|Author: Ondrej Klipa|
PROBLEM OF THE SPECIAL ECONOMIC ZONES WITHIN THE UKRAINIAN ECONOMY AND POLITICS
One of the most problematic and most criticized measures of the “orange” government in Ukraine was abolishing the tax breaks of the existing program for attracting foreign investment. The program’s abbreviation is SPRID, which means Special Legal Regime for Investment Activities. However, names of its two models are commonly used instead – SEZ, which stands for the Special Economic Zone, and TPR, which stands for the Territory of Priority Development. But in media and in politics, the program is most commonly called only as the Special (or Free) Economic Zones or just “zones”, which have parallels around the entire world and with which the public is the most familiar.
Controversial Character of the Ukrainian Zones
After the victory of Yushchenko in the presidential elections, there were eleven functional Special Economic Zones and nine Territories of Priority Development in Ukraine. They covered approximately 10 percent of the country’s territory. Even though most of them were relatively new (12 SEZ’s and TPR’s came into existence in 2000), the establishing Act on “General principles of creating and functioning of SEZ” dates all the way back to 1992. Since then, 12 SEZ’s and 9 TPR’s have been established. However, operational time of the oldest zone, “Sivash” on Crimea from 1996, expired after its five years.
Although according to the law, the zones are established by the Supreme Council (Ukrainian parliament) by adopting respective regulations, an overwhelming majority of them has their legal basis in a decree issued by president Kuchma. But already in 2003, Kuchma’s attitude was in a sharp contradiction to this situation. He appealed for their complete abolition and he called the investment zones “free semi-criminal zones”.1 What caused such a sharp turn in his opinion?
The presidential candidate at that time, Viktor Yushchenko, exceptionally agreed with Kuchma on this topic when he said that “wherever a (oligarchy) clan is established, its zone immediately follows”2 . Already as the president, he said that “the principal of forming the zones is that when the Medvedchuk’s clan works in Carpathian Ukraine, there is a free zone there; when the Yanukovych’s clan works in Donetsk, a zone must be there too”. 3
A very suspicious disproportion is immediately obvious in the investment activity between activities of Ukraine’s residents and purely foreign capital, for which the program was primarily designed. During the entire time of its existence, SPRID has received an investment amounting to approximately 1.5 billion USD from Ukraine’s residents and approximately 600 million USD from foreigners (the ratio had not been very different beforehand either, for example in 2003: 378.5 million USD from residents and 118.6 million USD from foreigners). The dominant activity of local entrepreneurs is reflected also in the direction where the investments went – especially into TPR (in the middle of 2000, investments into TPR formed even 90 percent of the total volume in SPRID). The reason is that the law prescribes SEZ an objective to attract foreign investments, while TPR’s are “only” supposed to help weak regions by the means of a development of priority sectors. It is, however, necessary to say here that from the many advantages, TPR’s probably provide overall more attractive conditions; for example, they are exempted from paying the value added tax and import customs duty in all cases (as opposed to SEZ), and furthermore, they also cover more territory and in majority of instances they do not require any minimal investment volume.
