Your Money Matters: Ukraine's emerging market

Since 2000, Ukraine's economy has averaged 7.4% annual growth. Projections are for 7.5% 2007 GDP growth in 2007 - up from 7.1% in 2006.

globus mall 88 224 (photo credit: Bloomberg)
globus mall 88 224
(photo credit: Bloomberg)
Ukraine has come a long way since its independence in 1991. During the Soviet period, the country was the Soviet Union's largest economy after Russia. Ukraine's rich soil lands provided 25% of the former Soviet Union's agricultural production. Ukraine was a major heavy industrial manufacturer for the Soviet empire. After receiving independence from the former Soviet Union, Ukraine's economy entered into an inflationary environment accompanied by a sharp decline in industrial production. The loss of its traditional buyer (the former Soviet Union republics) caused a severe disruption in traditional markets for the Ukraine's heavy industry, resulting in a dramatic decline in its manufacturing sector. From 1991 to 1999, manufacturing output declined 40%. This economic period was accompanied by political unrest. Despite these problems, the country was able to implement economic structural reforms, including privatization, and encourage foreign investor activity. From 2000, the economic situation began to improve due to a rise in steel and coal prices and Russia's strong economic growth, which translated to increased demand for Ukraine's natural resources form its largest customer This led to a path of recovery and economic growth. The political relationship with the west would remain distant until the 2004 elections which ousted the existing pro-Russia president with Viktor Yushchenko whose platform included stronger ties with the rest and less economic dependence on Russia. Since 2000, Ukraine's economy has averaged 7.4% annual growth. Projections are for 7.5% 2007 GDP growth in 2007 - up from 7.1% in 2006. Foreign investors have understood the potential of the country's economy based primarily on a developed industrial base, an inexpensive and educated labor force (relative to the West) and one of the fastest growing domestic consumer markets increasing in tandem with an ever-improving standard of living. Ukraine's GDP is $134 billion, which translates into $2,869 per capita. Ukraine is rich in natural resources including coal, metals and chemicals as well as significant land areas rich with soil conducive for agriculture. When one considers Ukraine's geographically strategic position and both economic and political potential, it is clearly a country to be considered by an equity investor seeking emerging markets exposure. Let's look at the facts. Ukraine is a country steeped in both Russian and European history. The country is second in size, only to Russia, in Europe. The country is in Eastern Europe. bordering Russia, Belarus, Hungary, Slovakia, Poland, Moldavia and Romania with a population of 46.6 million. Risks in investing in Ukraine are not insignificant. Ukraine imports 75% of its energy sources. Natural gas composes 50% of its energy requirements. Ukraine historically imported all its natural gas from Russia at low market prices. Since the 2004 election, Russia has doubled the cost of gas. Also as a result of ongoing political friction, there have been periodic deliberate disruptions of Russia's gas supply to Ukraine and implied threats of more serious consequences. Ukraine's high inflation rate is another area of concern. Inflation was 11.6% in 2006 and projected to reach 11.8% for 2007. This high inflation rate threatens to choke Ukraine's growing economy. Ukraine's central bank's (NBU) interest rate is currently 8%. Ukraine has several regional exchanges, but most securities activities occur on two exchanges - the PFTS (Ukraine Stock Exchange) and the USE (Ukrainian Stock Exchange.) The PFTS index is recognized as the country's representative equity index representing 18 companies from six sectors. The PFTS represents 95% of all equity trading among the exchanges. Ukraine's capital market is relatively small: $77b. (as of June this year). But foreign investors are becoming more active in light of the attractive returns provided by its stock market. One of the advantages of investing in Ukrainian companies is that they are relatively large cap compared to other emerging European markets. Ukraine's stock market offers sector diversification including steel and iron manufacturing (22%), banking (17%), public services (14%), gas & oil (11%), and communications (9%). Ukraine's equity market, which commenced with the country's independence and privatization program, languished through the 90s and almost collapsed with the 1998 Russian crisis. The market surprisingly started to take off in 2004 and by July 2007 provided the best returns of any equity market globally. From its inception in 1997 to Nov. 20, 2007, the PFTS index has yielded a 131% return. In the last three years, the index has yielded 514% and over 2,000% for the last five years. Investing in Ukraine's equity market remains difficult due to limited investment. There are no mutual funds registered on Western exchanges with significant experience in the Ukrainian stock market. There are a few index notes (e.g. via ABN Amro) which merit consideration. Investors should consult with their financial adviser regarding their risk tolerance level and investment choices. [email protected] The author is Global Investment Strategist at Tandem Capital. Yulia Vaiman/Macro Research Analyst at Tandem Capital contributed to this report.