Political Stability
A Business-Risk Assessment
Editor’s Note: As requested by BMC Software, Inc., this report discusses the risk of doing business in Ukraine, focusing on the country’s political stability, economy, regulatory environment, security and labor issues as they relate (where possible) to the software sector. STRATFOR has also provided a forecast on any major shifts that might occur in these current conditions over the next three years.
Introduction
Outside of Russia, Ukraine is the most strategically important of all former Soviet states. Physically, Ukraine is the largest country in Europe, lying east of the European Union. Ukraine borders seven countries and the Black Sea. Ukraine has historically been Slavic, even as it was integrated and divided into and among various empires over the centuries. Seventy-eight percent of the population is Ukrainian and 17 percent Russian, and nearly a third of all Ukrainians consider Russian their first language. Almost all Ukrainians speak Russian as their second language.
Since the 19th century, Ukraine has been part of the Russian Empire then the Soviet Union before gaining independence in 1991. Hence, it is nearly impossible to talk about Ukraine without discussing Russia. Ukraine is the cornerstone to Russia’s defense and survival as any sort of power. The former Soviet state hosts the largest Russian community in the world outside of Russia -- approximately 15 million -- which resides in a zone geographically identical and contiguous to Russia itself. Ukraine has traditionally been the Russian and Soviet breadbasket, and it is tightly integrated into Russia’s industrial heartland. It is the location of nearly all of Russia’s infrastructural links not only to Europe but also to the Caucasus, making it critical to Russia for both trade and internal coherence. The most important piece of this infrastructure moves 80 percent of Russia’s natural gas supplies destined for Europe. Russia also houses its strategic Black Sea Fleet in Ukraine, not in Russia.
Ukraine gives Russia the ability to project political, military and economic power into Eastern Europe, the Caucasus and the Black Sea. Ukrainian territory also pushes deep into Russia’s sphere of influence (it is only 300 miles from Ukraine to both Volgograd and Moscow). Without Ukraine, Russia would have fewer ways to become a regional power and would have trouble maintaining internal stability. Moreover, so many in Ukraine consider their ties to Russia not only as a form of protection but also as an inextricable bond.
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Political Stability
This deep connection to Russia is why Ukraine’s pro-Western 2004 Orange Revolution was a nightmare for Russia and many Ukrainians. The change in government in Kiev during the revolution brought in a president, Victor Yushchenko, who was hostile to Russian interests and with him a slew of scenarios that could harm Russia, including the possibility of Ukraine being integrated into the European Union or NATO. The Orange Revolution also deepened the Ukrainian-Russian divide within the country. Ukraine’s population is divided between those that look east toward Russia and those who look west to the EU. The divide nearly runs perfectly down the Dnieper River, meaning half of Kiev and the eastern and southern parts of Ukraine are highly pro-Russian, while the rest of the country is pro-Western. Such a divide can be clearly seen in political allegiances with the pro-Western parties that came to power during the Orange Revolution, which were supported almost exclusively by voters in the western part of the country.
However, the wave of change generated by the Orange Revolution did not materialize into the pro-Western country Europe and the United States had hoped for. The deepening divide exacerbated already existing political tensions. Pro-Western forces under Yushchenko and former Prime Minister Yulia Timoshenko struggled to hold onto power while being completely ineffective in actually implementing any Western reforms. In short, the Orange Revolution led only to chaos. After 2004, Russia did not attempt a full counter to the Orangists. Instead, Moscow was content merely to meddle in Ukrainian affairs in order to keep the country destabilized and prevent it from falling completely into the orbit of the West.
The rolling back of the Orange tide began in 2007 when Victor Yanukovich’s pro-Russian Party of Regions won back the parliament and began to pick away at Yushchenko and Timoshenko’s popularity. Helping Yanukovich were internal squabbles between Yushchenko’s Our Ukraine party and Timoshenko’s eponymous bloc. Moreover, the Ukrainian people began to grow tired of a chaotic government. The only real stability the country knew was under Moscow’s wing, a realization that led to the inevitable change in government in 2010 that brought pro-Russian Yanukovich into the presidency while also holding together a coalition with a majority in the parliament.
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Under Yanukovich, the political theater has calmed by Ukrainian standards. Having Moscow’s meddling end with a pro-Russian government has settled the upheaval of the previous five years. But this does not mean that all the chaos is over; Ukrainian politics are inherently dramatic, unstable and unpredictable. Orange leader and former President Yushchenko has nearly dropped out of the public eye altogether, while his partner Timoshenko is still attempting to be an opposition figure against Yanukovich, though her popularity has been in heavy decline since the elections. Since Timoshenko is a political survivor, however, she could return at some point as a real force.