Table 1. List of Ukrainian SPRID
|No||Name||Location||Date of establishment, term|
Free economic zones (SEZ)
|1.||SEZ Syvash||t. Krasnoperekopsk, rayon Krasnoperekopsk t. Armjansk, Autonomous Republic of Crimea||18.09.1996, 5 years|
|2.||SEZ Slavutych||t. Slavutych, Kyiv Oblast||30.06.1998, 20 years|
|3.||SEZ Donetsk||t. Donetsk, Donetsk Oblast||21.07.1998, 60 years|
|4.||SEZ Asov||t. Mariupol, Donetsk Oblast||21.07.1998, 60 years|
|5.||SEZ Zakarpattia||Uzhhorod a Mukachevo rayons, Zakarpattia Oblast||09.01.1999, 30 years|
|6.||SEZ Yavoriv||Yavoriv district, Lviv Oblast||17.02.1999, 20 years|
|7.||SEZ Health Resort Polis Truskavets||t.Truskavets, Lviv Oblast||01.01.2000, 20 years|
|8.||SEZ Interport Kovel||t. Kovel, Volyn Oblast||01.01.2000, 20 years|
|9.||SEZ Mykolaiv||t. Mykolaiv, Mykolaiv Oblast||01.01.2000, 30 years|
|10.||SEZ Crimea Port||t. Kerch, Autonomous Republic of Crimea||01.01.2000, 30 years|
|11.||SEZ Porto-Franko||t. Odesa, territory of Odesa Commercial Sea Port, Odesa Oblast||01.01.2000, 25 years|
|12.||SEZ Reni||t. Reni, Odesa Oblast||17.05.2000, 30 years|
Priority development areas with special investment regime (TPR)
|1.||TPR in Donetsk Oblast||21 towns and 5 rayons in Donetsk Oblast||21.07.1998, 30 years|
|2.||TPR in Zakarpattia Oblast||All rayons in Zakarpattia Oblast||29.01.1999, 15 years|
|3.||TPR in Luhansk Oblast||6 towns and 3 rayons in Luhansk Oblast||04.02.1999, 30 years|
|4.||TPR in Autonomous Republic of Crimea||7 towns and 2 rayons in Autonomous Republic of Crimea||01.01.2000, 30 years|
|5.||TPR Shostka town||In Shostka town, Sumy Oblast||01.01.2000, 30 years|
|6.||TPR in Zhytomyr Oblast||9 rayons and 3 towns in Zhytomyr Oblast||01.01.2000, 30 years|
|7.||TPR Kharkiv City||T Kharkiv, Kharkiv Oblast||01.01.2000, 30 years|
|8.||TPR in Chernihiv Oblast||7 rayons in Chernihiv Oblast||01.01.2000, 30 years|
|9.||TPR in Volyn Oblast||t. Novovolynsk, Zhovtneve in Volyn Oblast||01.01.2000, 30 l years|
Source: Server Ukraine-Poland,http://www.ukraine-poland.com/
Decline of the Zones under Kuchma
After being given the accreditation for operation under SPRID, some domestic investors began to circumvent their binding obligations and the original intentions of their projects. Especially SEZ had clear objectives defined: usually creating working places, creating infrastructure or modernization and development of particular working places. The investors, however, concentrated recklessly only on their own profit, for which they very often used, for example, the duty free import. In the middle of 2005, an information was published that for the previous year, the state budget lost 3.4 billion hryvnias due to illegal import of meat through the zones. 91.3 percent of meat imported to Ukraine went through SPRID and, from the total volume, 87 percent was actually imported through SEZ and TPR in Donetsk.
The total modest results of the investments in SPRID – in 2000, they formed only 8.5 percent of the total volume of investments in Ukraine (four years later, it was 11.5 percent) – including the above-mentioned frauds were of course not missed by the Ukrainian tax inspection. The Ukrainian government, which is the explicit guarantor of the tax benefits of SEZ and TPR, was therefore getting constantly under pressure. Already in 2000, the Ministry of Economics came with an initiative to abolish the zones, which are very difficult to control from the customs perspective, while preserving the advantages for already existing investments. Since August 2002, a moratorium to found new zones was in effect (until January 1st, 2005). The crisis culminated with Kuchma’s criticism (February 2003), after which the Minister of Economics and European Integration Valeriy Khoroschovskyy still attempted to save the situation by calming the investors down, making the investment regime stricter, and by initiating an investigation of SPRID. In May 2003, the parliament and government appointed a control commission (more of them were consequently appointed also by Kuchma). A month later, Khoroschovskyy receded; he acknowledged ineffectiveness of the zones and agreed with their stop-status.
Abolishing Zones as a Motto of New Politics
No wonder that an immediate abolition of the zones appeared high on the list of Yushchenko’s election program. The program pillars supporting this measure were “equal opportunities” for all investors and “widening of the tax base”. He was led to the first point by his conviction that the zones cause destabilization of the economic situation. It is, indeed, true that the zones discriminate subjects that have invested outside of the zones earlier, and also give an advantage to a certain group of investors, for whom they are made-to-measure. At the same time, he was justly worried about corruption, which the possibility of operating under such convenient conditions could make tempting. Within the next point, abolition of the zones formed only a supplement to the overall revision of tax policies in Ukraine: radical decrease of income tax and therefore also a motivation to emerge from the shadow economy, which is multiplying the number of taxpayers. Investors from the zones paying the same taxes as anybody else were supposed to further widen this base.
