to ensure management efficiency in this sector. To
ensure this, the State railway administration (Ukrzaliznitsi) must be split
off the Ministry of transportation and transformed into an independent
economic entity. Ministry must remain in charge of strategic development
planning of the sector.

Monitoring of access to infrastructure and licensing of private companies,
including supervision of tariff regulations, quality and safety standards
must be performed by an independent regulatory body, and not by Ministry
of transportation or railway administration.

Second, additional services (construction, maintenance etc.) should be
singled out into separate business units. Analysis of privatization options
must be performed and privatization plan must be drafted.

Third, the infrastructure management shall be separated from provision of
transportation services and regulatory activity. State administration of
railway transport must own and manage the infrastructure that should become
accessible both for the state and private railway operators. Principles
behind granting of access to infrastructure and access costs valuation
methods (equal for everybody) must be determined by an independent
regulatory body. Privatization of the rolling-stock must be considered to
ensure further competitive advantages of the sector.

Next, existing practice of cross-subsidies for passenger transportation at
the expense of the freight transportation should be stopped. To put it into
practice, decisions on tariffs pricing for the freight transportation and
investment  must be made regardless of financial performance indicators
existing in other segments of the railway service. Discount fares for
special categories in passenger transportation must be fully covered by the
state budget [21]. This requires additional budget allocations, or decrease
in the number of discounted passenger categories as well as the number of
subsidized routes.

Main issue of road transportation is underdevelopment of private capital
involvement schemes resulting in inadequate development and poor quality of
roads infrastructure. Besides, for urban and suburban transportation sectors
excessive interference of the state with the pricing policy of carriers is

In order to create incentives for infrastructure investments, the
legislation framework must be improved to ensure development of concessions
among other forms of public and private partnerships. Law enforcement
procedures must be created and relevant bylaws must be enacted to ensure
efficient practical implementation of legislation.

Market entry procedures must be simplified for the private companies
operating in the area of roads construction and management. Clear and simple
selection criteria must be developed for contractors for implementation of
the projects. Presently access of private companies to road construction
meets difficulties as the client of roadwork in Ukraine (Ukravtodor) is
acting simultaneously as a contractor for the same projects.

Responsibilities of the client and the contractor must be separated, and
construction department must be restructured into an independent company.

Licensing procedure for private road transportation operators must be
simplified and the control of compliance with safety regulations
simultaneously improved .

Finally, to create favourable development environment for public road
transportation the state must abandon limitations imposed on the tariff
rates of private operators.

Modernization and increase of capacity of the air transport is necessary,
including provision of equal access of all airlines to existing

A number of airports must be upgraded to European standards, and in some
cases expansion and building of new terminals will be necessary. Options for
privatization of airport terminals must be considered to attract private
investments for these projects, provided that the state ownership of runways
and aeronautical services is maintained.

In order to facilitate access of foreign airlines to the airport
infrastructure, drafting of Open-Sky Policy agreement between EC and Ukraine
and other countries must be expedited. Broader access to infrastructure must
be accompanied with enforcement of transportation safety regulations.

There is a high demand for modernization and expansion of sea ports. In
future, privatization of some port terminals may be considered to attract
investments in extension and improvement of their operational efficiency. At
the same time, quay walls must remain in state ownership.

Improvement of transport infrastructure will contribute to development of
transit potential of Ukraine. Construction of multimodal terminals in the
sea ports and airports (also by taking advantage of aforementioned private
capital attraction instruments, and transition to partial - under 100% -
public guarantees made available using uniform rules applicable for
everybody) will contribute further to improvement of transit corridors.
Acceleration of customs clearance procedures is also necessary (for example
through introduction of IT systems reducing hard copy documents flow).

Priority measures for improvement of transport infrastructure include
organizational separation of Ukrzaliznitsi from Ministry of Transport and
revision of public-private partnership legislation.

Labour market

The economic growth of the last few years has noticeably improved the
situation on the Ukrainian labour market in the area of demand.  For
example, the level of activity on the labour market has risen [22], the
general unemployment rate has fallen to 6.5% including a decrease in the
share of long-term unemployment.

In terms of supply the labour market has developed less successfully.  For
example, despite on the 3.5% increase in the 2001-2006 period, general
employment rate in Ukraine continues to stay below the median indicator for
OECD countries (61,5 and 66,3% correspondingly [23]) Due to a weak
correspondence between the education system and market demands, the
share of unemployed among graduates of higher education institutions is
rising [24].

The situation is complicated by low regional mobility of the labour
force [25].

Such a combination of increasing demand and insufficient supply on the
labour market could already in the mid-term perspective create obstacles for
sustainable economic growth. By some estimates, by 2015 the labour market
will be able to satisfy the needs of the economy in skilled personnel merely
by 40% [26].

In order to prevent such a threatening scale the government should take a
number of urgent steps. First, ensure the ability of the labour market to
effectively redistribute the labour-force that has been released in
consequence of increasing productivity in some industries. These resources
can be directed to the industries of extensive growth.

This would demand a substantial strengthening of the national system of
retraining, creating effective labour exchanges and developing methods of
increasing of regional mobility. In order to prepare a complex packet of
measures it is necessary to study the experience of other countries, which
have encountered similar problems.

Secondly, it is necessary to evaluate the needs and staffing of fundamental
sectors of the economy for the next 5-10 years in order to expose those
professional categories and qualifications, which will suffer from
structural unemployment and deficit. This data allows coordination of the
calibration of the system of higher and technical-professional education
with the needs of the market.

Third, in the scope of educational reform it is necessary to raise the
quality of education in the most essential specialities in the mid-term,
bringing them into line with the desires of the modern business

Improvement of business environment

Tax policy
Radical and unplanned shift of the economic system of the former USSR states
along with the inconsistent tax legislation policy which followed led to a
situation where today's Ukraine has a tax system which is one of the least
favorable for business in the world, leaving the country next to the last
among 178 countries in the World Bank's tax systems rating[28].

This situation creates barriers for direct foreign investments, undermines the
competitive power of the Ukrainian businesses and contributes to extremely
high presence of shadow economy, which according to different reaches
50% of the country's GDP [29].

The key issues of the Ukrainian tax system are: heavy tax burden borne by
the business, high indirect costs faced by taxpayers willing to follow the
tax regulations, inconsistent application of the norms on the part of tax

   [1] The effective tax rate for business is 57% of profit versus the
average of 46% for OECD countries, 38% in Poland and 29% in Ireland

   [2] Because of tax system complexity, the Ukrainian taxpaying
businesses have to spend 11 times as much time to fulfill tax requirements
as their counterparts from the developed countries [30], which indirectly
increases their tax burden

   [3] The regulatory imbalance which exists between the rights of the tax
authorities and the taxpayers, coupled with abuse on the part of the tax
authorities [31] results in inconsistent application of tax norms and
widespread tax evasion [32]

The transition from the need to stabilize to the need to stimulate rapid
economy growth dictates a revision of the current tax system towards the
three objectives:

   [1] Bring both direct and indirect tax burden borne by the business
   down to the average Eastern European level,
   [2] Improve tax administration performance to slash shadow economy by
   [3] Make local governments more financially independent (increase the
   number of self-sufficient local budgets 1.5 times) by implementing
   decentralized sources of revenue

The key components of the strategy to reduce direct tax burden borne by the
business are the expansion of the tax base and simultaneous taxation rate
cuts. Expanding the tax base can be achieved by eliminating the existing
exceptions and special tax regimes. Rate cuts down to Eastern European
average may be introduced gradually, including by shifting some part of the
tax burden, e.g. social payments, from employers over to their employees.

Together with cutting direct tax costs, it is necessary to combat the
indirect costs - time outlays, transaction costs, manager time costs, etc. -
faced by companies willing to pay taxes.

A considerable potential in slashing indirect tax burden lies in the social
payments system. The existing system where the four social payments are
administered by four separate funds creates unnecessary complications for
the business and the state. In this context, one needs to introduce the
single social payment system, make a shift towards electronic reporting
format and transfer the collection functions to one collecting authority -
Pension Fund in the short-term and Tax Administration in the mid-term.

Another step towards reducing the indirect costs would be the simplification
of profit tax accounting system for businesses converging tax and business

In addition to that, there us the need for urgent steps to adopt a uniform
tax code needed to integrate scattered taxation norms, eliminate the
existing contradictions and ambiguities, rebuild the balance of the rights
between taxpayers and tax authorities thereby limiting the corruption field,
and introduce mandatory EU tax norms, e.g. those on VAT.

The second important move to improve the tax system would be to optimize tax
administration to ensure equal competitive conditions and improve tax
collection. The tax administration system needs to be improved for all taxes
and duties alike. This will require an effort to improve staff
qualification, implement a transparent accountability system and optimize
the internal processes used by tax bodies. A special task would be to create
analytical functions capable of performing risk assessment for various
groups of taxpayers, allowing tax authorities to effectively use their tax
management resources.

The most urgent tax administration issue in Ukraine is the VAT refund
mechanism. The current practice of greatly delayed VAT refund payments tries
to cope the widely spread fraud in this area. Despite some positive effect
achieved in combating fraud, this approach inflicts great damage to
Ukraine's overall business climate. The European experience in combating
VAT-related fraud indicates that targeted measures to restrict VAT refund
procedures (e.g., a mechanism where VAT is paid by the buyer, introduced for
the most affected industries and activities) prove the most effective.

Despite the existing challenges in VAT administration, it is not advisable
to have this tax abolished or replaced, taking into account Ukraine's
declared path towards accession to the EU, where VAT is a mandatory part
of European regulatory base.

The third tax system improvement area is making local autonomies more
financially independent through decentralized sources of revenue. The most
potentially effective and economically neutral way of expanding the income
basis of the autonomies would be a step-by-step introduction of a real
estate tax for businesses and individuals, based upon mass evaluation of
real estate and tax collection at a local level.  Before this tax can be
introduced, the landowner registration system will have to be sorted out as
the first step.

The real estate tax will not only make local administrations better funded,
but help shift tax burden from manufacturer to consumer, improve tax
collection (the tax is relatively simple to charge) and stimulate the
effective use of property. Successful introduction of the real estate tax
will also create potential for cutting other less effective and more
distorting taxes.

