"THE ACTION UKRAINE REPORT - AUR"
An International Newsletter
In-Depth Ukrainian News, Analysis, and Commentary

"The Art of Ukrainian History, Culture, Arts, Business, Religion,
Sports, Government, and Politics, in Ukraine and Around the World"

NOW'S NOT THE TIME FOR EUROPE TO GO WOBBLY
The disheveled state of the European Union
After the bright hopes of last year, failure in Ukraine would be disastrous

"Similarly, without the incentive of E.U. membership, Ukraine's new leaders
may prove either not committed or not strong enough to root out corruption
and reform the security services. These are tough challenges -- but ones
that Ukraine's neighbors were determined to overcome once they realized
this was the price they had to pay for entering Europe. If Ukraine fails to
get a clear signal that its future lies with Europe, the hopes of the Orange
Revolution will fade fast......

After the bright hopes of last year, failure in Ukraine would be disastrous
for the former Soviet Union as a whole, producing a sense of crisis not only
for Ukraine's neighbors in the east but also for some of its E.U. neighbors
in the west, potentially increasing Moscow's leverage over these nations."
[Commentary, The Washington Post, article one]

"THE ACTION UKRAINE REPORT - AUR" - Number 514
Mr. E. Morgan Williams, Publisher and Editor
morganw@patriot.net, ArtUkraine.com@starpower.net
Washington, D.C. and Kyiv, Ukraine, MONDAY, July 4, 2005

------INDEX OF ARTICLES------
"Major International News Headlines and Articles"

1. THE STATE OF THEIR UNION:
NOW'S NOT THE TIME FOR EUROPE TO GO WOBBLY
After the bright hopes of last year, failure in Ukraine would be disastrous
COMMENTARY: by Ivo Daalder and James M. Goldgeier
On the disheveled state of the European Union
Outlook Section, The Washington Post
Washington, D.C., Sunday, July 3, 2005; Page B02

2. THE STATE OF THEIR UNION:
CAN POLAND KEEP THE CLUB FROM FLYING APART?
COMMENTARY: by Krzysztof Bobinski, in Warsaw
On the disheveled state of the European Union
Outlook Section: The Washington Post
Washington, D.C., Sunday, July 3, 2005; Page B02

3. UKRAINE'S TOP ASSETS ARE THE SPOILS IN A POST-ELECTION
POWER STRUGGLE THAT'S FAR FROM OVER
Ukraine Workers Await Word of Factories' Fate
The New York Times, New York, NY, Sunday, July 3, 2005
International Herald Tribune, Europe, Monday, July 4, 2005

4. POLITICAL RIVALRIES THREATEN UKRAINE'S REFORMS
By Tom Warner in Kyiv, Financial Times
London, United Kingdom, Monday, July 4 2005

5. UKRAINE: A QUESTION OF PRIORITIES AND PR
By James Hydzik, Kyiv,
ForeignDirectInvestment magazine
Financial Times Business, Ltd.
London, Ukraine, June 07, 2005

6. UKRAINE: "OWNER BEWARE"
EDITORIAL: Wall Street Journal Europe
Europe/USA, Thursday, June 30, 2005

7. REPRESENTATIVES OF PARLIAMENT AND CABINET AGREE ON
PACKAGE OF DRAFT LAWS ON UKRAINE'S ADMISSION INTO WTO
Ukrainian News Agency, Kyiv, Ukraine, Friday, July 1, 2005

8. UKRAINE HASTENS TO OPEN MARKETS FOR IMPORTS,
LIFE OR DEATH?
ANALYSIS: By Roman Bryl, Ukraine
ISI - Intellinews, Kyiv, Ukraine, Wed, June 29, 2005

9. YUSHCHENKO SIGNS RADA'S REINSTATEMENT OF SIMPLIFIED
TAXATION SYSTEM FOR SMALL AND MEDIUM BUSINESSES
Ukrainian News Agency, Kyiv, Ukraine, June 25, 2005

10. WORLD BANK LOANS UKRAINE 106M: HYDROELECTRIC POWER
Reform-minded government scored a financial victory last
week
New Europe, Athens, Greece, Monday, July 4, 2005

11. POLISH, UKRAINIAN PRESIDENTS WITNESS CAR, STEEL PLANT DEALS
Warsaw urges visa-free travel for Ukrainians for European Union
New Europe, Athens, Greece, Monday, July 4, 2005

12. UKRAINE: THE LONG ROAD WEST
So the road West is long - but it is open for Ukraine.
Stabilisation of investor confidence and inflows of new foreign direct
investment (FDI) will hinge decisively on the EU's reaction to the new
political era in Kiev.
By Moritz Schularick, Current Issue
Deutsche Bank Research, Deutsche Bank
Frankfort, Germany, 27 May 2005
==============================================================
1. THE STATE OF THEIR UNION:
NOW'S NOT THE TIME FOR EUROPE TO GO WOBBLY
After the bright hopes of last year, failure in Ukraine would be disastrous

COMMENTARY: by Ivo Daalder and James M. Goldgeier
On the disheveled state of the European Union
Outlook Section, The Washington Post
Washington, D.C., Sunday, July 3, 2005; Page B02

From the beginning, Europeans have greeted President Bush's
"transformational diplomacy" with disdain. To them, the mess in Iraq
demonstrates the failure of a policy that relies on speaking loudly and
carrying a big stick. Instead of pursuing a policy of invasion, Western
Europe has used the prospect of membership in the European Union to
help transform the countries of Central and Eastern Europe into stable
market democracies, thus continuing a process that saw Greece, Spain
and Portugal join after they too pursued a democratic path.

The crisis in Europe that has emerged in recent weeks, first with the
rejection of the European constitution by voters in France and the
Netherlands and then with the breakdown of budget negotiations at last
month's E.U. summit, has put the brakes on talk of continuing the
enlargement process. The consequences of turning inward will not be
temporary -- nor confined to Europe alone.

Nations that had hoped to join instead face a future marked by economic
decline, creeping authoritarianism, growing instability and possibly even
violence. As for the European model of transformation -- recently heralded
as the reason "Why Europe Will Run the 21st Century" -- it will lose its
luster in other parts of the world, which looked to Europe's success as a
way to direct their own future.

In the last 15 years, many east European countries reformed their
economies, tackled corruption and opened their political systems in the
expectation that E.U. membership would bring them the peace and prosperity
their western neighbors had long enjoyed. That hope may now be lost for all
remaining aspirants but Bulgaria and Romania, whose negotiations with the
E.U. are far enough along that they may join in 2007. Turkey will have to
rethink its assumption that the opening of formal accession talks on Oct. 3
would be the first sure step to membership down the road.

