Caught in the throes of three consecutive recessions since 2008, Ukraine is now negotiating for support from Russia, the European Union, the International Monetary Fund and China. If Ukraine had years of experience as an independent country and balanced internal politics, these circumstances would be difficult but might have the nation’s interests front and center. But, that’s not the case and it seems the oligarch’s who have emerged since 1991 as the real power players behind national decisions are casting the most influence on the countries future.
Ukraine has little experience as a stand alone, independent country. As part of the buffer region between Russia and Western Europe the Ukrainian people have been pulled east and then west by larger empires. With rich soil and natural resources that support industry, it seems as if this region should be highly developed. Having been the second richest region within the Soviet Union, behind Russia, it was exploited in horrifying ways. As a newly established stand alone country the lack of development is glaring. And the problems are all about culture and government structure; corruption is an endemic problem.
The ability of a country to grow is tied to infrastructure and Ukraine has trouble with infrastructure. Most of Ukraine’s industrial construction was done by the Soviets and most of it is old. After 1991 independence, Russia negotiated deals with Ukraine to be a transport channel for Russian natural gas and oil westward to Hungary, Germany, Turkey and other European countries. Due to government resistance the Ukrainian government has not reformed into a dynamic support structure guiding the country in a new independent direction. By 1999, Ukraine’s industrial output had fallen 40% from it’s output as a part of the Soviet system.
Most of Ukraine’s oil, natural gas, and all of its nuclear fuel needs are imported, much of it from Russia. In 2009 Ukraine signed a ten year deal with Russia to supply and also transport Russian gas and oil. That deal has hobbled the Ukrainian national gas company and combined with the government’s inability to reform, industrial growth remains low, even though there were a few years of expansion from 2005 until 2008; expansion based largely on steel exports. Due to the global financial crisis starting in 2008, Ukraine’s GDP fell by 15 percent in 2009. Even with a renegotiation of terms with Russia to get discounted oil and gas prices, the economy fell into recession in 2012.
Agriculture And Oligarchs
Faced with a stagnant economy and corrupt government, which resists reform, Ukraine falls back on its agriculture. With fertile, black soil there is high farm output of meat, milk, grain and vegetables. Family farming is widespread, but no longer supported by the government in the way farmers were supported as a collective under the Soviet Union. Farming families are thrown into confusion about market conditions and what crops will bring the highest returns. The entire organization of agriculture is muddled by lack of guidance for resources and markets. Farmers are turning to cell phones as contact methods and for internet access, seeking information. But small farms are not the center of Ukrainian agriculture.
In October 2013 China arranged a fifty year agricultural deal with a Ukrainian Agricultural company named, KSG Agro. The deal provides investment money for Ukraine and food for China. Crops raised in an eastern Ukrainian province (Dnipropetrovsk) are going to be sold at below-market prices to two Chinese state-owned farms. The crops will be raised on over six million acres of prime Ukrainian soil, which is about five percent of Ukraine’s total acreage and nine percent of its arable land, or 11,583 square miles.
In return for crops, China will invest $2.6 billion dollars in infrastructure improvements, material inputs such as seeds and fertilizer, as well as Chinese workers. None of this would have been possible prior to 2012, but last year the Ukrainian government lifted a ban on land purchase by foreigners. That land reform opened the door to the Chinese deal. Unfortunately in a country so new to a free-market economy, reforms often favor inside players and it seems the November 2012 Ukrainian land reform gave advantages to a small group of inside agricultural players (oligarchs) to buy up land and use it for their profit. It’s not clear if the Chinese deal will play poorly for smaller farmers in Ukraine. What is clear is that KSG Agro is an oligarch’s company. Serhiy Kasianov is Chariman of the Board and majority shareholder. Kasianov’s total compensation and stock options as well as his education are not listed in Bloomberg’s executive profile, which leads to the assumption he is a typical post-Soviet style oligarch.
Ukraine’s large grain companies, like KSG Agro use transfer pricing as a means of not paying taxes on their production. Here’s how the method works, the company sells their grain at a deeply reduced price through a third party that is listed in a location where taxes are very low or non-existent, places like Cyprus, where KSG Agriculture and Industrial Holdings Limited is listed. Resale from a location with low taxes means a higher price can be charged, while taxes are avoided. The people of Ukraine are the losers and the stockholders of the the big agro company are the winners.
But turning a profit on unethical trading arrangements can only last as long as there are harvests, so reinvestment into agricultural infrastructure is important. In fact broad investment into all kinds of infrastructure are important and deals structured by oligarchs at large agro holding companies aren’t able or interested in doing anything beyond what helps them profit. If they can cut a deal with a foreign country that offers necessary agricultural improvements, but ignores other national infrastructure, then that is considered a wise arrangement. Hence the Chinese deals.
To address the much larger problem of Ukrainian infrastructure, President Viktor Yanukovych has negotiated simultaneously with Russia and the European Union for access to financial support. For six months or more the European Union negotiated association and free trade agreements with Ukraine and at the same time listened to threats and offers from Vladimir Putin of Russia. Finally, on December 21, Yanukovych opted for a Russian $15 billion bailout package rather than a European Union trade treaty.
In all of these negotiations what is most obvious is that Ukraine is struggling to establish itself as an independent country by playing off external rivals. The problem is that this strategy may succeed in gaining Ukraine geopolitical independence without providing enough economic support and investment to modernize her long neglected infrastructure. That outcome is likely to have political ramifications leading to opposition political leaders gaining control and then taking the country off in yet another direction. For now the oligarch’s and their chosen political leader are muddling through, oligarchs packing away hefty profits and Yanukovych dancing between multiple outside power influences. In the mean time prospects for western investors looking to project entrepreneurial energies into the Ukraine are not looking very positive.