To deliver on these targets, it is important to first:

   [1] Complete and submit to Rada the Tax Code that went through public
consultation in 2007

   [2] Develop a concept and a plan to optimize the social payments
   system, including the introduction of a single social payment and the
   planting of administrative functions with a single collecting authority

   [3] Develop a real estate tax implementation concept, including a real
   estate registration system development plan, a tax base assessment method,
   a taxation principle, tax rate, a tax collection system, an approximate
   calculation of the revenues to be gained by the autonomies

   [4] Develop a Tax Administration performance improvement program,
   covering staff qualification and responsibility improvement, process
   optimization and the necessary organizational changes, new instruments and
   methods to be implemented

   [5] Prepare a program of targeted measures to combat VAT fraud based
   on EU countries' best practice experience

Business law

Ukraine still faces serious challenges in creating a favorable legal
environment to enable economic growth. To give an example, according to the
World Economic Forum's (WEF) competitiveness report for 2007-2008, Ukraine
rated 115 out of 131 in institute development. The ratings were especially
low as far as private institutes were concerned, which is due to low scores
in ethical behavior of firms and protection of minority shareholders'
interests. The poor state of the Ukraine's legal framework development has
been pointed out in the reports offered by the World Bank, UNDP, OECD.

Among the key issues in the Ukraine's business law are contradictions
between the Economy Code (EC) and the Civil Code (CC), extremely outdated
legislation on business entities, bankruptcy and depositary system. In the
aggregate, this results in judicial arbitrariness, blossoming corporate
raiding as a merger and acquisition mechanism, and infringement of the
rights of shareholders and creditors.

To create a favorable business environment for Ukraine, it is important to
liquidate the gaps and contradictions currently affecting the economic
legislation and have it aligned with the European standards, e.g. those of
the Eastern European countries, by 2015. Should WEF scores reach the current
Eastern European level (+0.9-1.1 over current institute development rating)
by 2015, the effort shall be seen as successful.

To achieve this, the first thing to do is to eliminate the discrepancies
existing between EC and CC, which allow for a situation where property
relations between business entities are governed by legal norms with
conflicting content.

The main contradictions are:
   [1] Definition variations (e.g. definitions of a contract)

   [2] Differences in types and corporate forms of legal entities[33]; EC
   gives a definition of collective property while CC disc
   usses no such ownership category

   [3] Differences in specific fields (ownership rights, funding, bank
   accounts, etc.[34])

The most effective solution would be to incorporate all EC norms regulating
business-related property relations into an integrated CC with an indication
that such norms apply to relations between business entities. To have it
done, first of all, EC terminology must be aligned with CC terminology.

Some of EC norms that either repeat CC or are in conflict with the nature of
civil law, its principles or key provisions (for example, those on
collectively owned businesses, intellectual property), must be discarded
completely. EC must be limited to regulating relations dealing with the
state control over business activities.

Second, shareholders' right protection and corporate management principles
should be aligned with the international standards. The draft bill "On
Joint-Stock Companies" approved by the Verkhovna Rada in its first reading
had failed to fulfill this objective. The bill should be amended to fit OECD
principles in order to stimulate the creation of joint-stock companies,
ensure adequate protection of the basic shareholders' rights and minority
shareholders' rights, eliminate abuse of the rights.

The draft bill "On Joint-Stock Companies" needs to be updated as follows:

   [1] Clarify conditions and shorten transition time for transformation
of the existing forms of incorporation into private and public joint-stock
companies, reduce mandatory authorized capital size for joint-stock

   [2] Improve shareholder basic rights protection by reducing quorum to
50% plus 1 share, require a mandatory letter with content description,
enforce priority rights to acquisition

   [3] Improve minority shareholder rights protection by giving them the
right to initiate independent audits, requiring that the Board of Directors
be elected via cumulative voting, reducing the threshold for including items
on the agenda to 5%

   [4]  Regulate the keeping and provision of information, introduce of
criminal penalties for its non-provision or distortion, mandatory provision
to shareholders of the share register by its keeper, require making public
information on acquisition of shareholding exceeding 50%, mandatory require
to go through the listing procedure and inform the stock exchange on current

   [5] Eliminate the opportunity for shareholders to abuse their rights by
limiting their access to accounting documents to which they are not a party

   [6] Eliminate the opportunity for joint-stock-company's managing bodies
to abuse their rights by giving greater authority to the board of directors
and limiting the authorities of the general meeting, regulating its
processes and guaranteeing the rule of law by having a tabulation commission

After the Law "On Joint-Stock Companies" is adopted, work should be
continued to develop legislation on other business entities. Currently this
area is regulated by the Law "On Business Entities" of 1991, which is
already quite out-of-date. In line with the world practices, the number of
the possible forms of incorporation should be reduced several-fold.

Special attention should be given to regulating companies with state
participation: their status and principles of managing state-owned property
must be formulated. The number of types of such companies should be reduced,
the mechanisms for their transition to other forms of incorporation should
be developed and put down in law.

Mechanisms should be developed for the state to exercise its corporate
rights (including dividend and management rights, etc.) so that joint-stock
companies with state participation (whether partial or full) could be
managed using the same mechanisms as those without state participation.

Third, the efficiency of the bankruptcy procedure needs to be improved. The
Law "On Bankruptcy" should be updated to stimulate wider use of
reorganization as a method to pursue economical revival of companies and
eliminate legislative gaps used for fraudulent action.

Main changes to be introduced:

   [1] Simplify and give a detailed definition of the bankruptcy
procedure, including for credit and insurance organizations, pension and
investment funds, and managing companies, especially regarding refunding
of borrowed capital
   [2] Give definition of the status and remuneration of the bankruptcy
   [3] Make state-owned companies subject to bankruptcy in accordance with
the principle of equality for the law of all types of commercial entities
   [4] Ensure protection of the creditors' primary rights of recovery of
   [5] Give a clear definition of a parent company's responsibilities
towards non-payments of its daughter company
   [6] Eliminate collisions between the Law "On Bankruptcy" and laws
regulating enforcement, tax and labour-related legal relations
   [7] Clarify ambiguities in some parts of the Law (e.g., adding new
creditors to the register after it had been finalized and approved)

Finally, gaps should be covered in the Law "On National Depositary System
and the Nature of Electronic Circulation of Securities in Ukraine" in order
to eliminate rights abuse in keeping share registers.

To implement the reform, it is of primary importance to update and adopt in
its new version the Law "On Joint-Stock Companies". Then regulation of
activity of enterprises with state participation needs be developed by
introducing necessary amendments to legislation. After that, amendments to
the Civil Code, the Law "On Bankruptcy" and the Law "On National Depositary
System (.)" need to be developed and adopted.

During the next phase, draft bills should be developed on other types of
business entities. Finally, a list of other economy-related statutes that
need updating should be made, and the appropriate amendments should be
prepared. It is important to involve in this work representatives of all
branches of the power and the business so that the problem is given a
comprehensive analysis and the best possible solution.

Business courts

Commercial dispute resolution practice remains one of barriers to develop an
advanced market economy in Ukraine. According to Competitiveness report for
2007-2008 by World Economic Forum (WEF), Ukraine is ranked 111 out of 131
countries for its legal system independency level which is due to existing
possibility of placing political pressure on judges.

A low level of legal law observance is noted also by the World Bank and
UNDP. This situation is determined mainly by the legal system structure and
procedures for appointment, promotion, and removal of judges, failing to
ensure independency and objectivity of juridical decisions.

The main objective of the reform is to improve quality, legality, and
transparency of juridical decisions on commercial disputes. Functioning
principles and mechanisms applied by Ukrainian commercial courts need
to be adjusted to international practice in order to achieve the objective.

Success in this area of reforms shall be indicated by increased to the
European level confidence of public and business in jurisdiction and
improvement of Ukrainian ranking on its legal system independence indicated
in WEF reports to the current level of Eastern Europe (+0.8-1.0 points to
its current level) by 2015.

A number of issues should be resolved simultaneously to achieve the
objective. First of all, an issue related to ensuring independence of judges
should be addressed including establishment of mechanisms for objective
control and appraisal of their performance. In addition, skilled specialists
and adequate financial resources should be provided for the legal system.
Finally, a three level system of commercial courts should function properly.

Implementation of these changes will require reforming of the entire
judicial organization. Only individual measures related to changes in
procedural legislation (jurisdiction, security for claim, regulation of time
for proceedings, etc.) may be initially tested at economy courts and then
implemented in other fields of law.

To ensure independence of the legal system, excessive control provided by
other government departments over the legal system should be eliminated,
particularly, control by the Government should be removed, and impact of
Verkhovna Rada and the President should be reduced.

In addition, any possibility to affect judges within the legal system itself
should be reduced: during appointment process (over the five-year
approbation in the position) by reducing the probation period; during
promotion or dismissal - by improving transparency (make examination results
transparent as well as process of making decision on appointment, promotion,
or dismissal).

At the same time, high control over judges performance should be established
based on objective criteria and continuous performance evaluation. A
reasonable and effective mechanism to recall judges should be developed, and
responsibilities of judges for any action should be guaranteed (violation of
time for proceedings, inconformity of a decision with law, corruption,
etc.). To do this:

   [1]  A mechanism for systematic data gathering should be developed, and
data selection criteria should be determined
   [2] Objectivity of disciplinary criteria shall be ensured
   [3] A clear complaints mechanism should be established
   [4] A functioning mechanism to protect rights of accused judges should
be provided
   [5] Transparency of making any decision on dismissal should be ensured
   [6] Enforced dismissal and leave by own decision should be

Clear procedures for appointment, professional development and promotion of
judicial manpower should be elaborated to ensure a supply of skilled
specialists for the legal system:

   [1] Clear requirements to educational level of legal staff, their
selection and promotion criteria should be elaborated
   [2] Professional development programs for legal staff should be
developed and implemented

To ensure a required level of financing for the system, financing volumes
should be increased, and control by the legal system over the budgeting
process should be strengthened. As a whole, this will allow to guarantee a
salary level sufficient to attract and retain the best specialists, and to
avoid use of "sponsorship schemes" making courts dependable on authorities
or companies.

To ensure accurate functioning of commercial courts system, it is necessary
to detail jurisdiction criteria with regard to commercial deals as well as
jurisdiction of commercial courts in order to avoid simultaneous proceedings
in courts of different levels.