The Balkan countries of Croatia, Macedonia and Bosnia will have to revise
their hopes that the years of war could finally be put behind them as they
joined Europe, paving the way perhaps for Serbia and Montenegro and a
final resolution of the festering sore of Kosovo. And Ukrainians will have
to think again about whether the 2004 Orange Revolution really heralded
a new Euro-Atlantic orientation after years of increasingly corrupt and
authoritarian rule.

For all of these countries, Europe's current crisis could not have come at
a worse moment. Conflict over the future course of reform will be likely in
them all, halting if not reversing the progress made to date. Europe's
entire periphery will be that much more unstable -- with consequences for
stability within the E.U. itself.

The growing resistance to enlargement is shortsighted. Let's remember what
earlier enlargement did for Europe in just 15 years. A continent that
produced World War I, World War II and the Cold War has been transformed
into a Europe nearly whole and free and at peace. Never before have so many
countries with so many people made such political and economic progress in
such a short period of time as the countries imprisoned for decades behind
the Iron Curtain. These gains are now being put at risk.

Take the Balkans. While the violence of the 1990s is behind us, the
situation there remains fragile. For now, the ugly face of nationalism is
being held in check as Bosnia, Croatia, Macedonia and Serbia have
embarked on the reforms necessary to be considered for E.U. membership.

Once that door closes, the political consensus in favor of reform will
likely shatter as leaders fall back into their old ways. The situation in
Kosovo remains particularly volatile -- with the only viable long-term
solution being for both Kosovo and Serbia to join the larger Europe.

Turkey offers the more immediate challenge. While voters in France and the
Netherlands made clear that they did not want Turkey to join their Union,
can Europe really afford not to continue on a path that would lead to
membership for the first primarily Muslim country? Consider what might be
lost. Because of the need to satisfy the E.U.'s criteria, Ankara's leaders
have already undertaken extraordinary reforms.

On the political side, Turkey has abolished the death penalty, allowed much
greater freedom of speech and introduced civilian control over military
budgets. On the economic front, Ankara has slashed government subsidies.

The government has reached out to the country's Kurdish minority and to
neighboring Greece, with which relations are better than ever. All this
might be lost if Europe fails to leave open the possibility of Turkey's
membership.

Similarly, without the incentive of E.U. membership, Ukraine's new leaders
may prove either not committed or not strong enough to root out corruption
and reform the security services. These are tough challenges -- but ones
that Ukraine's neighbors were determined to overcome once they realized
this was the price they had to pay for entering Europe. If Ukraine fails to
get a clear signal that its future lies with Europe, the hopes of the Orange
Revolution will fade fast.

The consequences for Europe of a failure to keep the enlargement process
moving are grave. Failure in Turkey might well inflame Muslim populations
throughout Europe. And while many Europeans fear that Turkish membership
brings Europe to the borders of Iran, Iraq and Syria, Europe cannot hope to
play a stabilizing role in the broader Middle East if it does not help
Turkey succeed.

After the bright hopes of last year, failure in Ukraine would be disastrous
for the former Soviet Union as a whole, producing a sense of crisis not only
for Ukraine's neighbors in the east but also for some of its E.U. neighbors
in the west, potentially increasing Moscow's leverage over these nations.

There is too much at stake for Europe to accept risks like these. Washington
must help its European friends in developing policies that minimize the
damage. NATO's expansion policy, which has languished as E.U. enlarge-
ment took center stage, should be put back on the front burner to address
the fears and aspirations of countries like Ukraine, Serbia and Bosnia. The
E.U. must also create new kinds of association arrangements that fall short
of membership, and thus do not evoke the kind of public opposition that full
membership now does.

Unless the door to Europe is kept ajar, the instability that continues to
bedevil Europe's periphery in the broader Middle East and the former Soviet
Union will come to plague Europe itself and all that has been accomplished
there.

The consequences would be bad not just for Europe, but also for the
United States, which needs a strong partner to address challenges
emanating from Northern Africa, the Middle East and Eurasia. -30-
----------------------------------------------------------------------------------------------------------------------
Ivo Daalder is a senior fellow at the Brookings Institution. James Goldgeier
is a professor of political science at George Washington University.
Authors' e-mails: idaalder@brookings.edu; jimg@gwu.edu
===============================================================
2. THE STATE OF THEIR UNION:
CAN POLAND KEEP THE CLUB FROM FLYING APART?

"We need the E.U. to have a common policy toward Poland's eastern
neighbors -- such as Ukraine, Belarus and Russia -- that would secure
democracy and stability in this part of the world."

COMMENTARY: by Krzysztof Bobinski, in Warsaw
On the disheveled state of the European Union
Outlook Section: The Washington Post
Washington, D.C., Sunday, July 3, 2005; Page B02

WARSAW - I met Marlena Golombek, a twenty-something clutching an
overnight bag, in the waiting lounge of Brussels' Charleroi airport as we
prepared to board a low-cost flight home to Warsaw. Marlena works as a
housecleaner in the Belgian capital and flies back to Poland once a month
to catch up on her university courses in Bialystok, in the eastern part of
the country.

We chatted during the journey, and she reflected enthusiastically on how
Polish membership in the European Union has made it possible for
someone like her to work in Brussels while studying in Poland.

This sort of arrangement was unheard of for a Pole only 15 years ago.
Freedom to travel was unthinkable under communist rule, which ended in
1989; but even after that, it wasn't until the cost of travel was brought
down by the E.U.'s forced liberalization of air routes that legions of Poles
were able to take wing. Now they go abroad eagerly, young people most
of all, heading off to Paris or Rome at the drop of a knapsack.

Under communism, when people wanted to leave the country, they had to
ask the police for a passport and many, if not most, were refused. But when
Pope John Paul II died earlier this year, tens of thousands of Poles just
got up and went to the funeral in Rome.

This is a freedom that Poles don't want to lose. Yet now the Union is in
crisis over last month's rejection of the proposed E.U. constitution by
France and Holland and the more recent failure to agree on a budget for
the seven years starting in 2007. And that has Poland worrying about the
stability of the organization it sought so eagerly to join for nearly a
decade -- and what that means for its own prosperity and security.

Indeed, Poland's adventure with the European Union gives a new twist to
Groucho Marx's famous quip that he wouldn't want to join any club that
would have him as a member: We Poles are thrilled to have signed on to
the European club, but it seems that some of the earlier members are
regretting their decision to let us in.

The French and Dutch defeat of the E.U. constitution seems to have been
powered in large part by those countries' fear of the economic and political
consequences of having admitted several former Soviet bloc countries, of
which Poland is the largest, to the Union last year.