On the question of particular tax benefits, Yushchenko stood sharply against exemptions from paying the value added tax and customs duty. However, he found meaningful the tax benefits in the case of income tax, provided that the income is invested into production, as well as in the case of payments for soil. He was supporting his election campaign with the weight of his own actions from the time of his rule, when he abolished more than 250 government stipulations on providing tax benefits to businesses.
Neither equal opportunities nor widening the tax base were, however, Yushchenko’s invention. For a long time, the first requirement had been argued for by, for example, the International Monetary Fund, which was even conditioning its financial help to Ukraine by abolition of the zones (EU had presented a very similar opinion). The second requirement can also be found earlier, for example in the work of the Analytic Razumkov Center. 4
Final Solution of the Zone Problem by Thymoshenko’s Government
The critical point came with the transformation of program slogans into actions under the leadership of the “orange” government of Yuliya Thymoshenko. As opposed to plans in their “ideal” form, in reality, some new risk factors came in the play here. First of all, because of the “revolution” atmosphere surrounding the new government, the procedure was too fierce and over hasty. The original plan, which called for carrying out a complete analysis of the results of SEZ and TPR activities in the spring of 2005, based on which conclusions was supposed to be decided about the fate of particular zones, was swept of the table. The Minister of Economics Serhiy Terekhin literally said: “The government shall not engage in any active policies in relation to SEZ and TPR because there will be no SEZ and TPR.” 5 Among others, the head of the Committee for Industrial Policies and Enterprise at that time, Yuriy Yekhanurov, was also in tune with him. He spoke sharply against a selective liquidation of the zones. According to him, it was “necessary to abolish all of them; the only way to do this is a revolution situation, which is in place now.” 6
Second of all, one year before the key parliamentary election, the new government partially devoted itself to “campaign” policies, particularly to increasing social spending. A rapid widening of the tax base was therefore being considered more so than possible negative impacts of the abolition of the zones.
In March of this year, the Supreme Council adopted a government’s proposal on updating the budget Act, by which important changes in the Ukrainian tax rules were introduced and, among others, tax benefits for SEZ and TPR were repealed. The zones therefore lost their meaning, which amounted to their abolition. Minister Terekhin expressed the initial euphoria by data about a sharp increase in foreign investments immediately after the abolition of the zones. However, from the perspective of the expected growth, the Polish analysts from the Center of Eastern Studies7 , for example, assessed the development of foreign investments to the contrary. It was not long before serious problems appeared.
Negative Consequences of the Abolition of the Zones
Even before the consequences could show in their full extent, individual investors began to complain. Ones of the most affected were Polish companies. Poland is not too significant partner judged based on absolute numbers of invested capital. The Poles did not even belong among the group of the biggest foreign investors in SPRID, where Hungarians, Britons, Americans, Germans, and others occupied the leading positions. In the key sectors of Ukrainian economy – petrochemical and especially metallurgical industry – Ukrainian activities of these sectors in Poland are rather more important than the other way around. 8
Nevertheless, the Poles have an important position and great weight in the zones. It is because they belong among the most honest and exemplary investors. The only zone where the Poles occupied one of the leading positions was Javorov SEZ, which is located to the west of Lvov by the border with Poland, with its administrative center in the town of Javorov. The territory of this SEZ amounts to 114.6 km2. Javorov was also the most dynamically developing zone with several fold higher than the average efficiency of the rest of SPRID. According to the results of the analysis from summer 2005, the Minister of Economics Serhiy Terekhin named mere four companies, out of 626 operating in SPRID, which completely met the obligations that they undertook. Two of these companies were Polish. 9 Although the Poles in Javorov SEZ got over the investment minimum (500,000 USD) usually only narrowly, their contribution laid, besides their high efficiency, in helping in the process of diversification of Ukrainian production, which is a vital objective of the economy in Ukraine.