Additional measures to improve quality of legal system administration will
include implementation of performance management system and improvement
of legal system transparency by providing an unrestricted access to juridical
decisions. The latter may be achieved by obligatory publication of
commercial courts' decisions on the Internet.

At the same time, mechanisms to protect state, commercial, and bank secrets
shall be applied when any confidential information is used for purposes of
legal proceedings.

Reforming of commercial court system should be also accompanied by further
development of effective mechanisms of extrajudicial commercial dispute
resolution to enable reduction of load on the legal system.

Implementation of the reform requires elaboration of amendments to the
Commercial Procedural Code and Laws "On the Status of Judges" and "On
Judicial Organization". Initial efforts should be focused on changes with
possibly the most substantial impact.

Amendments to areas of the reform not requiring development of new
functioning mechanisms (procedures for appointment of judges, continuous
training of judges, remuneration of judges, and distribution of proceedings)
should be approved within several months.

For more complex issues (budgeting process, disciplinary procedures and
dismissal of judges, advancement of appellations, process of filing
complaints on judges), elaboration of more effective and transparent
processes shall be started.

Meetings with key stakeholders should be conducted to address areas of the
reform that require discussion of the target state (anti-corruption
measures, procedural rules, court structure, jurisdiction authorities,
control over the legal system, procedure for appointment of chief justice).

Areas of further improvements should be determined regarding issues with
less significant impact expected: recommendations on reforms should be
provided (performance management, development and remuneration of
administrative staff, judges associations, material resources and safety of
courts, free access to judicial proceedings) or the direction of reforms
should be determined (a court administration structure, a system of terms of

Lowering administrative burden for enterprises

State regulation and business supervision system existing in Ukraine impedes
stable economic growth. For example, according to World Bank Report "Doing
Business 2008" the Ukraine is ranking 139 out of 178 economics in evaluation
of business enabling environment. According to IFC, the main administrative
obstacles for business include licensing and business approval system,
enterprise inspection system and technical regulatory system.

Regulatory approval system in Ukraine is one of the strictest among other
CIS countries. For example, share of enterprises in Ukraine that obtain
licenses during one year (54 %) is higher than in Belarus (45 %), Uzbekistan
(33 %) and Georgia (6 %), and share of enterprises undergoing inspections
performed by various regulatory bodies is 95%. Presently the total list of
regulatory documents mandatory for the conduct of business includes 198

High frequency of inspections, their irregularity and low efficiency is
typical for the Ukrainian public supervision system. Fault-finding and
imposing penalties on the enterprises remains the fundamental principle of
work for supervisory authorities, instead of assistance in compliance with
relevant legislation. State customs administration, State fire safety
department and State sanitary-epidemiological department remain the most
active inspection bodies: each of them inspected more than 50% of
enterprises in the country in 2006.

Over this period the enterprises paid their employees about 189 million
hryvnia (over 37 million US dollars) for time they spent working with
supervisory authorities. At the same time, frequency of inspections is
irrelevant to magnitude of potential threats for the public or damage to the
environment posed by business activities. Most often trade businesses and
public catering enterprises with considerable cash flow are inspected.

Technical regulatory system is the third most important obstacle for
business development. Firstly, the range of products intended for mandatory
standardization and certification is disproportionately big; many standards
remain in force since the time of the Soviet Union. Secondly, issuing
procedure for certificates of compliance (or technical specifications) is
extremely bureaucratic, and highly demanding in terms of additional time and
costs borne by the enterprises. Corruption is thriving on complexity of
procedures. As a result the system fails to guarantee product safety for the
consumers, or full product conformity even with obsolete standards.

Reform of economic activity regulation system has an objective to ensure
efficient business operation and growth in Ukraine through removal of
administrative obstacles. Success criteria must include increase of the
general country rating using "Doing Business" methodology up to the existing
level of Eastern European countries by 2015.

Main administrative barriers for doing business can be reduced by
facilitating licensing procedures (drastic reduction in numbers of documents
mandatory to establish and develop a business; introduction of a "one-stop
shop" principle), facilitation and cutting of inspections (reducing
frequency of inspections by rating them according to types of business
activities; introduction of checklists; approval of unified inspection
procedures; establishment of complete and comprehensive powers for
supervisory bodies). List of mandatory certification products must be
shortened; standards system must be harmonized with the standards system
existing in the European Union.

First steps were already taken along these lines by enacting two laws, the
Law "On business regulatory approval system" (entered into full force on
October 5, 2006), and the law "On fundamentals of state supervision
(control) of business activities" (entered into full force on January 1,
2008). According to expert opinion, the implementation of these laws will
provide most of the solutions to the licensing and supervision system.

Nevertheless, the legislation failed to produce the desired effect for the
time being. For instance, operation of approval and licensing centres with
"one-stop shop" system capability has not yet been established. Also,
replacement of licensing procedure with forwarding of notifications in cases
named by the law is not yet fully implemented (implementation of declaratory

According to expert opinion, the main challenge behind implementation of the
law "On fundamentals of state supervision (.)" is expressed in the fact that
degree of compliance of supervisory bodies with this legislation equals to
10-15%. Under the law, before the legislation takes force, the supervisory
bodies were expected to submit proposals on harmonization of all subordinate
legislation with the law, including the detailed drafting of actions to
rationalize inspections (allocation of various types of enterprises by risk
groups and drafting of checklists among others). The nature of other problem
is that supervisory bodies are trying to withdraw from jurisdiction of the
law, and this was already done by Tax inspection.

Amendments to the law "On business regulatory approval system" must be
passed, that provide for :

a) legislative consolidation of complete and comprehensive list of all
licensing and approval documents;
b) introduction of "tacit consent" principle to ensure automatic approval of
certain types of activity with respect to which any supervisory body failed
to reply or issue a prohibition within deadlines prescribed in legislation;
c) detailed disclosure of technicalities of operations of the approval and
licensing centres.

Tax inspection should be returned under the jurisdiction of the Law "On
fundamentals of state supervision (control) of business activities", and
efforts must be taken (including use of political will) to ensure proper
compliance with the law.

List of mandatory certification and standardization products must be
shortened, technical standards must be harmonized with major EU legislation,
standardisation procedure and issuance of certificates of conformity must be

Management of natural monopolies

Natural monopolies in Ukraine include the main part of infrastructural
industries (the Ukrainian railroads, communications, postal service,
electric power transmission, sea ports, airports and water supply). Almost
every sector subject to natural monopoly is obsolete - especially transport
and communications. At the same time the government is not able to provide
the full investment required by the natural monopolies to maintain the
necessary level of infrastructure.

The main problems in the area of natural monopolies are - the lack and
inefficient use of investment which was aimed to support and develop the
infrastructure, the fact that the sectors with natural monopolies have not
been duly optimized, the activities of sectors and individual enterprises
are not transparent and prices offered for the services of some monopolies
do not correspond with their value.

Where industries with a natural monopoly component are concerned, by the
year 2010 the government should adopt programs for their development
defining the goals set for these industries which will provide for increase
of those industries' efficiency.

Well-defined concepts of development of sectors with natural monopolies
should be developed.

Industrial concepts should define clear strategic goals for the development,
including the target capital structure of the industries, regulation
procedures, conditions for de-regulation and guidelines for tariff
regulation. Ordinarily sub-industries and enterprises that do not belong to
natural monopolies would be singled out for privatization.

Strategic goals set for industry development should in all cases provide for
the demands that the growing economy poses in relation to the services of
these industries and for increase in their efficiency as well as for the
transition from cross-subsidizing different consumer groups to the targeted
assistance directed to the ones in need of it.

The targeted structure should clearly define which part of the industry
belongs to the natural monopoly and which can be competitive - which
enterprises are better to privatize and which enterprises might remain
state-owned. The privatisation program of the enterprises, outside of
natural monopolies, could introduce tariffs or other regulations. For the
industries with natural monopolies the detailed concept of sector
regulations should be developed:

   [1]Conditions for new players to enter the sector (for example, with a
view to provide services): the number of players that might be accepted, the
conditions and established practices required to be able to obtain licenses,
access points, a list of services which might be allowed for the new players
to offer and the speed of liberalization of the sector

   [2] Regulations to set tariffs for new players to the network

   [3]  Regulations to set tariffs for the end customers

Generally, the control of the sectors with natural monopolies would imitate
the competitive market. In this respect the mechanism of tariff regulation
becomes very important. It should give incentives to the monopolies to
increase their efficiency while keeping opportunities for development and
investment in the infrastructure.

The method of defining tariffs used in Ukraine - namely "cost plus" - does
not allow Companies to invest in the development of infrastructure,
therefore it is necessary to change to the Rate-of-Return method that takes
into account return on investment and includes cost saving mechanisms.

In some sectors, for example, telecommunication and electric power industry
have a more progressive way of calculating tariffs which could be adopted
based on the experience of the European Union countries. It is known as LRIC
(log-run incremental cost) which in addition to the advantages of
Rate-of-Return method includes a technology-development factor (based on
determining the price that would justify the investment made by a modern
investor into a similar project considering the most effective technology
available today).

The regulatory functions shall be distinguished from those of the corporate
management where it has not been done yet (railway transport and housing)
and the sectors where such division has been made - the concept of
independence from a controlling body should be understood.

Regulatory function should be transferred from the Ministries to an
independent organization such as, for example, the National Regulatory
Commission which might be set up for a particular sector.

The Head of each National Regulatory Commission might be assigned by a
President or by Verkhovna Rada. These national commissions would be
responsible for defining the terms of licensing, tariffs and control of the
quality of services. By this method they would remove all these functions
from the national Ministries.

The next step in the area of natural monopolies would be the lay-out of
industrial concepts for the development of sectors with natural monopolies,
including clear objectives of sector development, targeted capital structure
for that sector, defining the regulation pattern for the sectors including
tariffs, defining powers and responsibilities of the body regulating the
sector, as well as of the relevant executives.

Management of state-owned enterprises

The operating conditions of State-owned enterprises in Ukraine are often
more favorable than those available in private sector companies. Subsidies,
bankruptcy protection, soft-term financing, advantageous access to land use,
soft control of monopoly tendencies and guarantee of state purchase - these
are the policies widely used in relation to the national enterprises.