The Airbus plane Marlena and I flew on was a microcosmic sample of what the
worry may stem from -- and of what integration is doing for Poles. The plane
was full, and most of the passengers were young. Some were students; others
were tourists. Many others were manual laborers working wherever they could
find jobs, legal or not. Though Poland's economy is improving, a Pole can
still make far more money abroad than at home, and the lure of better
paydays draws many to the West.

The United Kingdom has opened its labor market to workers from the 10 new
member states that joined the E.U. on May 1, 2004. In France, however, any
work done by Poles without permits is still illegal. But Poland's E.U.
membership has now made it easier to get work on the black market. This is
what gave rise to the specter of the "Polish plumber," that mythical figure
that during the E.U. constitutional referendum in France became the
archetype of the low-cost worker who would take jobs away from local
laborers.

Warsaw's chattering classes were aghast at the anti-Polish plumber
campaign. "Why can't the French admit that every time a Pole does an odd
job in their home, that makes a desperate French housewife all the happier?"
quipped Tessa Kapon, a writer for a women's magazine here. Most Poles
don't see the cause for French concern, believing that Polish workers are
doing jobs that local people won't -- or don't -- do, from heavy unskilled
labor to semi-skilled and skilled work for which there aren't enough
qualified natives.

And they've been doing them for years. Pawel Kuchta and his brother, sons of
a farmer from Kruczy Borek, a small hamlet about 30 miles north of Warsaw,
have been going to France for more than 10 years to work at any odd jobs
they can find . "We think nothing of just up and going," Kuchta told me. "In
the summer we help our father on the farm. Then we leave wife and child
with our parents and we go off."

What Poles really hope is that their E.U. membership will eventually make
this sort of migrant work unnecessary. "I didn't do it for myself, I did it
for my children and their children," was something I heard many say after
they cast their vote to join the Union in the 2003 referendum.

Poland is poorer than our Western European partners, but the hope is that
membership will allow us to catch up and modernize. We're proud of the
entrepreneurial spirit that has allowed us to make more economic progress
since 1989 than eastern Germany, the former German Democratic Republic,
even though it was absorbed into wealthy West Germany more than a decade
ago.

The Poles were expecting to join an E.U. where the principle of solidarity
meant that richer members like Germany and Holland helped poorer
countries like Spain, Ireland or Portugal to develop. And that growth meant
that democracy would be secured against a return of the totalitarian demons
of the past. "The present crisis risks a return of the old nationalisms, a
nightmare scenario for Poland," says Slawomir Popowski, a leading
journalist.

Indeed, I'm convinced that the main reason why Polish support for the
European Union remains high -- opinion polls show it at just under 80
percent, as high as it was in the mid-'90s, when membership was no
more than a mirage -- is that belonging to it separates Poland from its
Soviet-bloc past and places it firmly in the West.

Given the country's long history of partition, and the tragic experience of
having been the victim of two totalitarianisms -- fascism and Stalinism --
in the last century, being the poor cousins in the E.U. is a price Poles are
willing to pay for the feeling of basic security we now have.

That feeling of security is being threatened not only by other E.U. members,
but also from inside Poland itself. Though ordinary people have jumped at
the chance to escape from a no-hope situation of high unemployment in
small towns and rural areas, many Polish politicians remain less
enthusiastic about the E.U. This is especially true on the center-right.

Parties like the pro-market Civic Platform (PO) and the nationalist Law and
Justice movement (PiS), which appear set to govern in tandem after
parliamentary elections in September, continue to look askance at the Union.

Both fiercely opposed changes to voting rules in the moribund constitution
that they say weakened Poland's position in the E.U., and they are happy
that the French and Dutch have put paid to the treaty.

The current center-left government, meanwhile, which won a major
parliamentary victory four years ago, is now facing the prospect of
political oblivion in a welter of accusations of corruption and
mismanagement. But it is trying to tap into the popular support for the E.U.
that the opinion polls are showing. Knowing that the provinces are looking
to the E.U. for local development funds, the present government, led by
Prime Minister Marek Belka, is seeking to turn the E.U. budget crisis to its
advantage.

Recently, it undertook to help repair the rift over the budget between
President Jacques Chirac of France and British Prime Minister Tony Blair
by arranging meetings between the French, German and British foreign
ministers in Warsaw. The attempt didn't come to much; the row is too fresh,
and Warsaw doesn't have the political clout to actually bang heads together
and force the French and British to come to any agreement soon.

But it underlined how much Poland needs an integrated E.U. moving ahead
rather than one paralyzed by internal strife. And this is not least because
we need the E.U. to have a common policy toward Poland's eastern
neighbors -- such as Ukraine, Belarus and Russia -- that would secure
democracy and stability in this part of the world. Poles saw entry into the
E.U. as entry into a safe harbor, but now the harbor walls are in danger of
being dismantled and the sea has become decidedly choppy. This means
that Poland will have to hone new diplomatic skills for the effort to help
keep the E.U. together.

In the 1950s, when the two Frenchmen Jean Monnet and Robert Schuman
crafted their vision of a European Union -- a community that would help
former enemies become friends and allies -- the memory of wars in Europe
was still fresh.

The wartime memories that inspired Monnet and Schuman's sense of
urgency have now faded in Western Europe. But in Poland and the other
Eastern European member states, the memory of Soviet occupation and of
the more recent strife in the Balkans is very much alive.

Which means, it seems to me, that the new member states of the Union are
now closer to the E.U.'s roots than their partners in the West -- in "old"
Europe. And it may well be that the future of the E.U. depends on the
ability of the new members to remind the old of what the original, essential
mission of the European Union was. -30-
-------------------------------------------------------------------------------------------------------
Krzystof Bobinski, former Warsaw correspondent for the London Financial
Times, now works with the Warsaw-based think tank Unia & Bolska (The
Union & Poland). Author's e-mail: bobinski@it.com.pl
------------------------------------------------------------------------------------------------------
LINK: http://www.washingtonpost.com
===============================================================
3. UKRAINE'S TOP ASSETS ARE THE SPOILS IN A POST-ELECTION
POWER STRUGGLE THAT'S FAR FROM OVER
Ukraine Workers Await Word of Factories' Fate

The New York Times, New York, NY, Sunday, July 3, 2005
International Herald Tribune, Europe, Monday, July 4, 2005

ZAPORIZHYA, Ukraine - With his face turned to the hellish river of molten
metal, Vasily Fedko, 55, said he left the Soviet Army 30 years ago and
joined a new force, the metal workers at Nikopol, a mill in eastern Ukraine
that produces steel alloys. He earns about $300 a month - and he does
not talk politics.