Besides the Polish economic losses, political factors came into play as well. It was indeed Poland that has from the beginning acted as a patron of the “orange” government, and its former role of a strategic partner in the eyes of Poles and Ukrainians even deepened. The unexpected measure against Polish interests – devaluation of the zones10 – was therefore at first passively ignored by Warsaw. At the same time, Yushchenko was more and more indicating that a strategic partnership is becoming rather a more economically oriented issue and is focusing on investors with incomparably greater financial volumes like Germany and others. For their investments of such a magnitude and for sectors they invest in, the investment zones are less important.
The Poles expressed their understanding with the abolition of the zones, but at the same time touched its most critical point: SPRID was obviously a bad project, but if it is solved by its complete abolition instead of a probably more beneficial stricter control and improvement of its legal base, the abolition process should have proceeded in a different manner. The fierce and over hasty approach, following mainly the objective of a rapid increase of income for the state budget, did not take into account the investors and it was not consulted with them. The worst consequence of ignoring the zone users was then the absence of a mechanism to compensate them for their loses.
Analyses of the Ukrainian investment environment, for example by PricewaterhouseCoopers, 11 show that the abolition of the zones before their expiration date damaged some attractiveness criteria for foreign investments – stability and predictability. 12 The investment potential for 2005 in itself is at the same time enormously high due to the legal reforms introduced still during the Kuchma’s regime (1/1/2004), previous strong growth of GDP, expanding EU to the borders of Ukraine, and especially persistent effort of the new regime to reach the status of market economy and to join WTO. Furthermore, the total actual volume of foreign investments has great reserves. 13 From the perspective of the investment volume, SPRID were not too significant of areas. However, their abolition (especially the method of it) damaged the stability of the Ukrainian investment environment as an entity. 14 Foreign investors have therefore announced lower investments for Ukraine than they have planned. 15
Uncertainty in the “Orange” Camp
Ukrainian government has gradually started to see the underside of the abolition of the zones. A few months after revoking the easements, the chief of the presidential administration at that time, Oleksandr Zinchenko in Donets’k, hinted at possible reevaluation of this measure. He conditioned the possible reestablishing of the zones by stricter defined conditions. The interest should shift from mere processing of raw materials to final products, reaching European standards of production, and also development of the neglected social aspect of investments.
In July, disputes on high level were set afoot by published researches that were supposed to evaluate the practicality of abolishing or preserving the zones. Their results were explicit. The research of the Ministry of Economics that monitors individual businesses announced those already mentioned four companies out of 626 that meet their obligations. According to the research done by the Ministry of Finances that monitors individual projects, from the total of 800 registered projects, 510 began with their implementation and only 15 of them fulfill their obligations. The ministry claimed that the companies received easements in the amount of 8.4 billion hrivnas, while they paid into the state budget only 3.5 billion in taxes. The government was therefore reassured about the correctness of its decision, however the reasons of the critique have still persisted.
Deputy premier Anatoliy Kinakh, a supporter of the zones already under Kuchma’s regime, has also pleaded for the Special Economic Zones. Kinakh proposed to open a wide discussion prior to the definite decisison of the cabinet on abolition of SEZ and TPR. He condemned the research presented by Terekhin for its superficiality and fragmentariness. Thymoshenko did not agree with this charge and confirmed that she does not intend to repeal the decision on abolition of the zones, already adopted by the parliament. However, at the same time, she agreed with the proposed discussion and ordered preparation of pro-investment laws oriented on awarding “obedient” companies and punishing “disobedient” ones. She receded yet another step after a duel with the Minister of Industrial Policies Volodymyr Shandra, who fairly rightfully objected the laws for the “four righteous” companies; the premier then authorized him to put together a wider list of companies suitable for government help and special investment conditions. So, the system of easements has been basically gradually restored.