Despite this, the public sector falls behind the private one in these
criteria due to their lack of labor efficiency, capital assets and return on
investment. The lack of fair competition and low efficiency of national
enterprises slows down the growth of domestic product for those industries.

Moreover -  low efficiency of the industries in which the State has a
monopoly (for example, aircraft engineering) is also slowing down the
development of the whole industry in terms of technology and innovations and
thus deepening the gap between the country and its foreign competition.

The poor condition of state-owned industries has an adverse influence, not
only on the industry itself but also on the industries they support and that
affects the national economy.

Reasons for poor performance of the Ukrainian state-owned enterprises are -

   [1] Week corporate management
Board of Directors simply do not exist - cases of direct interference of the
state  in the business activities are abundant - tasks and objectives of the
National Enterprises are not transparent and are effective only for a short
term (1 year); the pay level of Managing personnel is low and has no bearing
on their work results.   .

   [2] Lack of Managerial skills
The control of public companies is in the hands of Managers with limited
work experience in the private sector; there is a lack of industry
professionals in the executive bodies; the world's best experience in
management is slow to be absorbed by public enterprises because of lack of
managers with the experience of working abroad.

   [3] Commercial and social goals set for state-owned enterprises are not
accompanied by procedures for priority setting, which leads to low
transparency of costs arising from pursuing social objectives; this diverts
the attention of the Management and Executive bodies away from the operation
efficiency of their enterprises.

After the accomplishment of privatization the goals related to the
management of the enterprises remaining in the public possession will be as
follows - increase the efficiency of public enterprises and enable necessary
development of important infrastructural and innovative industries to
satisfy the needs of the growing economy and those of the population - in
the services provided by these industries.

Before embarking on the process of improving the efficiency of a state-owned
company, objectives of development for every industry concerned should be
set out and a regulation procedure that would correspond with the objectives
to conduct privatization and de-regulation of the market, wherever it is
possible, should be drawn up.

The enterprises that will remain as national property would be taken out of
the Industry Department control and put under the control of the State
holding (or a number of designated industrial holdings). Management
techniques employed by the private sector should be introduced and adopted
within the public sector.

Numerous examples of the recently established state 'holding agencies' that
deal with implementation of the rights of the state as an owner - emphasize
their efficiency (examples are France, Malaysia, the UK, China). In the
model of 'state holding' the government focuses its efforts on shaping its
social and economic policies and controlling delegating its rights as an
owner of  public companies with its appointed board of directors.

State holdings introduce to public companies procedures and skills employed
by private company CEOs while allowing the state to keep control over the
assets. As a result the state, state holding and public enterprise
management acquires clear and well-defined roles.

To change over to the state holding scheme the following measures are
required: -Develop a well-defined industrial policy with transparent
commercial and social goals with deadlines; move public enterprises out of
the industrial department control and put them under the control of a
holding; exclude direct interaction between departments and enterprises so
that a holding becomes a single point of contact with the government; limit
the tasks of relevant departments to the development of industrial policies.

Management techniques employed by the private sector should be introduced
and adopted within the public sector, such as establishing a board of
directors and relevant committees (audit, strategies, assignments,
reimbursement and others).

Public enterprises also need to develop and introduce management systems to
control performance and motivational incentives - methods which are already
employed by the private sector. Also thoroughly select, and then offer
career development for managers; develop and introduce clear procedures to
define objectives, monitor the process of achieving the set objectives and
take corrective measures in case of deviation from the planned targets.

In cases where, in addition to economical objectives, the enterprise must
work towards achieving social goals as well then it would be necessary to
formalize the process, monitor the achievement of set objectives and define
the way the controversies of commercial and non-commercial objectives are

Fast establishment and start-up of the state holding should be one of the
short-term priorities. There should be drawn-up concepts of the development
of industries incorporating government goals, instruments of regulation,
privatization and deregulation of industries and establishment of the legal
status of enterprises that remain public property. Then the concept of
establishing a state holding needs to be accepted, as will the definition of
relevant guidelines and an implementation plan upon which the transfer of
the remaining public enterprises to the holding could take place while
implementing the management practices adopted by the private sector.

Training of skilled workforce for economy

Skilled workforce is one of vital pre-requisites for economic growth. The
effective education system guarantees sustainable development of the nation
in the long term. Education spending as percentage of Ukraine's total budget
is relatively high: 5.7% of GDP (while it is 5.5% in EU countries) [35];
spending on science and education will increase to 7% of GDP in 2008. By
the same token, the quality training and caliber of specialists has noticeably
deteriorated since Ukraine became independent.

The main problem of Ukraine's existing system of workforce training is a
large gap between the skills and knowledge taught and the real world demands
of the economy. Very often the qualifications taught by the system are
simply not relevant to enterprises and companies [36].

The main reasons of the low quality of work force training are excess
government regulations of the education process, low level of competition
for attracting students between educational institutions, and the lack of
easily accessible objective information about economy's demands and the
education market.

Excess government intervention in the education process is a legacy of the
Soviet system that exercised tight control over work force training. Strict
regulation of the application of the allocated funds does not allow
educational institutions to use the funds for anything other than their
designated purpose. The limited flexibility in financial decisions lowers
the useful effect of the funds application, and, among other things,
negatively impacts the faculty's salaries, which remain low, and the level
of equipment support of the education process, which remains insufficient.

Low salaries cause brain exodus and corruption. Aside from that, the absence
of transparency in the criteria for funds allocation does not stimulate the
effort to improve the quality of the education. The government does not only
control the fund allocation, but also the content of education - through
approval and coordination of curricula, courses and majors. This approach
limits the ability of educational institutions to react to the labour
market's demands in a timely manner.

Another problem of the current workforce training system is failure to
comply with the existing educational standards and qualification

The goal of the education reform is to ensure that the work force is trained
for the real world economic demands. To achieve this it is necessary to
create an education market complete with competition and transparency, where
financing flows to the areas that provide the highest quality and
compatibility with the market demand.

An indicator of the success will be the job placement ratio of 50% of
graduates within their major of study [shortly] upon graduation. An indirect
indicator of the improvement inn the quality of education would be listing
of Ukrainian educational institutions in international ratings (first
hundred) by 2015.

The first step toward the solution of the above problems is granting
autonomy to the state-owned educational institutions. The autonomy should
guarantee independence in organizing the educational process, and it should
also extend to funds allocation and adoption of course curricula and
training programs. Independence is a must-have pre-requisite of the higher
feeling of responsibility for the quality of the educational services
provided by the institution, it also allows for a quicker reaction to the
labour market demands.

The government should position itself as a regulator (not a manager) of the
education market, and enforce rigorous compliance with legislative
standards. The autonomy will hand real power to the Supervisory Boards,
which include representatives of the business, as they will have a direct
say in funds allocation and their efficient use, as well as in deciding the
subject matter of the courses and the education process itself. The rise in
financial effectiveness will contribute to attracting private capital and
raising the salaries for the faculty.

The amount of the government financing should depend on two factors: the
number of students in a specific educational institution (and not its total
needs) and the growth and development plans for that institution.

The first factor is constant, the second is variable. Government funds for
the growth and development of the institution (the variable component) will
be granted on a competitive basis according to strategic plans (or business
plans), provided certain transparent criteria are met.

This, rather than fragmenting funds, will promote their concentration in the
area of the highest demand. Strategic plans should be assessed by an
independent authority, reporting directly to the Cabinet.

It is imperative to create legal requirements for a budget of any
educational institution that receives government financing to be an open
document. Such a measure will bring about more transparency to the
application of funds. All in all, all information on government spending on
science and education should be easily accessible to the public.

It is necessary to create a transparent system of government evaluation of
educational institutions using best international practices. The system
should be de-bureaucratized to the maximum and should allow for an objective
assessment of educational institutions' performance on the basis of a
sufficient number of criteria.

Evaluations should be held on a regular basis by an independent authority,
its results, including the ratings, should be openly published. Educational
institutions that fail to pass the evaluation and do not meet the standards
should be denied government funding and their licenses should be revoked.

The freed up funds should be allocated to the educational institutions that
passed the evaluation. This will prevent squandering of the government
money, eliminate the unnecessary educational institutions (including
vocational schools) and will improve the overall quality of education.

In order to promote competition between educational institutions, it is
necessary to engage an international rating agency in developing a system of
yearly performance assessment of Ukraine's educational institutions in
comparison with European universities.

The ratings will include assessment by employers (business-associations) of
the training quality and caliber of specialists and job placement figures
upon graduation from a specific university. The yearly independent ratings
will promote competition and serve as an indicator of efficient application
of budgeted money.

It is advisory to prepare and publish national labour market reviews. These
reviews will research the needs of the enterprises and forecast the demand
for different majors for both higher-education institutions and vocational
schools. Such forecasts will help form the government contract for work
force training, and, on the other hand, will contribute to the adequate
occupational guidance for the youth. These reviews should be prepared by an
independent, preferably international agency with flawless reputation.

Thus, the priority measures should be: granting autonomy to educational
institutions and preparation of labour market reviews. From there, the
principles of government funding should be re-examined: the allocated funds
should be tied to the number of students in and the plans for growth and
development of the educational institution (on a competitive basis).
Independent professional evaluation and regular independent rating will
promote a significant increase in competition, and, therefore, in the
quality of education.

Protection of competition

Competition is one of the key factors that stimulates productivity growth
and ensures sustainable economic growth. The role of government is to
protect the markets from unfair competition, including from abuse of a
dominant market position, collusion between competitors and excess market
concentration [37].

The major elements in Ukraine's competition protection system are the Law on
protection of economic competition and Anti-Monopoly Commission of Ukraine
(AMCU). The main problems of Ukraine's anti-monopoly policies are, firstly,
excessively wide coverage by the anti-monopoly system, especially in the
area of regulating market concentration, and, secondly, high level of
pressure on businesses caused by the complex process of approval of merges
and acquisitions.

Excessively wide coverage of market concentration regulations in the Law on
protection of economic competition (the threshold for merger approval in
Ukraine is 20 times lower than in the EU) [38] requires approval by the AMCU
of a vast number of transactions that, essentially, have no impact on the
competitive landscape. This puts an unnecessary stress on AMCU diverting
resources and attention from investigating cartel collusions and abuses of
dominant position.

