Purple posters with three words, “Army, language, faith” have lined the road to the airport in Kiev since last summer. These posters are incumbent President Poroshenko’s campaign slogan and they differ from his previous campaign rhetoric in 2014. Yet, from the perspective of a foreign investor or business partner, the words you would probably prefer to read after landing in Kiev would be something like “Trade, Positive Business Environment, and Transferability of Funds”.

Many companies regard Ukraine as a latent market for well-known reasons, such as volatile domestic demand, fragile financial position and a creeping internal conflict, that have been weighing on Kiev’s potential. The Ukrainian authorities have been able to restore macro-economic stability and reach a moderate 3 percent growth rate in 2018 following the severe crisis of 2014-15. However, efforts to create a more dynamic, open, and competitive economy have fallen short of expectations and the economy remains vulnerable to shocks. In early March 2019, the National Anti-Corruption Bureau closed its investigation against the former head of the State Fiscal Service. The investigation's closure was driven by last month’s constitutional court ruling that an illicit enrichment article in the country’s criminal code contradicts the constitution. Efforts to combat corruption are a key element in the structural economic and institutional reform programs that the Ukrainian government promised in return for a financial support package from official lenders including the International Monetary Fund (IMF) and the European Union. The presidential elections will shape the environment and usher in further developments for the country’s economic partners.

Apparently, though, Ukraine is already running a trade deficit, importing much more than it exports.  In 2018, according to UkrStat,  Ukrainian imports  returned to 2014 levels, totalling $57 bn, marking a 15 percent increase compared to 2017. This large jump in imports came despite the military escalation in the Azov Sea, the introduction of a 30-day martial law across ten regions of the country at year-end and political tensions arising from the presidential campaign. Exports on the other hand increased by a modest 9 percent, reaching $47 bn, which led to the highest trade gap since the 2014 crisis.

While the ongoing conflict between the Ukraine and Russia is weighing down bilateral trade, the effects have been felt disproportionately. Russian exports account for 14% of all Ukrainian imports, roughly double the weight of Ukrainian exports going to Russia (7%). Moscow remains Kiev’s main supplier, even if its market share is narrowing. Nearly half of all Russian goods supplied to the Ukraine in 2017 were refined fuels.

All these factors are affecting the industrial landscape as well as the trade balance of the country. It is no secret that heavy industries, which typically have long supply chains and are more capital intensive, suffer from high interest rates and business interruption. Ukraine is experiencing both, as the key rate set by the National Bank stands at 18 percent. In spite of a moderate GDP growth in 2018, the industrial sector lost momentum throughout the year from 2.6 percent output growth over the first half to just 1.1 percent at year-end. At first, limited availability of long-term credit, then logistic problems in Eastern Ukraine influenced the slowdown.

The Ukrainian steelmaking industry has suffered significantly showing a declining output over the last 10 years. Historically, the sector’s contribution to exports was crucial and remains pivotal in counterbalancing Kiev’s trade balance. Credit restrictions and the geographical distribution of the supply chain have amplified their impacts on the sector as several metallurgical plants and mineral mines are located in Eastern Ukraine.

Steel output among selected producers, million metric tonnes per year

Source: World Steel Association, SACE

These credit and logistical weaknesses plus the partial loss of the Russian market affected the export pattern at large, with a resurgence of agricultural products over metals, chemicals and minerals. The Ukraine–EU Association Agreement might help to reroute several traditional export flows from Russia to the EU, although it has not induced a massive change in the industrial pattern to date.

What did Ukraine export between 2004 and 2016?

Source: The Atlas of Economic Complexity

In its transformation towards a mature processing economy, however, Ukraine remains a latent market. Value-added products are crucial in increasing the export share and keep pace with regional competitors such as Turkey and Belarus. In recent years, some developments contributed to ease liquidity constraints for corporates, strengthening the banking sector and balance financial regulation. In September 2017, the National Bank of Ukraine (NBU) simplified the criteria and procedures for securing loans for residents from international financial institutions. An annual assessment of the banks' resilience by the NBU is effective from 1 January 2018. In February 2018, Ukraine’s Parliament passed a law on establishing and maintaining a credit register to access data about loan servicing at other banks. Under a new currency law, the proceeds from export transactions are excluded from mandatory exchange since February 2019. Ukrainian residents are then able to acquire foreign currency, irrespective of their contractual obligations. It should be noted, though, that the NBU could always set forth mandatory exchange requirements depending on the situation of the FX market or in the banking sector, etc. In early March 2019, Ukraine’s central bank cut the amount of foreign currency that companies must sell to 30 percent from 50 percent of their earnings, but limited currency restrictions still linger on the whole system.

Further interventions to set an attractive environment are required, such as implementing an independent and accountable anti-corruption body, normalizing external relations after a heated electoral campaign, and easing FX transactions. The results of the upcoming presidential contest and the parliamentary elections scheduled for October will tell if these long-awaited measures are to move forward, speed up or derail.