Ukrainian-Russian conflict scared off investors from both countries

The winter revolution, the annexation of Crimea and the military conflict in the eastern part of Ukraine inspired caution among Ukraine’s foreign investors and also undermined the investment attractiveness of Russia.

Over the first three months of the year Ukraine lost USD 6.2 bn in foreign direct investments accumulated since the start of investments. This is not the result of the mass flight of investors amid political instability. Investors reduced their investments into the economy during these months by nearly three times – from USD 1559.7 mn in the first quarter of last year to US USD 570.2 in the same period this year, but also slightly reduced capital withdrawal from the country – from USD 562.4 mn to USD 468.4 mn.

It was hryvnia devaluation that “ate” the lion’s share of FDI accumulated over the years of independence. It cost foreign investors as much as USD 6.3 bn. Overall, taking into account the funds Ukraine invested abroad, the net FDI inflow over this period was negative at – USD 543 mn, according to the National Bank of Ukraine. The net capital outflow, both FDI and other articles of the financial account of the balance sheet, amounted to UAH 3.6 bn in Q1.

The losses of capital in Russia were also significant. The Central Bank of Russia has not yet published the final data on FDI, but according to preliminary information, the inflow of FDI into the non-banking sector decreased by three times from USD 37.1 bn a year ago to USD 11.9 bn. At the same time, the net outflow of investments from Russia is increasing. According to the CBR, capital outflow amounted to USD 50.6 bn in Q1 2014, compared to USD 59.7 bn over the whole last year.

Regional losses

It is fully rational that Russia became one of the countries, whose investments into Ukraine decreased the most – by USD 759.8 mn over three months (without taking into account Cyprus, where Ukrainian capital traditionally waits until better times and from where the inflow of FDI into Ukraine dropped by USD 2.9 bn in the first quarter of the year).

For comparison, accumulated investments from Germany shrunk since the start of the year by USD 180.9 mn and from the Netherlands by USD 135.9 mn. Among the oblasts in Ukraine the main recipients of foreign capital in the past suffered the most from the outflow of previous FDI into the country and the exchange rate difference. For instance, the volume of FDI in Kyiv dropped by USD 3.2 bn, Dnipropetrovsk – USD 747.9 mn, Donetsk – USD 596.4 mn and Crimea – another USD 135 mn of FDI.

The capital outflow through FDI, portfolio investments (USD 252 mn) and medium-term and long-term loans and bonds (US $931 mn) was only partially compensated by the inflow of short-term loans and bonds, attracted mainly by banks. Ukraine will finish the year with a very weak net FDI inflow, according to the forecasts of the International Monetary Fund – only USD 2.8 bn versus last year’s USD 3.3 bn. Overall, there will be a net outflow of capital in the amount of USD 4.9 bn observed in the financial account.

Sad prospects

Capital outflow from Russia began last year and cannot be connected with the escalation of the conflict between Kyiv and Moscow. The main reason behind it was the slowdown of Russia’s economic growth from 3.4% in 2012 to 1.3% in 2013 as investments decreased after the investment boom in the process of preparations for the Olympic Games in Sochi and the decline in consumer appetites. This year the trend continues.

The Russian economy is expected to grow by only 0.7%, according to the consensus-forecast of the international consulting company FocusEconomics. This undermines its investment attractiveness even more. In their May regional report, experts of the European Bank for Reconstruction and Development wrote that the net outflow of capital in early 2014 increased driven by lower external borrowing and to a lesser degree – massive investments abroad and the outflow of investments into Russia earlier. The corporate sector borrowed from abroad only USD 9 bn in the first quarter compared to USD 36 bn in the first quarter of 2013 due to such factors as weaker investment activity and more constrained access to external financing, reads the report.

The conflict between Ukraine and Russia – in the first quarter on the issue of Crimea – only accelerated the capital outflow from Russia. In February-March investor confidence, which had been already feeble, took a major hit from the events in the Ukraine-Russia conflict, say experts of the EBRD.