Besides, AMCU may have jurisdiction over extraterritorial merges of
companies that are not active, do not have direct investments, offices or
subsidiaries in Ukraine [39]. These companies can also be sanctioned up to
5% of the total revenue.

The high level of pressure on businesses during the approval process of
mergers and acquisitions is a result of a lengthy, complex and opaque
process of document submission, especially to the ever-changing list of
required documentation and information that significantly exceeds analogous
requirements in the European Union[40]. Besides, the methods and criteria of
decision making are not transparent, for instance, the market segmentation
methods used to identify dominant positions. All this creates potential for
corruption, increases risks and unpredictability of the economic activity,
increases costs and time requirements for the M&A transactions.

Ukraine's goal in this regard should be achieving the balance between the EU
level of competition protection and minimizing the potential negative
effects of the oversight system on business and investment climate.

In order to achieve this goal, first and foremost, the law should be

   [1] Increase the thresholds for M&A's that are subject to mandatory
AMCU approval to the level that will have a higher degree of relevancy to
the tasks of oversight and preventing unfair competition

   [2] Modify the market concentration stipulations, regulating the
process of submission and review of applications for M&A in order to
simplify the approval process. It is necessary to adopt a reduced final list
of documentation and information, required for the M&A approval, reduce
the time required for the review and eliminate equivocal clauses that create
potential for abuse.

From the point of view of enforcing the law, the AMCU investigative
functions should be reinforced for the purposes of investigating cases of
dominant position abuses and collusions, through increased professionalism
of AMCU officers. This will require changes in the compensation system and a
possible increase in the staffing levels.

Central government reform

Ukraine faces a task of reforming many areas of government activities. The
center for enacting these transformations should be the central apparatus of
the government. If the central apparatus does not function quickly and
efficiently, the success of the reforms is doomed.

According to the researches' assessments, the effectiveness level of
Ukraine's government is low. It is caused by the lack of transparency in political
decision making, excessive burden of government regulation, and inefficiency
of the legal system and government spending [41].

The causes of Ukraine's government apparatus ineffectiveness rest in four

   [1] Incomplete separation of functions in the apparatus (supervisory,
        political leadership, control over implementation of political decisions,
        approval of personnel appointments, arbitration)

   [2] Inadequate provision with personnel
-       Deficit of managers at both top and mid-levels
-       Low continuity of policy making (personnel appointments are
        politicized, political and administrative functions of personnel are
        not separated)

   [3] Low performance effectiveness
-       Long and opaque procedures of development of laws
-       Frequent delaying in enacting the laws
-       Corruption
   [4] Lack of results-orientation of the system
-       No unified vision of goals, cascaded to the mid-level of government
-       The performance results are not transparent neither to the highest
        level of leadership nor to the general public

The goal of the reform is to increase the government effectiveness in
performing its functions and efficient use of resources. An increase to the
current levels of effectiveness of the governments in Central and Eastern
European countries in the WEF ratings by 2015 (+0.6 to +0.8 points to
Ukraine's current grade) can serve as an indicator of success.

This can be achieved by increasing effectiveness of the central government
apparatus to the productivity and service quality levels of best Ukrainian

In accordance with the international precedents when comparable reform goals
of the central apparatus were achieved, the following objectives should be

   [1]  Bring the government apparatus in compliance with the democratic
   power structure (separation of functions)
   [2]  Ensure adequate staffing of the apparatus
   [3]  Optimize internal processes and fight corruption
   [4]  Increase transparency level of the apparatus' performance results
   and each official's responsibility for the results

In order for the government to perform effectively under the conditions of
democracy the supervisory function, political leadership functions, control
over implementation of political decisions, approval of personnel
appointments and arbitration functions should be institutionally separated.
Therefore, it is necessary to leave the central apparatus only with the
political leadership function and assign the rest to independent offices.

A complex of measures to attract and retain personnel is required in order
to ensure the adequate staffing levels of the government apparatus. A raise
in the salaries of top and mid-level managers and specialized experts, that
would make public service competitive in the labour market, is necessary to
reduce the deficit in the staffing levels of those categories. Development
of career plans and creation of a managerial reserve comprised of promising
officials of different levels will contribute to personnel retention.

In order to improve continuity of policy making it is necessary, first, to
ensure open and competitive hiring procedures for all positions. Second, an
independent body dealing with the personnel policies should be created, its
task will be improved stability of the government personnel. It should have
jurisdiction over appointment and firing of mid- and top-level officials
excluding ministers.

Processes of government services to the public and businesses, as well as
key internal processes (planning, budgeting, etc) should be re-constructed
to ensure improved quality. The government apparatus agencies should hold
open policy meetings in the cases where it does not jeopardize safe-guarding
state secrets.

Development of laws should also be accompanied by open public consultations
using the public feedback mechanism from all stakeholders. The time limits
for law adoption and enactment should be reduced through planning and plan
implantation control at each smaller milestone.

Standards of quality should be defined for the services in other areas of
government activity (for example, precise rules for case reviews and
decision making, transparent processes for transactions with the public and
businesses), schedules of their implementation should be determined.

It is imperative to analyze the functions of the government apparatus,
eliminate the redundancies, and increase resource allocations for "tight
spots". The guiding line should be increasing transparency of all processes
that will aid in the effort against processes inefficiencies and in reducing

In order to increase the result-orientation of the government performance,
key targets should be identified: first for ministries, then for departments
and sub-departments. Independent experts should be engaged in defining the

These goals should be constant and should not suffer cardinal modifications
in case of the leadership change. They should have specific, measurable
indicators. Their achievement (deadlines and quality) should be
systematically checked.

The goals themselves and the current status of their achievement on all
levels, including measures taken when deviations from the plan occurs,
should be open to the public. The achievement of results should be discussed
openly and should be the main criteria for career growth.

In order to improve coordination of the government apparatus reform efforts
a government program of the reform should be adopted and a unified strategic
center for the reform advancement, reporting directly to President or
Prime-Minister, should be created. The primary objective of the Center will
be to solve the personnel problem and increase the transparency of the
government apparatus' decision making and performance results.

The Center should be involved in defining the performance goals, formulation
of the plans for adoption, enactment and enforcement of laws. After that,
the Center can be engaged in the analysis of potential separation of
functions and definition of the quality standards for government services.

The Center should be staffed with highly qualified officers with business,
academic and public service backgrounds. Adequate compensation should be

Development of sectors - engines of growth

Financial sector
In the course of the last few years, the Ukrainian market of financial
services has grown at a quick pace. The banking sector, which in five years
from 2001 grew more than 700%, has been developing especially dynamically
[42]. Joint investment institutions are growing quickly, though from an
initially low level.

For example, the total net-wealth of open investment funds had risen 750%
during the course of 2007 [43].  A little less successful, but still fast
enough, has been the growth of the insurance market, which grew almost
500% over six years from 2000 [44].

At the same time market of financial services continues to hold considerable
potential for the further growth. In the banking sector this is indirectly
confirmed by continuing coming of big foreign investors: 47 of 173 banks
have some share of foreign capital (17 are with 100% of foreign capital) and
8 of the 20 largest banks in Ukraine belong to foreign investors, this
representing 30% of all bank assets [45].

Meanwhile, a number of challenges await this sector. For example, the
banking sector is noticeably fragmented [46]. A large share of banks which do
not meet the criteria of bank functions. The industry median indicator of
the capital adequacy ratio is decreasing, in the face of simultaneous growth
in consumer-loan portfolios.

These factors undermine the stability of the entire banking sector [47] and
the level of trust in it, which limits the extent of bank services
penetration and further market growth. In turn, inadequate supply and
heightened risks lead to high interest rates, inhibiting business activity.

In the field of joint investment, growth is occurring in conditions of weak
product diversification conditioned by an undeveloped normative base and by

In the insurance industry strong distortions are introduced by the wide
practice of using insurance schemes for tax evasion [48].

There are a number of instruments capable to stably accelerate the growth
of the financial services market. In spite of the existence of particular
barriers in every sector, the greatest obstacles to the growth[49] of the
financial sector are universal barriers.

For example, an ineffective court system markedly increases transaction
costs and lending risks, complications in questions of land rights hamper
the development of the subsidiary network, the inconsistent enforcement of
administrative regulation slows down the process of undertaking and
realizing business development projects. Specific industry barriers will be
relevant restraining factors in the mid-term.

In order to eliminate these in the banking sector it is necessary to lift
the burden of reporting and to balance the amount of regulation in the area
of operational activity of the banking sector.

At the same time, in order to increase the stability of the banking system
it is necessary to introduce monitoring and effective supervision of the
total amount and quality of the portfolio of consumer loans, with
synchronous increase of reservation rates and standards of assessment of
loan-portfolio quality. Besides the risks of destabilization, the aggressive
growth in consumer lending[50] creates additional inflationary pressure,
noticeably increasing the already quickly rising incomes of the population.

The experience of some East-European countries shows that an overly
aggressive pace of lending, used for consumer spending and real-estate,
doesn't increase the long-term potential of an economy[51]. At the same
time, the quality of a loan portfolio is frequently highly cyclical, which
creates the risk of volatility during the periods of slowed growth.

Development levers in the area of joint investment are:

   [1] Improvement of regulatory base
   [2] Enforcement of the regulator

Development of regulatory base should be in direction of new investment
products legitimization (for example, investment fund-in-trusts, currency
and money markets) and relaxing of excessive regulation (e.g. the rigid
regulation of share issuance according to a single model).

In the field of joint investment institutions the keys to growth are the
establishment of the normative base and strengthening regulation. The
development of the normative base should occur in the direction of the
authorization of new types of investment products (for example, specialized
real-estate investment funds and money-markets) and relaxing excessive
regulation (e.g. the rigid regulation of booklets issuance according to a
single model).

The institutional strengthening of regulatory bodies is necessary in order
to raise the quality of their services and to provide more effective
supervision of the expanding assortment of investment institutions. Such
strengthening would require a marked enlargement of the budget expenditures,
which can be financed by implementing legislatively determined mandatory
fees charged to participants of the market - proportionally to the volume of
shares under their control, as it is done in a some countries of the
European Union.

In the insurance industry key priorities of state policy should be:

   [1] the repeal of the special taxation regime for insurance companies,
   eliminating the conditions which encourage tax avoiding schemes;
   [2] implementing tax-incentive mechanisms for life insurance;
   protecting and ensuring consistent implementation of the regulations
   concerning mandatory liability insurance for automobile owners - an
   important catalyst for other forms of retail insurance.