Another possible destabilizing factor is whether Yanukovich’s coalition, which consists of his party, a handful of independents, the Communist Party and the Litvin bloc, breaks apart. After the 2010 elections, Yanukovich gave nearly all his Cabinet positions to his own party with only a few doled out to the Litvin bloc. So far the coalition partners (including those without Cabinet positions) have not contested Yanukovich’s domination of the government, but egos are a driving factor in Ukrainian politics, and a break in Yanukovich’s bloc cannot be ruled out.
Typically, with each turnover of the government and coalitions the laws and reforms passed by the former ruling group are either undone or ignored. This has seriously retarded any restructuring or improvement in almost any sector or institution in the country.
Economic Overview
Ukraine’s economy is volatile at best, leaving little hope for the country to pull itself out of any difficulty. One problem is that each region in Ukraine is highly dependent on a specific industry for money. When that industry fails, the entire region tends to fail. Furthermore, most of Ukraine’s lucrative businesses are based in the eastern half of the country, which typically gives that half (and Russia) a bit more political and economic power. Although Ukraine’s economy depends mainly on its metallurgical industry, it also gains much revenue from grain, military exports and energy transit. However, each of these sectors is suffering from deep problems that could not be easily fixed even if the country had the proper tools.
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Ukraine did not start to pull out of its post-Soviet economic slump until around 2000, when the country began to see the results of rebuilding and modernizing its core sectors -- heavy industrial manufacturing and agriculture. But the 2008 global economic crisis hit Ukraine hard, shrinking its economy by 15 percent in 2009. A major component of this was steel demand, which fell 43 percent in 2009. During the crisis, inflation soared to 16.4 percent, and the value of Ukraine’s currency, the hryvnia, dropped by 38 percent against the dollar. Ukrainian banks faced depositor flight during the crisis due to instability and lack of confidence, forcing the government to nationalize more than a dozen banks.
The International Monetary Fund (IMF) planned on loaning $16.43 billion to Ukraine, though only $2.2 billion has been released -- the rest of the world, especially other European countries, were begging for funds as well. The IMF money that was released showed little effect, entangled as it was in the volatile political situation at the time, with every faction fighting for (and stealing) funds. Russia also stepped up to help Ukraine, issuing a $5 billion loan, which also became entangled in the factional fighting.
With the new and more stable government coming into office in 2010, Ukraine’s economy has seen some recovery. Inflation has fallen to around 7 percent, growth for 2011 is projected to be 4.5 percent and private consumption and investment is starting to pick back up, due mainly to plans for the Euro 2012 football (soccer) tournament (more on this below). Ukraine’s economic activity is expected to surpass its pre-crisis peak by 2013.
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Regarding information technology specifically (including software), the sector now ranks fourth among Central and Eastern European countries. The IT sector was virtually immune to the global financial and domestic political crises that hit Ukraine, since it is isolated from the country’s strategic economic sectors, which rise and fall together, and has not been as affected by government interference. Ukraine’s IT industry has actually grown since 2004 and this growth is expected to continue.
Infrastructure
Ukraine’s transportation infrastructure used to be on the low end by Western standards, and the minimal maintenance it received after the fall of the Soviet Union led to nearly holistic degradation. Today, this infrastructure (roads, rails, seaports and airports) is still in desperate need of modernization. One reason it has not been a priority is the cultural divide in the country, which has most people traveling very little outside of their respective regions. As a result, Ukraine has uncommonly high transport costs. This could all be changing, however, as transportation infrastructure as well as real estate and commercial development become top priorities for Kiev in the run-up to the Union of European Football Associations ( UEFA) Euro 2012 football tournament in June and July 2012.
Telecommunications is much stronger sector in Ukraine than other types of infrastructure, though this depends on the region. Nearly all regional capitals have modern digital infrastructure, and analog and digital cellular services are available in many areas. In rural areas, however, telephone services are outdated, inadequate and of low-density, and a large demand for landline telephone service remains unsatisfied.
Overall, infrastructure deterioration has become the norm in Ukraine mainly because Kiev still expects foreign groups to come in and fund modernization projects even though the government runs the large strategic firms and organizations needed to invest in the projects. This is a lingering effect of the 2004-2010 disarray in government and factional disagreement about what is needed to move the country forward.
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