Panel Discussion with Government Ministers. 11th Annual Ukraine Investor Conference

Below please find highlights from the keynote speeches delivered by Natalie Jaresko, Minister of Finance, Aivaras Abromavicius, Minister of Economic Development and Trade, Andrii Pyvovarskyi, Minister of Infrastructure, Volodymyr Demchyshyn, Minister of Energy and Coal Industry, Oleksii Pavlenko, Minister of Agrarian Policy and Food at the Panel Discussion with Government Ministers.

Dragon Capital held its 11th Annual Ukraine Investor Conference on Feb. 17-18 in Kyiv. Despite the country’s tense security situation and economic challenges predictably affecting investor sentiment, the conference was attended by over 100 international investors as well as about 200 local investors and Ukrainian companies.

Below please find highlights from the keynote speeches delivered by Natalie Jaresko, Minister of Finance, Aivaras Abromavicius, Minister of Economic Development and Trade, Andrii Pyvovarskyi, Minister of Infrastructure, Volodymyr Demchyshyn, Minister of Energy and Coal Industry, Oleksii Pavlenko, Minister of Agrarian Policy and Foodat the Panel Discussion with Government Ministers.

• Ms. Jaresko said the IMF’s $17.5bn Extended Fund Facility, announced last week as part of a $40bn Western aid package for Ukraine, “is, as a percentage of GDP, one of the largest IMF programs in history” and symbolizes a “recognition on the part of the Ukrainian government that the challenges that we face are not short term challenges”. It also demonstrates the government has committed itself to a “complex and deep program of reforms” to be carried over the medium term. Ms. Jaresko said the “$40bn is not the end-all number” as, in addition to the four year IMF program, it includes 1.5-year bilateral and multilateral support from the World Bank, the U.S, and the EU and “I would not expect that to be the end of the support that we receive from our partners during that same four-year period”.

• The aforementioned $40bn also includes “up to $15bn expected from the debt operation that we will begin after the IMF approves the EFF in full”. Elaborating on the steps preceding talks with bondholders, she said the government needs to complete the IMF-required “prior actions”, for which a special parliamentary session would be held next week, which would clear the way to have the EFF approved by the IMF Board and the first loan tranche disbursed in the first week of March. The government is thus looking to begin official consultations with sovereign bondholders towards the end of the week of March 2-6 or the following week.

• Asked about the $3bn bond held by Russia and whether it would be part of the prospective restructuring process, Ms. Jaresko said the government looked forward to meeting with all its creditors and would approach and treat them on an equal basis. So far, there has been “no official communication”. Speaking on budget amendments related to the IMF program, Ms. Jaresko said one of the largest items of additional spending was a UAH 12.5bn increase in subsidies to low-income households (on top of the previously budgeted UAH 11.9bn) to compensate them for planned increases in utilities tariffs. These additional subsidies would be financed with a commensurate increase in royalties for state-owned gas companies (incl. Ukrgazvydobuvannya, a Naftogaz Ukrainy subsidiary). According to Ms. Jaresko, this essentially amounts to taking state-provided subsidies out of state owned enterprises and transferring them onto the balance sheet of the government in order to distribute them in a “much more transparent fashion” to those truly in need. As a result, government financing to cover Naftogaz Ukrainy’s deficit is projected to be cut this year to UAH 29.7bn, or a third of the 2014 level.

• Another major block of changes on the revenue and spending sides was necessitated by the hryvnia’s sharper devaluation than was projected in the original 2015 budget draft (like a nominal increase in hryvnia terms of import VAT receipts).

• Sizable spending cuts are also expected to be achieved by reducing so called special pensions and pensions for working retirees, which Ms. Jaresko said was the first step in a long-term process of reducing the Pension Fund deficit and carrying out associated pension reforms. Likewise, comprehensive long-term reforms would start in many other areas in the framework of the IMF program.

• Mr. Abromavicius elaborated on his Ministry’s steps in the area of business deregulation. He said the Ministry is completing the first stage of its regulatory reform, which is focused on removing barriers to doing business through the cancellation of various licenses and permits (e.g. last week parliament passed legislation introducing more business-friendly terms for leasing farmland and removing certification of agricultural produce that “does not even exist in the EU”). In the coming days, the Ministry will propose abolishing an additional 177 permits.

• Next, the Ministry plans to employ a “guillotine approach” to radically downsize or liquidate various controlling bodies and their c. 14,000 regulatory functions within a short time frame (to this end, the Ministry has consulted global regulatory reform advisers Jacobs, Cordova & Associates, who have helped complete regulatory reforms in over 100 countries since 2005).

• The third and final regulatory reform stage envisages putting in place preventive mechanisms to ensure that the agencies or functions abolished do not reappear in a disguised form in the future.

• Concurrently, the Economy Ministry itself is being streamlined and its 1,300 staff downsized.