Paradoxically, even President Yushchenko has joined the critics of the government investment policies, its disparate and unpredictable measures. As a matter of fact, the same mistake has been repeated as under Kuchma (not only the parallel of both presidents changing their opinions). The contradictory measures, perplexity, and unpredictability remind the moratorium and at the same time the promises to widen the zones of some of the politicians of the previous regime. 16
Furthermore, the government had to consider the political pressure to refund the losses of foreign investors; this pressure was even supported by the special round table of the International Worldwide Economic Forum (so-called MiniDavos) that took place last summer in Kiev. In June, Thymoshenko promised compensation to the Poles. A little bit later, at the Ukraine-Poland forum, Yushchenko promised the same, even though he recalled the criminal character of the zones, but, at the same time, he already clearly distanced himself from their abolition. Even before that, he initiated analyses of the zones and creating a mechanism for compensation of honest investors.
Way to Restoring the Zones?
New solution was made possible by recalling the government of Yuliya Tymoshenko. Radical conclusion of disputes among members of the government, and between the premier and the president, provided Yushchenko with an opportunity to voice his criticism over the policies of the former government against SPRID, face to face the growing problems with foreign investments. He especially criticized the absence of a mechanism of compensations for the investors in the zones. The main accents of the new government have become restoring stability and protecting private property, which meant, among others, reevaluating the liquidation of the zones and terminating re-privatization.
Anatoliy Kinakh, supporter of the zones, reappeared on the scene, this time in the role of the secretary of the Committee of National Security and Defense. Kinakh admitted the deep drop in foreign investments and, as the main priority, set out their protection and creation of favorable investment conditions. Implementation of effective investment projects in SPRID is, once again, becoming an important point. According to Kinakh, 35 percent of the zones function successfully. At the same time, he announced that the people who provided the president with biased information about the work of the zones should be held responsible. Obviously, the former Minister of Economics Terekhin sharply objected to such an allegation and accused Kinakh of artificial improving the results of the research on functionality of the zones.
While the previous government sank into arguing about bad functionality of the zones, it appears that now Yushchenko with the new suite is attempting to fix at least the biggest mistake – he is intensely communicating with investors. In October, he attended, together with Yekhanurov, the sixth conference of the Consultation Committee for Foreign Investments17 and warranted foreign investors about the plans to solve the problems. With regard to the zones, which he by the way mentioned in his list of mistakes of the former government on the first place, he will concentrate on both main mentioned problems, that is at the general level on restoring stability, and at the particular level on compensating investors.
At the end of October, Yushchenko signed a decree “On measures to improve investment climate in Ukraine”, which represents a complex reform spread out into several time phases. Already within one month, the government was supposed to prepare a special regime for investment activities and compensation mechanisms for investors who have been till then honestly working in the zones. During November, the mechanism of compensations was indeed responsibly consulted with the investors. 18 The new system of easements will probably affect especially investors that produce for export (certainly preferred), who will be refunded the value added tax and customs duty for their imported goods and machinery. Participation in this regime will probably also represent a certain form of compensations for losses incurred in previous periods of abolished easements. Nevertheless, the Minister of Economics Arseniy Yatsenyuk announced that easements for SEZ and TPR definitely cannot be restored to their full extent.
On the other hand, president Yushchenko categorically stated that the government found a mechanism to repay the customs duty and value added tax, while he was refusing to consider the zones a problematic topic any more. It well illustrates his effort to restore stability and investor confidence.
The problem of the Special Economic Zones is therefore rather a history with an open end. It is, however, certain that the coexistence of the equal opportunities principal and the system of zones with a special investment regime is completely normal even in the most developed economies of the world. Ukraine therefore probably has to get over their criminal past and anchor them again in some form or other into its economic system. At the same time, it is necessary to create a stricter control and conditions for accreditation of companies in the zones together with a structure of offered easements.
To acquire great financial volumes, Ukraine is of course trying to make key (formerly protected) sectors accessible to foreign investors – especially the metallurgical sector. From long-term perspective, it is, however, necessary to attract more small investors into so far marginal sectors with a great potential growth, in which Special Economic Zones play a meaningful role. Attracting big investors as well as the smaller ones into marginal sectors is highly topical because of the necessity of modernizing big sectors and, at the same time, production diversification, apart from a shamefully low total amount of foreign investments.
The task number one is, however, stabilizing a more permanent conception of pro-investment policies (although only the results of the key parliamentary elections in March 2006 will be the deciding factor for many investors) and unifying opinions of individual government politicians. A stable and predictable environment cannot be created without unified and firm opinions.