"I like the work, and no, I don't speak about that sort of thing," Fedko
said, flipping his mask down and jabbing his long metal feeder into the
blast furnace, where metal ores fed into the fire emerge as finished pipe.

Nevertheless, politics may decide the fate of his plant, one of many prize
assets at the center of an enormous fight in Ukraine over the spoils of a
social and political upheaval known as the Orange Revolution that pitted a
conservative old guard from eastern Ukraine - oriented toward Russia and
heavily industrialized - against the more liberal, market-oriented
challengers from the west and the capital, Kiev.

Viktor Yushchenko was inaugurated as president in January after two votes
last autumn that resulted in accusations of election fraud against the
government. Mass protests followed, as well as a legal challenge that led to
a third round of voting and Yuschenko's victory.

The challengers won in part because of a campaign promise to reverse the
country's controversial 1990s privatizations, in which state-owned companies
were sold to political insiders for pennies on the dollar. But the past is
proving extremely hard to unravel and is threatening to divide Yushchenko
and his nationalistic prime minister, Yulia Tymoshenko.

The two are openly struggling for power as they look to parliamentary
elections scheduled for March 2006. Tymoshenko is widely described as
ambitious and willing to split with Yushchenko to gain power - and possibly
even to run for president herself someday.

Yushchenko remains popular as he raises pensions and salaries, and he
has raised his country's international profile as well, by traveling the
globe appealing for aid and investment. But six months into his term,
Ukrainians are grumbling about the economy, which has slowed sharply in
the last year while inflation has taken off.

Business leaders blame Tymoshenko and her brand of economic populism,
which they say is undermining Ukraine's image as a market-friendly country
that aspires to join the European Union. In May, for example, her critics
say, she created a fuel shortage by capping the prices of gasoline and
diesel fuel, calling rising prices a "plot" by international oil companies.

Later in May, Yushchenko removed the price controls and blamed Tymoshenko
for the fuel crisis in a harshly worded statement. "What happened on the oil
market was a clear example of how not to manage affairs," he told news
agencies.

Tymoshenko is also faulted for holding up the review of state assets sold to
private investors under the previous administration, dragging her feet in
issuing the hotly debated list of privately held companies that could be up
for resale.

During his election campaign, Yushchenko promised a government review
of the privatization sales of the 1990s, which were often rigged. But he
delegated making the list of companies to his prime minister. Tymoshenko
still has not published it, although at least one version was leaked to
Ukrainian and Russian newspapers.

"It's not in her interest for the list to be released before the March 2006
parliamentary elections," said Katya Malofeeva, director of new markets
strategy for Renaissance Capital, a brokerage in Kiev. "It makes more
sense for her to keep as many business people on the hook for as long as
possible."

Meanwhile, the economy is suffering as foreign investors step back,
wondering if Ukraine is truly as market-oriented as its democratically
elected leadership promised it would be. Tymoshenko has not helped
matters by wondering aloud if Ukraine might not be better off
renationalizing its largest industries.

Caught in the middle are workers like Fedko at the Nikopol mill. The
government wants to take back the factory from its wealthy owner, Viktor
Pinchuk, son-in-law of the former president, Leonid Kuchma. The plant, like
many others that were privatized, has become a profitable and stable
employer.

"No seizure! Law for everyone!" read a banner over the employee entrance
at Nikopol. A security force patrols the grounds with dogs, and shiny
concertina wire rings the plant.

Company managers said nearly half the 8,000-strong work force gathered for
arecent protest after Pinchuk asserted that a rival business group in league
with the new government had staged an illegal shareholders' meeting to try a
hostile takeover. He said he hired the security force to ensure they did not
succeed.

But according to some reports in the Ukrainian news media, the
demonstration, broadcast widely on national television, could well have been
staged. After all, Pinchuk also owns two of the country's main television
channels. Pinchuk, whose personal worth was estimated at $1.3 billion by
Forbes magazine, is a prime target of the new administration's privatization
review.

Pinchuk argued in an interview that his workers benefited if he compromised
with the government. "We never said we were angels or saints," he said.
"The workers know I am a capitalist, I am a rich guy. But I speak frankly to
them. We want profits, the workers want salaries, we have a joint interest
and we both need stability." -30- [ Ukraine Report Monitoring Service]
===============================================================
4. POLITICAL RIVALRIES THREATEN UKRAINE'S REFORMS

By Tom Warner in Kyiv, Financial Times
London, United Kingdom, Monday, July 4 2005

Six months after Ukraine's Orange Revolution, growing rivalries among
its leaders are threatening planned political and economic reforms.
Allies of Viktor Yushchenko, the mild-mannered president, and Yulia
Tymoshenko, the firebrand prime minister, are splitting into competing
camps.

Mr Yushchenko himself has tried to stay above the fray and assert his
authority over both factions. But he is struggling to hold together a
disparate alliance that united to overthrow former president Leonid Kuchma
but is now starting to come apart.

Mr Yushchenko said this week: "I'm happy to have the dialogue [with my
colleagues]. But if somebody questions a decision after it is made, there
might be a problem. I will not allow that."

The Orange Revolution's supporters are worried the conflicts could increase
over the next few months as the competing factions prepare for parliamentary
elections next March.

One group is formed of politicians close to Mr Yushchenko and led by Petro
Poroshenko, the National Security Council secretary. Ms Tymoshenko leads
the other group, which includes Viktor Pynzenyk, the finance minister.

Mr Poroshenko, a businessman with interests in confectionery, banking and
media, favours pro-business policies. On the vital question of a review of
questionable privatisations carried out by Mr Kuchma, Mr Poroshenko supports
examining only a limited list of deals for fear of upsetting business and
delaying new investment.

Ms Tymoshenko, a populist who enjoys strong support among poorer Ukrainians,
has argued for a wider assault on the assets of business people linked to Mr
Kuchma. She also wants to end tax-minimisation schemes such as transfer
pricing, used aggressively by Ukraine businesses.

Asked about her conflicts with Mr Poroshenko, Ms Tymoshenko declined to
name names but broadly explained the rivalry within Mr Yushchenko's team
as an argument between those she saw as dedicated public servants and
those who "came to increase their capital and re-divide property, not for
the sake of creating a competitive economy, but for their own benefit".

Mr Poroshenko said he was glad there were many businessmen in Mr
Yushchenko's administration because they had proved their effectiveness.
All his own shares were placed in an independent trust and he denied that
he looked out for his companies' welfare.