Construction is the engine sector of an economy.  The experience of
East-European countries shows that this sector in the short-term perspective
is able to bring a substantial contribution to GDP growth and increase
employment, and also stimulate the development of connected sectors of the

The construction sector makes up 4.4% of Ukraine's GDP, whereas in
East-European countries this share is noticeably higher (e.g. in Poland the
construction sector accounts for 8% of GDP[52]), the same figure occurs in
China (8%), and is slightly lower in Russia (7.5%), which bears witness to
the weak development of the construction sector in Ukraine.

The fundamental obstacle to the development of the construction industry is
the large number of barriers for new players entering the market and
barriers to the growth of existing ones, as well as unequal law-enforcement,
which gives rise to corruption.

Fundamental barriers include the complicated and nontransparent procedures
for changing land-use zoning (e.g. converting land designation from
agricultural-use to construction), as well as the nontransparent process
involved with the sale of state-owned plots, and unequal access for
interested buyers, which markedly complicates obtaining plots of land for

A further barrier is the complicated and expensive licensing procedure, as
well as obtaining necessary construction permits. When developing a project,
the investor must obtain approval and get the consent of up to 130
government bodies, upon which the further development of the project

There exist considerable barriers to the entry of large foreign construction
companies on the Ukrainian market (for example, complications with
registering the branch office of a foreign company in Ukraine, limitations
for foreign companies on buying building land which is outside the bounds of
populated areas) which substantially hampers the development of competition
and impedes raising the quality of construction services.

According the World Bank rating, Ukraine holds 174th place out of 178
countries for the complexity of obtaining construction permits.[53].
Construction companies experience the lack of a qualified work-force (e.g.
construction engineers).  A governmental mechanism to regulate
urban-planning is also lacking.

The main benchmarks for the development of the construction industry are the
elimination of existing barriers to the growth of the industry and the
creation of conditions allowing more domestic competition. Already in 2008
it is imperative to formulate and implement a transparent procedure for the
obtainment of building land. The share of the construction sector in
Ukraine's GDP should by 2015 near the level seen in East-European
countries (8-10%).

In order to solve the present problems the following measures should be

It is necessary to simplify the procedure for the sale and lease of state
and municipal plots of building land and ensure equal access to all
interested parties. A possible method could be to hold auctions on the sale
of municipal and state building land, as one of the most transparent methods
of sale.

It is necessary to simplify the procedure for the obtainment of construction
permissions and licenses, decrease a number of those needed and shorten the
period of time of their issue.  The procedure should be on a "one-stop shop"

It is necessary to remove barriers for foreign companies to enter the market
(for example, after the transfer of financial assets from Ukraine to other
countries and vice-versa, simplify the procedure for the registration of
foreign companies).  It is necessary to remove all limitations on the
purchase of non-agricultural land-plots by foreign companies.

It is necessary to simplify the procedure for changing land-use zoning (for
example, switching land designation from agricultural use to construction),
and make the process more transparent.

It is necessary to reconsider limitations on permission for private
companies to performing construction of infrastructure and defence-sector
objects. State contracts should be sold through open auctions.

It is necessary to develop specialized education programmes jointly with
representatives of the business community in order to train highly-qualified
specialists and attract the best specialists from the most developed
countries (e.g. engineers and project planners)


Retail promotes the economic growth of a country. The development of retail
in a short-term perspective is able to deliver a real contribution to GDP
growth and raise the employment rate.

In addition, the retail sector is able to absorb the low-qualified labour
forces released by other sectors of economy during reforms.  Retail
stimulates the development of connected and dependent sectors of the economy
(agriculture, food industry, light industry, etc.)

Modern processes of retail promote the improvement of sanitary conditions in
trade, lower prices on some food products, assist in tax collection, and
lower the sales-volume of counterfeit goods. Retail product turnover in
Ukraine in 2007 grew by 29% (Ukrstat).

Nonetheless, its share of GDP remains lower that that in the majority of
East-European countries (Ukraine - 12%, Poland - 24%, Hungary - 23%).  A
considerable share of retail is in the shadowed economy.

Dynamic growth in the volume of retail is hampered by the following

   [1] Lack of land for development;

   [2] The procedure for sale and lease of plots and sites which fall
under government and municipal ownership. This procedure is complicated,
long, and does not guarantee equal access to all interested in such

   [3] Non-transparent procedure for the conversion of residential,
administrative, and industrial zoned sites to commercial zoning.  .

   [4] The excessive number of permissions and agreements necessary to
start and develop retail companies, as well as all too frequent inspections
by authorities.

   [5] The regulation of prices through administrative methods, disrupting
competition mechanisms, and from the long-term point of view deteriorating
the situation on goods markets.

First and foremost, it is necessary to stimulate growth of retail, at the
cost of creating conditions for the development of modern methods of
commerce.  By 2015, the share of retail turnover should be 20% of GDP.

In order to stimulate the development of retail it is necessary to eliminate
the moratorium on land sales and develop regulations concerning changes in
land-zoning designations.  Furthermore, a complete register of commercial
real estate and land-plots should be developed for open access.

This would facilitate more transparency in conducting operations. The
allocation of special zones on the outskirts of large cities would stimulate
the massive construction of mega-formats of retail.

The allotment of land lots and real-estate ought to occur on the basis of
legislatively formulated and approved regulations.  The first regulation -
on the allocation of lots of land and sites from state and municipal
ownership, and the second - on the conversion of residential, administrative
and industrial zones into commercial ones, designating a minimal closed
index of documents and a closed list of grounds for refusal of conversion.

The regulations should contain all necessary and sufficient procedures
(filing order, procedure for conducting public auctions, closed amount of
documents for   formalizing the deal) in order to minimize the possibility
of arbitrary decisions and ensure equal access to real estate.

In addition, it is necessary to implement the "one-stop shop" system for all
procedures and to limit by a law a period of time allowed for documents

Stimulating the development of retail also involves reducing the number of
inspections by state authorities. According to IFC data, the retail business
is one of the most inspected sectors of the economy. Effective realization
of the law "On the bases of state oversight (inspection) of economic
activity", which regulates inspections, should solve this problem.

In order to stimulate fair competition it is necessary to level up
approaches to taxation for all retail businesses. In order to stimulate
small business, a simplified taxation system should be applied for private
entrepreneurs only, making minimal use of possible trade spaces (to set up a
maximum trade space for which a single tax is paid).

Administrative regulation of prices at all levels including fixed prices for
so-called "socially-significant" products should be prohibited by a law.
The direct interference of the state only is acceptable with the help of the
mechanism of state reserves and commodity intervention and should happen
only in extreme situations. An important instrument of control for the state
over the process of price formation should become antitrust regulation.

Thus, retail growth can be ensured by liberalizing the real-estate and land
markets, in particular: elimination of the moratorium for land sales,
establishment of transparent regulations for leasing and land sales, as well
as state-owned sites, and redirection of residential, administrative and
industrial zones to commercial use.

These measures include diminishing the number of permits and simplifying
procedures to receive them, as well as frequency of inspections should be
significantly reduced. In addition, equal taxation systems should be used
for all retail businesses. Elimination of the Government's direct
administrative regulation of retail prices is also an important condition
for the successful retail growth.


Ukraine fairly recently made serious steps toward reforming its agriculture,
having eliminated collective agricultural enterprises in 1999-2000. Despite
individual property growth in the agricultural sector, agricultural output
growth in recent years was significantly lower (around 0 in 2005-2007 and a
5%decrease in 2007) than industrial output growth (10% in 2007) and GDP
growth (7.3% in 2007).

Ukraine's agricultural productivity is only 8.7% of the agricultural
productivity in the US[54]. The main reasons for the low productivity in
agriculture are unequal competition and obstacles to the access of foreign
and domestic companies to the market, which leads to low level of domestic
and foreign investments to the sector.

Unequal competition and low productivity in the sector are caused by the
following problems:

   [1]  Complex taxation (especially for businesses)
   [2]  Complicated licensing system
   [3]  Government intervention in price setting (for example, bread and
   sugar prices)
   [4]  Export quotas (especially for grains and cereals)
   [5]  Unequal and opaque distribution of government subsidies (20% of the
   largest producers receive more than 50% of the subsidies)
   [6]  Unequal access to subsidized loans
   [7]  Preferential and ineffective system of government purchases
   [8]  Moratorium on land sale and purchase and undeveloped system of
   property rights protection, which limits transfer of land to more efficient

The main goal for the next several years is a continual growth of labor
productivity, income growth of the population employed in agriculture, and
growth of agricultural output (agricultural component of GDP) to 7-8% of the
average GDP growth for the last two years.

To meet this goal Ukraine should implement the following in the next 5

Rescind the moratorium on sale and purchase of land designated for
agricultural use. Only a well-functioning full-fledged land market together
with leasing system can ensure the growth of domestic and foreign investment
in agriculture and access to the best practices in the sector.

Create the National Register of the land property rights (register of the
real estate property rights and their limitations) and the land cadastre
that ensures registration of property rights and leases and other
transactions with agricultural land in order to protect the rights of
producers that signed land leases.

Pass and fully accord the legislation regulating land market, land cadastre,
and land property rights register.

Simplify the licensing procedures for agricultural production and harmonize
it with the EU standards. Aside from that, Ukraine's government quality
standards and control over their observance should be brought in agreement
with international standards, in particular EU standards. This will
significantly simplify the recognition procedure of domestic agricultural
products in the world markets and improve competitiveness of domestic

Abandon such artificial market regulation methods as minimum and maximum
prices and other price controls.

Abandon export quotas. The quotas can be temporarily subbed with export
tariffs followed by reduction of such tariffs. Price controls and
export-import limits are often justified by the necessity to protect
domestic producers and support the poor by means of low food and produce
prices. In reality, they only protect interests of some, as a rule, large
producers, and impair overall competitiveness of the agricultural sector. In
lieu of protecting the producers, export quotas often result in reduced
production and consequent price growth.

Gradually reduce import tariffs. The import tariffs can be lowered to 5-7%
of the total value of the imported goods.