• Mr. Pavlenko said the Ukrainian agricultural sector had a strong year, harvesting a record 63.8 Mt of grain and intensifying exports despite some 1.5 Mt of grain having been lost due to the military conflict in the east and Russia’s annexation of Crimea. He reiterated the security crisis did not affect Ukraine’s agricultural export capacity, with all key sea ports remaining under central government control.

• The Agriculture Ministry’s key priority is to promote exports of Ukrainian agricultural produce, including under a broader association and free trade deal with the EU (AA/DCFTA) signed last year. Pursuant to AA/DCFTA provisions, this year the Ministry needs to approve 170 regulations on harmonizing domestic food safety and other relevant regulations in the dairy, meat and other food market segments with those of the EU. Going forward, the Ministry intends to negotiate increasing duty-free quotas on exports to the EU by end-2015.

• Talks are ongoing with a number of large Western producers such as Claas (farming machinery) and KWS (seeds) to set up local production in Ukraine.

• The Ministry is working with the World Bank on a project to attract investment into rehabilitating farmland irrigation in southern Ukraine. Additional EUsupported projects on land reform, food safety, rural development, and support for small and mid-sized farming businesses will be announced shortly.

• As a result of all aforementioned reforms, the Ministry targets increasing annual grain production to 100 Mt in three to four years.

• A nomination committed has been created within the government, including the ministers of finance, economy, infrastructure and agriculture, among others, to hold competitive tenders to select new CEOs for 61 big state-owned companies. This is part of a broader effort to root out corrupt practices at these companies.

• The Ministry has attracted Western accounting firms to audit state-owned enterprises such as the State Food and Grain Corporation, the Agrarian Fund and Ukrspyrt (ethyl alcohol producing monopoly). Identified instances of embezzlement and fraud schemes ($120m on grain operations alone so far) have been reported to the Prosecutor General’s Office, with which the Ministry is cooperating actively.

• Mr. Pyvovarskyi elaborated on the ongoing reform of Ukrzaliznytsya (UZ), the state rail monopoly, and his Ministry’s actions to make the procurement system for state-owned companies fully transparent.

• The plan is to corporatize UZ by end-2015 and streamline its management and centralize cash flows (ideally with a single bank account), scrapping the current structure that includes six regional railways “that are local kingdoms pretty much”. A management reshuffle is being readied at one of UZ’s six regional subsidiaries in response to complaints from businessmen about artificial delays in the provision of railcars for shipments — one of the many corruption issues the Ministry is fighting now.

• Going forward, the Ministry is in favor of keeping all immovable UZ assets in the state hands but is ready to consider allowing private competition in the rolling stock and repair base segments.

• However, the top priority now is to tackle corruption, including through overhauling the procurement system. New management was installed at Ukrzalizpostach, UZ’s main procurement arm, several weeks ago and has already taken the company’s entire procurement schedule online, with all UZ procurement tenders now being video-conferenced. Electronic bidding procedures are expected to be fully implemented by end-1H15.

• Competitive selection of candidates for the post of UZ CEO is in its final stage (over 200 people have applied) and the government nomination committee will soon make the final decision.

• Mr. Demchyshyn said his Ministry is looking into negotiating longer-term gas import contracts with EU suppliers in order to hedge itself against spot market volatility, induced most recently by a pick-up in oil prices.

• Ukraine wants to negotiate a “summer package” with Gazprom but the Russian side has not shown much willingness so far, insisting on adhering to the price formula in the current contract with Gazprom and being willing only to discuss a discount to the contract price. The Ministry, with support from the EU, is hopeful about talks on a summer package starting in the near future. However, geopolitics remains the overriding factor.

• While increased gas flows from the EU strengthen Ukraine’s bargaining position vis-à-vis Gazprom, the long-term priority is to develop domestic conventional gas production. Ukraine has some 1 trillion m3 of conventional gas reserves, with a relatively quick and cost-efficient way to tap them being to rehabilitate old wells. However, high subsoil taxes are discouraging investors, effectively meaning Ukraine is solving its ongoing fiscal difficulties at the cost of sacrificing progress towards achieving self-sufficiency in gas supply within three to four years.

• Mr. Demchyshyn said Shell and Chevron did not pull out indefinitely from their shale gas projects in Ukraine. While the falling oil price and unimpressive initial drilling results did discourage them, the Ministry is currently working jointly with tax authorities to develop more preferential investment terms for the two companies (incl. VAT refunds) so as to revive their projects.

• As the military conflict in the east effectively left Ukraine without the supply of anthracite coal, on which half of domestic thermal power generating capacity relies, the Ministry has initiated several projects to convert power plant boilers from anthracite to so called G-type coal, which is in higher supply currently.

• UAH devaluation is helping to increase electricity exports this year.

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