Mr Poroshenko and Ms Tymoshenko insist they share Mr Yushchenko's vision
of modernising Ukraine, joining the World Trade Organisation and pursuing
membership of the European Union. All three leaders also boast of increasing
social spending in this year's budget and there is broad agreement on the
principle of the privatisation review.

Mr Poroshenko and Ms Tymoshenko have often publicly disagreed and, when
Mr Yushchenko has intervened, he has usually come down on Mr Poroshenko's
side - for example, in arguments over the extent of the privatisation review
(where Mr Yushchenko supports limited action) and the capping of petrol
prices.

Mr Poroshenko, Ms Tymoshenko and Mr Yushchenko all say they would try
to form a joint bloc for next year's parliamentary elections. The vote is
important because it will be preceded by reforms that would transfer many
of the president's considerable powers to the prime minister and make the
prime minister answerable to parliament.

Mr Kuchma secured these reforms last December in return for agreeing
electoral law changes that paved the way for the re-run of the disputed
presidential election that brought Mr Yushchenko to power. Mr Yushchenko
would now like to cancel the reforms but parliament has refused. Mr
Yushchenko is considering over-riding parliament by holding a referendum.
The courts will soon rule whether that is possible. -30-
===============================================================
5. UKRAINE: A QUESTION OF PRIORITIES AND PR

By James Hydzik, Kyiv,
ForeignDirectInvestment magazine
Financial Times Business, Ltd.
London, Ukraine, June 07, 2005

Ukraine's new government's attempts to stamp out illegal trade and meet
WTO standards have led to hasty legislation on special economic zones.
In the process, it has alienated current investors and made potential ones
wary, reports James Hydzik.

Ukraine's development zones are undergoing a much needed legislative
overhaul. However, recent turmoil involving Ukraine's special economic
zones (SEZs) and priority development territories (PDTs) reflects both the
positive and less attractive characteristics of the learning process on the
part of Viktor Yushchenko's government.

The education of Ukraine's new rulers can be seen in their juggling of
legitimate business interests and the equally obvious need to end illegal
trade, apply tax burdens more evenly and bring the country's legal
framework, as well as commercial law enforcement, up to the standards
needed for World Trade Organization (WTO) accession.

The legal code of Ukraine was extensively modified, beginning in 2003, and
conflicting laws and even opposing paradigms made understanding Ukraine's
commercial system difficult. The rules around SEZs were no exception.

BUDGET GAP --------
Any hope of recreating the SEZ framework at a leisurely, painless tempo died
as the enormity of the budget gap left by the previous administration became
apparent. In the end, it is hoped that by the end of 2005, foreigners active
in these zones will benefit from the reconstruction of the framework that
they operate under. However, current uncertainty, exacerbated by poor PR
management, has hurt the Ukrainian government's image at home and abroad.

In March, operators in Ukraine's 11 SEZs and 72 PDTs had their tax
privileges withdrawn. This was part of a blanket cancellation of the roughly
3000 company-specific and industry-targeted tax exemptions granted by prior
administrations. The government made these changes by introducing them via
the revised 2005 budget which, by necessity, was quickly sent through the
Verkhovna Rada for passage by lawmakers within weeks of the new cabinet's
coming into power.

NO WARNING --------
However, due to the urgent need to bring the budget in line with the new
government's findings, there was no time for public consultation. The
revocation was announced with little warning.

"We've heard President Yushchenko state often that the rule of law will
prevail in Ukraine now. However, these privileges were removed essentially
by decree and without our input," a foreign diplomat based in Kiev notes.

The European Business Association (EBA) vice-president, Jorge Intriago,
points out that the administration has been in power for just over 100 days,
and though it is well intentioned, has made mistakes. "Cancelling the
benefits is one of those mistakes. Given Ukraine's competitive advantages,
those benefits might not have been necessary. But if the government grants
those advantages, it should keep its word. They could enforce existing
legislation instead and examine individual cases."

WINDS OF CHANGE --------
Some cancellation was expected. As early as January 2003, then-President
Leonid Kuchma attempted to close down what he called "semi-free criminal
zones". It was noted at the time that only two of the zones, in Yavoriv,
near the Polish border, and Uzhhorod, near Hungary, were profitable.

Mr Kuchma's attempt failed under domestic pressure, but the expectation of
a change lingered. "We aren't surprised that it's happening, but we are
about how it's happening," comments Ulrike Straka, commercial attaché at
the Austrian embassy. "When they speak of the rule of law, they should
understand that it means that legal changes which infringe upon personal or
corporate rights need to be introduced gradually, not overnight, and
certainly not retroactively."

POOR PR --------
Mr Intriago sees the problem as one of necessity combined with poor PR.
"One of the biggest differences between this government and the prior
administration is that this one is willing to listen. Within two weeks of Mr
Yushchenko's coming to power, the vice-premier, Oleg Rybachuk, started
a dialogue with us concerning changes that need to be made."

The vice-prime minister for EU integration has drafted legislation to
replace the SEZs with technology parks that will have the same basic
function, but under legislation tailored to meet WTO standards. "The draft
is comparable to EU norms. It is really well-written legislation," Mr
Intriago adds.

Despite Ukraine's closer ties with the international business community,
damaging communication errors still exist. Though the EBA has seen the draft
and commented upon it, commercial sections of central European embassies
in Kiev were unaware of any specifics.

Much of what has been doneto calm investors and governments has happened
face to face. Mr Yushchenko and Mr Rybachuk visited Poland to discuss the
issue with their counterparts in Warsaw, and the Polish embassy in Kiev has
been involved in talks as well.

POLISH PRAGMATISM --------
"Our businessmen who are currently involved in Ukraine's SEZs are being
pragmatic," says Zbigniew Szmuniewski of the commercial department of the
Polish embassy in Kiev. "After we sent a note through diplomatic channels
and the governments started talking, they understood that we would wait for
the Ukrainian government to sort things out."

Polish investors are in close communication and none are planning to
withdraw from the market. "We have heard of a court case against the
government being launched in Donetsk, however," Mr Szmuniewski says.

It is recognised that something needs to be done quickly, and that trust in
the new administration has been damaged. Mr Szmuniewski notes that as
long as there is uncertainty regarding how the Ukrainian government will
handle both the legislation itself and guarantees that the laws will stay in
place, future Polish investors will wait.

WTO HOPES --------
"Rebuilding confidence will be achieved mostly by WTO accession. If it
happens at the end of 2005, as the new administration desires, then we
should see a return to normalcy," Mr Szmuniewski says. "With accession,
the norms of relations between government and business will already be
established on a clear level." Talks regarding Ukraine's preparedness for
joining the WTO will be held in September.