Abandon production subsidies and replace them with direct disbursements
from the budget with subsequent reduction of such disbursements. Today,
agricultural subsidies in Ukraine consist of budget expenditures on
agricultural production and capital goods (fertilizers, chemical agents,
equipment, subsidized loans) and of reduced taxation by means of
preferential VAT exemptions or VAT compensations. Under these conditions
the criteria for subsidizing are opaque and preferential in character.

Direct budgetary disbursement based subsidies will ensure equal access of
all producers to the subsidies, provide precise criteria for receiving
subsidies and determining their amount, and minimize assistance related red
tape. For example, the land area under ownership can be a basis for such
disbursements to some agricultural producers.

Part of the money saved through improved efficiency of the agricultural
subsidy system and consequent reduction of subsidy amounts, can be
re-directed to direct monetary assistance to the poor.

The government purchases system is inefficient. It leads to corruption and
should be reduced to the very minimum. The volume of the government
purchases should not exceed the volume of goods required for the needs of
the military, other government needs and strategic reserve.

Significantly improve the current system of monitoring prices, production
volumes, and other indicators. This requires a significant improvement of
the database that will allow for access by any one through the
world-wide-web. A good example of such a database is the database of the US
Department of Agriculture (USDA). This will greatly facilitate forecasting
of market demands and will contribute to the right decisions by market

First priority measures of the Ukrainian government directed at development
of the agricultural sector in Ukraine, should be abandonment of the
moratorium on sale and purchase of land and respective modification of land
legislature, creation of the effective unified register of the property
rights for agricultural lands, and abandonment of the export quotas
(especially for grains and cereals).


The machinery-building industry is an important sector of the national
economy that creates relatively high added value of the end products as
compared with the raw material production industries; it also facilitates
development and implementation of new technologies.  Machinery-building
sector is the main area for direct foreign investments.

In the year of 2007 the Ukrainian machinery-building industry growth rate
was 28%[55], the fastest growth rate was observed in the transport
machinery-building sector (39.6%). This rate resulted from increased demand
for machinery in the CIS countries, firstly in Russia, because of the
large-scale technical upgrade programs covering both the state-owned and
private enterprises.

However, the share of machinery-building sector in the Ukrainian production
output is only 13%, which is 2-3 times lower than in developed countries.
According to some estimates, machinery companies use on average only 30-50%
of their capacity. At the same time, machinery-building sector can be one of
the key industries in terms of providing sustainable economic growth and
long-term competitiveness of Ukraine.

The key problem the Ukrainian machinery-building industry faces is finding
large markets where its products can be sold.  The traditional sales market
(CIS countries, mainly Russia) experienced decline of demand in 1990s, and
yet haven't fully recovered. At the same time, the new large markets for
sales, including those in West Europe, are highly competitive, which
requires high quality of products, introduction of state-of-the-art
technologies, and highly efficient manufacturing.

In reality, Ukrainian machinery is often outdated because of obsolete
manufacturing technologies, 60-80% worn equipment and limited level of
innovation activities. Sectors that are still in crisis are: manufacturing
of agricultural machinery, machine tool, and aviation.

The machinery-building industry reform is targeted at creation of conditions
that will facilitate development of competitive machinery-building sector.
The following can serve as success indicators:

   [1] Production output growth and increase of the sector share in the
   industry structure by increasing capacity usage up to 70%

   [2] Labour productivity increase to the level of that in the countries
   of Central and Eastern Europe

   [3] Increase of investments in the sector.

The following measures are required on the machinery supply side: Privatize
enterprises that are not critical for the state security, facilitate
technical upgrade of the machinery-building industry, and create a favorable
environment for development.

First, privatization will facilitate the increase of machinery-building
plants' performance. Results of the machinery-building sector operation in
2007 indicate that privatized enterprises grow faster (42%) than state
enterprises (11.8%). Nonetheless, from the national security standpoint, not
in all industries can handle privatization.  The privatization approach in
the machinery-building industry should be differentiated.

   [1] In sub-sectors that are critical for the state security (such as
military machine-building) it is necessary to keep it state-owned. With
that, it is advisable to consolidate assets, implement state-of-the-art
control systems and prioritize the products to be manufactured.

   [2] In sub-sectors that experience global competition, but do not
possess unique know-how or those that have lost such (manufacturing of
agricultural machinery and machine tools) direct privatization with
engagement of strategic investors shall be completed.

   [3] In certain sub-sectors that are not related to state security, but
possess some unique know-how and potential and that, in the future, could be
globally competitive on their own (aviation manufacturing, space industry)
assets should be consolidated under the overall control of the state.   Here
it will be possible to arrange targeted support from specific programs and
projects that have a chance to result in international success.

It is expedient to create a project partnership (consortia) with top global
manufacturers. It will allow for introduction of new technologies and
ensuring sales while retaining control over the enterprises.  Gradual
privatization of these sectors through IPO or sale to national corporations
is also possible.

Second, it is necessary to stimulate technical upgrade. The first step in
this direction will be abandonment of custom duties and deferred VAT for a
comprehensive list of process equipment for machinery-building industry. The
list of such equipment (TNVED codes) should be approved by the Cabinet of
Ministers based on the requests from the industry's enterprises.

Third, in order to improve the innovation and investment activity of
enterprises it is necessary to have a favorable environment, which emergence
can be facilitated by the state.  The critical components of a favorable
environment at this time are: Availability of skilled engineering personnel
and developed stock market that would allow to promptly obtain loans, direct
and portfolio investments.

On the machinery demand side, it is necessary to promote export (external
demand) and completely execute state programs aimed at development of
national industries (internal demand).

Ukrainian manufacturers should completely use opportunities that come up in
the course of the large-scale technical upgrade of a number of industries in
the CIS countries. Implementation of the announced programs for
transportation infrastructure upgrade (railway rolling stock), energy sector
and mining industry in Russia and Kazakhstan will continue to 2012.
Ukrainian companies should have the same degree of access to those markets
as the local manufacturers.

According to the experience gained for the last few years, political
relationships between the countries make direct impact to mutual trade.  In
this context, it is necessary to keep good political relationship with the
CIS countries and develop the free trade zone. It is important that in the
period of high demand the Ukrainian products won't face technical and
customs-related barriers or anti-damping investigations.

At the state level it is necessary to take measures for promotion of export
to the CIS countries that do not contradict the WTO regulations and
bilateral agreements. These measures are common in the global practice and
may include export credits, state guarantees, organization and co-financing
of trade shows, etc.  Besides, the term of VAT repayment shall be reduced
for export transactions; that will exclude diversion of current assets from
the sector's enterprises.

Internal demand for machinery often depends on implementation of state
programs in relevant sectors. For instance, mining machinery manufacturing
depends on implementation of the state program for mine construction and
upgrade. By the same token, manufacturing of agricultural machinery depends
on investments in agricultural sector. At this time the majority of such
state programs either do not work at all or are implemented by 10-20%.
Besides, financing of these programs is done from time to time.

This inconsistent state approach makes it impossible for enterprises to
develop adequate manufacturing plans and execute their development strategy.
Well-thought planning and strict discipline in execution of the state
programs will help to increase domestic demand for the machinery-building
industry products and improve predictability of this demand.

Therefore, the first steps in development of the machinery-building sector
should be: Facilitation of growing export to the CIS countries, consistent
assistance to technical upgrade through cancellation of customs duties and
deferral of VAT payment for process equipment. Next, privatization of
enterprises that are nor critical for the state security should be

And, finally, it is necessary to align the programs for development of
individual sectors of economy with the new budget and completely implement
these programs in compliance with the approved plan; it is also necessary to
reform the human resources training program and promote stock market
development to create a favorable environment for machinery-building
industry development.


In the last 15 years Ukraine lost its innovation potential to a large
degree; that left Ukraine behind other countries of Eastern Europe. In 1990
the rate of enterprises developing and implementing innovative or enhanced
products was 60-70%, but it dropped to 15% by 2005 versus 70% in developed
countries and 30% in Poland.

According to the report on global competitiveness of the World Economy
Forum, Ukraine is rated as 93rd in terms of technological conditions and as
65th with respect to innovations among 131 countries. That demonstrates that
even with a certain innovative practices in place, the practical yield is
very limited.

Both low market demand for innovations and limited availability of companies
owning innovative solutions or scientific groups pose difficulties to
implementation of innovations. No fair competition and/or access to the best
business practice, e.g. to the international companies, mostly limit market
demand for innovations.

Therefore, activities resulting in ensuring fair competition and easier
access for the foreign investors usually promote the overall implementation
of innovations to the industry sectors.

Other factors such as unfair tax regulations and import duties on high-tech
equipment and raw materials required for export production also put
constraints on innovation implementations.

On the other hand, the problems on the supply in Ukraine are caused by
insufficient protection of intellectual property, immaturity of venture
capital financing and, finally, lack of developers' knowledge of how to
commercialize an invention. Some new sectors cannot move forward die to
poorly developed infrastructure.

The main purpose of the innovation sector development should be removal of
existing barriers for development of innovations, assurance of fair
competition in all sectors, protection of intellectual property, development
of VC financing mechanisms, as well as development of technological and
informational infrastructure. By 2015 the share of companies involved in
innovation activities should be doubled and attained the level of Poland

Since the measures aimed at facilitation of competition and arrival of best
practices are described in other parts of this Concept, only measures
specific for innovation promotion are discussed here.

The state should provide favourable conditions stimulating inflow of private
investments rather than pouring finance into individual sectors or
innovation projects.

It is necessary to soften taxation by applying accelerated amortization
rates when calculating income tax, providing timely VAT compensation for
exporters, executing new and prolonging expired interstate agreements to
avoid double taxation, removing double taxation rates for income
repatriation. These result in, first, release of extra available funds for
re-investment and, second, facilitation of foreign investments in Ukraine.

A number of innovation sectors, e.g. IT-offshore outsourcing and offshore
outsourcing of R&D, face difficulties because of high rate of social
payments since the share of wages is high in the cost of the end product.
Possibility of reducing maximum rates of social charges should be reviewed.

It is necessary to simplify customs procedure and to lower customs duty on
raw materials for high tech industries. We suggest removing customs duty on
import of high-tech equipment that does not have equivalents manufactured in
Ukraine or have significantly higher specifications. It is necessary to
develop a procedure of compensation of customs duty on raw materials used in
the export production and paid by exporting enterprises.