Mr Intriago says that prompt passage of the new legislation regarding
development zones will help as well. This could happen before the parliament
closes its session at the end of June. "President Yushchenko has the support
in the Verkhovna Rada at this time to get the law passed fairly quickly."

Tax exemptions might well be restored after an analysis of each company.
However, Mr Intriago thinks tax incentives should not be necessary to
attract investment. "Given the comparative advantages that Ukraine
possesses, development in its SEZs makes sense. Ukraine has a well-
educated workforce right next to the EU and labour costs are low.

The locations, especially in Yavoriv and Uzhhorod, are ideally situated. If
the government wants to make them more attractive, cutting red tape and
continuing to fight successfully against corruption will bring in more
serious business than a tax break," he says.

INFLUX OF FDI --------
Given that only $1.5bn in foreign capital investment has made its way to
Ukraine's designated zones, the expected influx of $3bn to $4bn in total FDI
in 2005 will be felt in these places. Mr Intriago feels that this alone will
be a sign to investors that Ukraine's time has come.

"There were a lot of great projects that were put on hold because the prior
administration wasn't interested in implementing what was needed. That
changed 180 degrees within one week," he says.

Mr Intriago also notes that news headlines aren't a reliable indicator to
potential investors of what is happening in the country. "The biggest
problem we see with people coming to invest is a lack of preparation.
People who do their homework do well here."

In the case of Ukraine's SEZs, the homework includes watching for two
polls - the vote to pass Mr Rybachuk's legislation bringing in EU-comparable
designated areas and the vote that grants Ukraine WTO status. -30-
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6. UKRAINE: "OWNER BEWARE"

EDITORIAL: Wall Street Journal Europe
Europe/USA, Thursday, June 30, 2005

The hot button issue for countries making the move from Marx to the market
used to be privatization. Now, 15 years after the collapse of communism, a
new word enters the lexicon: reprivatization.

In Ukraine, the rulers who came to power in last year's "Orange Revolution"
propose to "reprivatize" select companies, starting with Krivorozhstal, the
largest steel maker. They claim corrupt insiders made off with the nation's
gems for a song under the old regime.

In Russia, President Vladimir Putin justified this year's rape and plunder
of Yukos, once the premier oil producer, by citing the chaotic
privatizations of the 1990s. Other oligarchs who made their fortunes under
previous Russian President Boris Yeltsin fear that they'll share the fate
of Mikhail Khodorkovsky, the Yukos founder who was sentenced to nine
years in prison earlier this month on fraud charges.

The Russian and Ukrainian cases are, for now, only superficially similar.
Before the world's eyes, the Kremlin trampled on property rights and rule
of law. Kangaroo courts, pliant prosecutors and loosely written tax laws
were exploited to destroy Mr. Khodorkovsky and Yukos. Investors took note,
and scurried away.

If Ukraine wants to attract foreign capital and claim its spot in the
Western club of free market democracies, President Viktor Yushchenko and
his government would be wise to steer clear of the Russian model. This
message is getting through. The early bluster about rolling back the
privatizations carried out under former President Leonid Kuchma has been
replaced in Kiev with a more cautious approach. Ukraine's inexperienced
rulers are trying to honor their pledge to root out Kuchma-era corruption
in a lawful, not vengeful, way.

Krivorozhstal, a symbol of the previous era, looks to be an obvious case to
revisit from a political and legal perspective. In June of last year,
companies controlled by Ukrainian billionaires Viktor Pinchuk and Renat
Akhmetov bought a 93% stake for $800 million in a mill that turned a profit
of $370 million. Their bid was nearly half the losing offer from U.S. Steel
and Mittal Steel, which priced the company at $1.5 billion. Oh, by the way,
Mr. Pinchuk happens to be married to then-President Kuchma's daughter.
Armed with several court rulings, Mr. Yushchenko's new government wrested
back control of Krivorozhstal, which will go back on the market again by
the end of this year.

In this case, the government went through the courts in an orderly way,
giving current owners the right of appeal and keeping the whole process in
the open. Its target was last year's controversial sale not Messrs. Pinchuk
or Akhmetov personally. Kiev also made clear that private owners, not the
state, are better placed to run and derive value from the mill in the
future.

"If they didn't do it, they'd have no political credibility," Jean
Lemierre, president of the European Bank for Reconstruction and
Development, Ukraine's biggest foreign investor, told us recently. "They
should take the most obvious cases, but shouldn't have too long a
[reprivatization] list." Kiev must weigh the legitimacy of contract, he
added, against the sanctity of contract.

Initially, Ukrainian leaders talked about hundreds of suspect
privatizations that would be reexamined. In May, Mr. Yushchenko whittled
that list down to 29 unnamed companies, before declaring this month that
"there will be no list." He now says that courts will review each case
individually. No investor likes a government seemingly on a mission to
appropriate private companies. The restraint is welcome.

Market economies are built on property rights, which in turn are
safeguarded and enforced by independent courts. The challenge for
Ukraine lies in strengthening its institutions and the rule of law -- rather
than weakening them, as Mr. Putin did in Moscow -- and in ensuring a level
playing field. That means that friends of the current regime aren't treated
any worse or better than friends of the last. Kiev might also take note
that in the early years after the U.S.S.R.'s collapse laws were unclear and
the rules of the game undefined. Except in egregious cases, Ukraine would
stand to err on the side of letting past deals stand rather than rerunning
the game.

Ukraine has a chance that Russia just missed to complete the transition
to a Western-style market economy. Milton Friedman advised the former
Communist countries in the 1990s to "privatize, privatize, privatize." "But
I was wrong," he recently said. "It turns out that the rule of law is
probably more basic than privatization."

With that in mind, any reprivatization would be best carried out in a way
that strengthens the rule of law. Kiev says it must undo the wrongs of its
predecessors. It can be judged successful if no future rulers will need, or
indeed be able to, reopen private property claims again. -30-
===============================================================
7. REPRESENTATIVES OF PARLIAMENT AND CABINET AGREE ON
PACKAGE OF DRAFT LAWS ON UKRAINE'S ADMISSION INTO WTO

Ukrainian News Agency, Kyiv, Ukraine, Friday, July 1, 2005

KYIV - Representatives of parliamentary factions and groups and the
Cabinet of Ministers have agreed a package of draft laws necessary for
admission of Ukraine into the World Trade Organization (WTO). Prime
Minister Yulia Tymoshenko announced this to journalists at the end of a
meeting of a governmental-parliamentary working group.

According to Tymoshenko, the package consists of 14 draft laws, and the
contents of all of them were agreed. "They were agreed in detail,"
Tymoshenko said. She stressed that the drafted legislative proposals fully
take into account the interests of Ukrainian manufacturers and the national
economy.

"I think that both farmers and industrialists will speak in support of these
initiatives next week," Tymoshenko said. She added that a decision was
also made to vote for these draft laws in the parliament as a single
package.

According to her, all members of the working group voted in favor of the
draft laws and only Parliamentary Deputy Valerii Asadchev of the Ukrainian
People's party faction abstained.

A package of draft laws on the housing construction program was also
approved at the working group's meeting. Tymoshenko said that this package
consists of six draft laws. According to her, the working group backed this
package of draft laws in essence, and the draft laws will be put to a vote
as a single package.

Moreover, the working group approved a draft law aimed at paying the debts
owed to coal-industry employees. According to Tymoshenko, these debts
presently amount to UAH 380 million. Tymoshenko stressed that the debt
accumulated during the "previous period." At the same time, she said that
the debt has not increased under the current government.

The working group also agreed two draft laws aimed at developing the sugar
industry. Tymoshenko said that the main aim of these documents is to
stabilize the price of sugar. According to her, this issue should also be
resolved in the final days of the current parliamentary session.

As Ukrainian News earlier reported, Tymoshenko called on the leadership of
the parliament on June 21 to vote for a package of 14 draft laws necessary
for admission of Ukraine into the World Trade Organization as well as for a
package of six draft laws on housing construction.

The Cabinet of Ministers approved a package of 22 draft laws necessary
for Ukraine's admission into the WTO at a meeting on May 26. -30-
===============================================================
8. UKRAINE HASTENS TO OPEN MARKETS FOR IMPORTS - LIFE OR DEATH?

ANALYSIS: By Roman Bryl, Ukraine
ISI - Intellinews, Kyiv, Ukraine, Wed, June 29, 2005

Ukraine significantly reduces import duties --------

Last week Ukrainian parliament (Verkhovna Rada) passed a law that
significantly lowers import duties on a wide range of imported goods. The
law was presented as a list of changes to the current customs tariff code.
But in fact, it is a new code providing new goals and priorities. It is the
most liberal code Ukraine ever had. The law comprises more than 1,000
printed pages.

Ukraine can lose up to USD 500mn in 2005 due to new customs tariff code

The changes presented in the law concern slashing import duties on 56% of
goods items or 54 goods groups listed in the customs tariff code. In
particular, the law decreases preferential duties, changes previous
preferential duties to full-payment duties, and replaces most special and
combined duties to ad valorem ones.

The new duties concern imported goods, total value of which in 2004 made up
USD 25.3bn. Imports charged with these duties amounted to USD 20.8bn or
82.5% of total imports in the year. The law effectively lowers the average
weighted import duty to 4.45% from 7.79%. State officials hint that fallout
revenues from the state budget will make up USD 100mn in 2005. Government
plans to offset these losses by widening the VAT taxable base. However, our
estimates show the gap will be at least USD 500mn for imports of the same
amount as in 2004.

The changes do not cover all excise goods (e.g. petroleum) and certain kinds
of items (e.g. lingerie, footwear) because of earlier made amendments to the
customs tariff code. All import duties are set according to Ukraine's
proposals related to WTO entrance, made in 2004.

Lobbying by food producers keeps related duties unchanged --------

According to some Rada MPs, parliament lowered the duties on goods that
are not produced in Ukraine and raised duties on those produced locally. 328
MPs out of 415 supported the new customs tariff code. In particular, the
most significant duty cuts concern hi-tech products and computers, i.e.
goods
Ukraine itself does not manufacture, Rada deputy chairman Vitaly Khomutynnik
(Regions of Ukraine fraction) informed. According to Khomutynnik, duties on
furniture and cable industries' products stayed unchanged.

Also, he informed that metallurgical and food industries were not even
mentioned in the new law. These industries are very important for the
Ukrainian economy. Food processing is mostly domestically oriented and is
the main supporter of stagnating agriculture. We should note that food
producers have a powerful lobby both in parliament and government. For a
long period of time they successfully opposed any import duty reductions. As
a result, the share of imported food products rarely exceeded 10-15% on the
Ukrainian market during the last 7 years.

Some import duties on steel products were actually included in new duties
list

Metallurgy is the most export-oriented industry, providing a great part of
state budget revenues. Thus, government supports protectionist measures. It
is necessary to note that in contradiction of Khomutynnik's statement, made
to a Ukrainian news agency, the new customs tariff code does lower import
duties on specific steel products.

These are several types of ferroalloys (20-53% duty cut) and rolled metal
(up to 100% reduction).

CHANGES IN IMPORT DUTIES:
Groups of goods, Import duties lowered by, %
Kaolin clay 50%; Granite 50; Limestone gumboil 50; White cement 60;
Coal rosin 100; Hydrochloric acid 63; Chloride ammonia 63;
Sodium carbonate and bicarbonate 78; Alcium carbide 45;
Cotton-wool 100; Perfumes, toilet water, shaving creams 35;
Soap 74; Umbrellas 33-56; Ferroalloys 20-53; Rolled-metal 100;
Leathers 40-100; Timber 100; Paper 70-100;
Pipes and wires 40-100; Bulldozer and power graders 60;
Combine harvesters 80; Printers 100; Electric engines 40-100;
Tram carriages 40; Tractors 40-92;
Auto cranes and auto concrete mixers 40; Space devices 100;
Furniture 30-65; Toys 100; Sport equipment 40-60;
Source: Interfax-Ukraine news agency, IntelliNews

New document would hopefully help tackle illegal imports --------

Supporters of the new customs tariff code say with one accord that the law
does protect local producers and allows combating smuggling more
efficiently. Tackling smuggling is proclaimed as the main goal of new
regulations. The previous code, for instance, included special duties that
were too high and imports of several types of goods was economically
unjustified.

At the same time, the duties were highly differentiated, which provoked
importers to abuse goods classification, lower customs value and avoid
paying duties. Government hopes that lowering overly high duties would
turn illegal imports into legal goods flow.

According to state customs authorities (SCA) information, such kind of
legalization will provide 50% extra payments to the state budget compares
with present payments made by SCA. Also, SCA informs that half of
imported goods were previously supplied to Ukraine through illegal or
"black schemes".

By way of history, until 2001 Ukraine did not have a single customs tariff
code. The duties were regulated through 16 laws and more that 70
governmental orders.

Ukraine supposed to sign final agreements with all WTO workgroup states
by end-summer

The SECOND strategic aim of the new document is speeding up WTO
accession. The government in its action plan set a target to enter WTO in
2005. Ukraine allegedly can obtain WTO membership this autumn during the
WTO annual meeting in Hong Kong.