New approaches for capital procurement, for example VC financing, should be
developed to provide innovation activity with additional funds. Relevant
legislation development should be reasonably supplemented by "venture
projects trade shows" to attract international venture capitalists to
Ukraine and also by development and support of the public databases
including the known venture funds and innovation developments needed

It is advisable to study Israel's experience in development of venture funds
with participation of the state (where the share of the state is minimal;
the funds shall be managed by leading international VC investors).

The information about development of innovation sector can become widely
available through generation of a unified electronic information centre that
would carry data on patents, licenses and innovation projects being
implemented, and also by means of holding annual "venture projects trade

Experience gained in many countries demonstrates that it is useful to
establish the information centre, e.g. website, for developers on innovation
projects, there information would be available on how to commercialize
innovations, how to prepare a business plan, find VC investors and work with
this investor.

This information could include the list of VC investors and advices on how
to promote development to companies-purchasers. In the developed countries
innovation coordinating centres are responsible for all of that. In Ukraine
the existing State Investments and Innovations Promotion Agency can fulfill
this task.

It is necessary to provide protection of intellectual property in line with
the best international practice, simplify registration procedure for
intellectual property items, eliminate discrepancies in intellectual
property legislation and Civil, Administrative and Criminal Codes with
respect to responsibility for violation of the established standards,
introduce a procedure valuation of intellectual property items and develop a
damage evaluation method, determine court procedures related to intellectual
property rights. It is necessary to effectively identify violations in the
intellectual property area.

It is necessary to consider advisability of creation of technological
clusters in the existing or perspective innovation development centres in
Ukraine. The clusters will help to solve infrastructure problems, assist
small companies in commercialization of their developments, to attract
foreign investments to a number of sectors, and also will results in the
knowledge concentration, accelerating innovations development and

Development and validation of development strategy for the country's R&D
sector including all measures mentioned above and removing barriers for the
innovative activity in business should become high priority steps for
evolution of the innovation sector.
[1] Access to services market, harmonization of standards, customs
procedures, procedures for certification of products, competition policy,
state purchasing and subsidies, investment environment (including land
purchase), environmental standards, intellectual property, etc.
[2] According to Institute for Economic Research and Policy Consulting data
[3] During 1999 - 2006 state debt decreased from 64% to 15% of GDP (compare,
so-called Maastrich criteria require EU states to keep the state debt below
60% of GDP).
[4] During  2000-2006 average total budget gap did not exceed 1% (compare,
Maastrich criteria require EU states to keep their gap within 3% to ensure
it is balanced in the mid-term)
[5] Fitch Rating Agency
[6] Government forecast of the budget gap in 2008 is 1.5% of GDP as opposed
to 0.5% of GDP in 2007
[7]UN Analytical Center report entitled 'Independence, accountability and
transparency of the central banks: Ukraine case'.
[8] In developed countries the criteria for removal from office of the top
management of Central Banks are clearly limited: does not qualify to perform
job responsibilities; could not perform duties during six months; convicted
of a serious (criminal) offense
[9] OECD Ukraine Economic Assessment 2007, p30
[10] From 2003 till 2005 the volume of state transfers grew from 17% to 23%
of GDP, primarily due to doubling of the size of pensions in real terms.
Compare, state investments made up 2.2% of GDP in 2005, which is far below
the level in other states with transitional economy.
[11] Size of consumer loans portfolio in relation to GDP grew up in 6 years
from 0.6% to 15%
[12] IMF, 2005
[13] According to Eurostat (including social sector)
[14] According to State Commission for Securities and Stock Market and World
Exchange Federation, the volume of organized shares trading was UAH 6
billion in Ukraine in 2006 which is equal to a half of average trading day
in comparison to Moscow Interbank Currency Exchange and Russian Trade
System, 5 trading days in comparison to Warsaw Stock Exchange, and 8
trading days in comparison to Budapest Stock Exchange
[15] In 2006, average capitalization level in countries analyzed was 69% of
GDP (37% in Ukraine), while the volume of organized trading was 58% of
capitalization level (3.6% in Ukraine).
[16] For example, co-investment institutions are not eligible to hold more
than 30% of assets in shares or establish any entirely monetary, foreign
exchange, or real estate fund.
[17] Currently, several bodies are involved into regulation and control over
capital markets, including Commission for Securities and Stock Market,
National Bank, and Ministry of Finance
[18] Here and below in this section all statistical data is data of the
Ministry of  Fuels and energy (unless specified otherwise)
[19] By the Directive of the Cabinet of Ministers of Ukraine of January 9
2008. ?57-?
[20] According to World economic forum Competitiveness report 2007-
2008 Ukraine is on 116 place out of 131 for quality of roads
[21] Transportation costs of subsidised categories amount to 147 million
hryvhia over the 6 months of 2007; compensation provided in the budget is
equal to 102,7 million hryvnia for 12 months of 2007.
[22] Labour force turnover - sum of the numbers of fired and hired to work -
reached 58% of the total number of employed
[23] OECD "Ukraine Economic Assessment 2007"
[24] UNDP "Blue Ribbon Report 2006"
[25] The general level of mobility of the work force in the last years
remains at the level of 1.5% of the total number of employed
[26] UNDP "Blue Ribbon Report 2006"
[27] This issue is further examined in the section "Work-force Training"
[28] World Bank "Doing Business 2008"
[29] UN's analytical center Blue Ribbon estimates the Ukraine's shadow
economy as reaching 40-60% of GDP, the World Bank gives it 50% of GDP.
[30] "Doing Business 2008" - Ukraine (2,085h) compared against OECD
average (183h)
[31] According to an IFC-led inquiry covering 3,000 Ukrainian companies
completed in 2005, tax authorities were quoted as the most corrupt power
agencies in Ukraine
[32] According to an IFC-led inquiry completed in 2005, out of 3,000
companies 72% responded that they were evading taxes in varying degrees
[33]Re: EC Article 63, CC Article 83
[34] For example, EC gives no definition of apportionment as a cessation of
a legal entity, while CC discusses it in Article 109
[35] Ukraine 2007. Report on Transformation, Foundation Institute for
Eastern Studies, Warsaw, p. 126.
[36] According to the State Employment Agency, 40% of newly trained
economists immediately register at the unemployment office, and the ratio of
higher education graduates to the vocational school graduates is 60:40,
which is directly opposite to the labour market demands where 60% of the
vacancies are for qualified blue collar workers
[37] Another Ukraine's goal relevant to this topic (discussed separately in
the sections "Monopoly Management" and "Privatization") is elimination of
distortions caused by a large number of un-reformed government monopolies
and excess government participation in economic activity
[38] In accordance with Article 24 of the Law on protection of economic
competition, all merges and acquisitions where participants' combined assets
or sales revenues reach 12 mil euros, or where assets and sales of at least
two participants exceed 1 mil euros, or where  assets or sales in Ukraine of
one of the participants exceed 1 mil euros, are subject to AMCU approval.
[39] For instance, in accordance with the current wording of the law
Mercedes and Chrysler merger are subject to AMCU approval, as well as the
pending purchase by Tata of Jaguar and Rover brands, as these transactions
meet all concentration criteria of the Law on protection of economic
[40] Salans Warsaw International Law Firm
[41] In the World Economic Forum report on the effectiveness of government
(World Economic Forum, 2007-2008) Ukraine was placed 119 out of 131
[42] According to statistics from the Ukrainian National Bank (NBU), in the
period from 2001 to 2006 the combined total of deposits and loan portfolios
of Ukrainian banks grew from $10 billions to $77 billions USD.
[43] The Ukrainian Association of the Investment Business, 2008
[44] According to data from the Ukraine Insurer's League, the total worth of
insurance industry premiums rose from $422 million to $2,025 million euros
in the period between 2000 and 2006.
[45] Ukrainian National Bank, 2008
[46] 173 banks operated in Ukraine as of 2007?
[47]  In Moody's rating of banking systems' stability Ukraine takes 87th
place among 92 countries (2007)
[48] According to various estimates (EIU, IMF), up to 80% of the volume
of insurance premiums fit in with tax evasion schemes.
[49] Interview with commercial bank managers in Ukraine
[50] In 2006 the growth in consumer lending fuelled 30% of the growth in
general household consumption.
[51] IMF, 2005
[52] Doing Business 2008, World Bank
[53] Doing Business 2008, World Bank
[54] For  2004
[55] The source of statistics in this section is Ukrstat (Ukrainian Bureau
of Statistics)

Foundation for Effective Governance was founded in 2007 to help improve
people's lives by assisting policy makers at all levels and stakeholders to
design and implement actionable public policy solutions, and by furthering
public debate on the most important development challenges facing Ukraine.

Foundation for Effective Governance is a Ukrainian foundation, aimed at
developing long-term national economic programs. Foundation's funding
source is Ukrainian business. According to the world's best practice, the
Foundation's funding is separated from developing content of programs and

Before the Foundation was created, the world's best practices from various
countries have been studied. In many leading countries of the world,
donations from businesses support independent research centers that assist
the Government in developing and implementing reform programs in various
spheres of Government activity. Many such organizations actively cooperate
with the Government, first of all, with Parliaments.

For instance, The Brookings Institution in the USA consults government
authorities on economic and democratic development programs.

The Heritage Foundation forms public opinion on country development
directions, according to the principles of free enterprise, limitation of
government intrusion in the economy, protection of individual freedoms.

British Adam Smith Institute consults the Governments all over the world on
privatization and transition to market economy.

In Australia - the Fraser Institute develops strategic solutions for State
Committees. Peruvian Institute of Liberty and Democracy, jointly with
governments of several developing markets, implements programs stimulating
economic growth by legalizing real estate property rights.

It is widely known that in Ukraine today there is an acute need in
developing and implementing long-term economic and social development
programs. In our view, the current situation, with its rapid pace of the
political changes, did not allow the Government to pay sufficient attention
to Ukraine's long-term development strategy.

We truly hope the Foundation's work will help formulate a long-term economic
development program, as well as create public and political consensus
regarding the main elements of such program.

Foundation for Effective Governance is Mr. Rinat Akhmetov's private
initiative; his personal contribution to the economic development of Ukraine
and to facilitation of systematic dialogue between experts, Government,
business, civil society organizations, and mass media.
LINK: http://www.feg.org.ua/en