Of course, Ukraine should satisfy all demands of 43 member-states of the
working group examining conditions of Ukraine's entrance. By now 32
countries have signed bilateral agreements with Ukraine on mutual goods
and services market access.

However, such agreements are not signed with major countries like China,
the US, Australia and Japan. Those nations have a huge say in the final
decision. We can suppose that countries mentioned will not block Ukraine's
accession to WTO because of their earlier declared support.

Especially after president Viktor Yuschenko's victory against the allegedly
anti-democratic regime of previous president Leonid Kuchma. At the next
meeting of the workgroup that will take place at the end of summer, Ukraine
might receive the final approval from remaining states. According to SCA,
the new customs tariff code corresponds to all demands of member-countries
by 90%.

Obviously, Ukraine is trying to swiftly accelerate the reform process to
meet WTO accession demands this year. Government abolished all tax
privileges for several industrial companies and companies working in free
economic zones. There an equal excise rate for foreign and local companies
was introduced. Also abolished was the obligatory transfer by exporters of
50% of their FX revenues to the National Bank of Ukraine.

Parliament strongly supports WTO accession idea --------

Furthermore, here in Ukraine we can witness unprecedented unity among
parliament fractions concerning acceleration of WTO entrance. It worth
mentioning that during the last 3 months government twice initiated changes
to the customs tariff code, but failed to receive support of the Rada
majority. Today only communist party members oppose WTO accession.

But their position to a great extent is populist rather than constructive.
The rest of parliament supports and, importantly, is adopting almost all
laws needed for WTO accession. The bills had been submitted by
government on May 26, 2005.

On a negative note, Rada rejected a bill necessary for Ukraine WTO
accession on Jun 23. The bill foresaw legislative implementation of
multilateral agreements on intellectual property trade rights. The law was
to introduce criminal responsibility for illegal CD sales. This thorny issue
might hinder Ukraine's WTO accession, as authorities are not doing enough
to counter mass violations in this area.

No clear evidence that rapid trade liberalization will benefit
Ukraine --------

We suppose that both the new customs tariff code and special laws aiming
to meet WTO requirements will provide more transparent and simplified rules
for foreign and local importers to Ukraine. Before, domestic enterprises
importing goods into the country enjoyed privileges compared to foreign
importers. The new government has no option but to free local markets for
imported goods. Otherwise it can be blamed of betraying the declared
strategic course of integration with liberal European, Atlantic and global
organizations.

On the other hand, government still did not present any economic
calculations regarding benefits and losses even of WTO accession.
Watching the parliamentary session when the new customs tariff code was
passed, the IntelliNews analyst noticed that many MPs made special remarks
thanking government for changing duties in a way that certain enterprises in
the regions they represent had demanded.

In most cases, such gratitude was expressed on behalf of large industrial
companies. And no one even mentioned whether small and medium-sized
enterprises are ready to survive after the rapid liberalization of external
trade. Lobbyists got their way. Will the entire economy get its?

Our conclusion is that the hastiness in WTO accession is mostly
politically-motivated, while the efforts lack detailed economic
calculations.

We would advise authorities to institute a more gradual (although not
protracted) reform. But now it might be too late already. The law has
been passed. We keep our fingers crossed. -30-
===============================================================
9. YUSHCHENKO SIGNS RADA'S REINSTATEMENT OF SIMPLIFIED
TAXATION SYSTEM FOR SMALL AND MEDIUM BUSINESSES

Ukrainian News Agency, Kyiv, Ukraine, June 25, 2005

KYIV - President Viktor Yuschenko has signed changes to the legislation that
reinstate simplified taxation system for entrepreneurs. The press service of
the President informed about this matter in a statement, a copy of which
Ukrainian News obtained.

As Ukrainian News earlier reported, the Ukrainian Union of Industrialists
and Entrepreneurs, Federation of Employers and Party of Industrialists and
Entrepreneurs asked Yuschenko in June to sign this law, believing it is
required for the proper work of small and medium business.

The law provides for resumption of easy taxation system, under which an
individual with goods turnover up to UAH 500,000 can pay 6% (with VAT)
or 10% of tax (without VAT). The law also envisages abolishing several
restrictions, under which some small business entities do not enjoy easy
taxation.

The Verkhovna Rada passed the bill on amendments to several legal acts
on June 3. The law on amendments to the national budget for 2005 set
restrictions on activities, to which easy taxation system may be applied.
===============================================================
10. WORLD BANK LOANS UKRAINE 106M: HYDROELECTRIC POWER
Reform-minded government scored a financial victory last week

New Europe, Athens, Greece, Monday, July 4, 2005

Ukraine's reform-minded government scored a financial victory last
Thursday by securing a multi-million dollar loan from the World Bank to
develop hydroelectric power, according to UT-1 television news report.
The USD 106 million credit will run for 18 years with a six-year grace
period.

The loan is the first instalment of a USD 374 million World Bank project
aimed at bringing Ukraine's national hydroelectric power infrastructure -
among Europe's largest - to modern standards.

The Ukrainian state-owned company Ukrhidroenergo will use the money to
overhaul six dams on the Dniepr River, and a seventh on the Dniestr River.
Once complete the programme will be the largest foreign assistance project
in Ukrainian history, after aid for the Chernobyl nuclear power disaster.

Besides dam repair the World Bank loan will enable Ukrhidroenergo to
purchase 70 new turbines for nine hydroelectric power stations. Much of the
money will remain in the Ukrainian economy as the Kharkiv-based company
Turboatom, one of the world's top producers of hydroelectric turbines, is
expected to win the tender to fit out the power stations.

Ukraine generates 8.7 percent of its electricity using hydroelectric
stations. Another 38 to 40 percent is produced by nuclear energy and the
remainder by fossil fuels.

Ukraine hopes to increase the share of water-produced power in the mix
by improving the efficiency of its hydroelectric stations, half of which
were built in the 1930s, and have been poorly maintained since then. -30-
===============================================================
11. POLISH, UKRAINIAN PRESIDENTS WITNESS CAR, STEEL PLANT DEALS
Warsaw urges visa-free travel for Ukrainians for European Union

New Europe, Athens, Greece, Monday, July 4, 2005

The presidents of Poland and Ukraine presided over the signing of two major
bilateral industrial deals at the VIII Poland-Ukraine Economic Forum in the
Baltic port city of Gdynia last Thursday.

Poland's Alexander Kwasniewski and Ukraine's Viktor Yushchenko watched as
Ukraine's Avtozaz motor company formally inked a deal for the takeover of 20
percent of shares in Poland's troubled FSO car plant and the acquisition of
Poland's Huta Czestochowa steel mill by Ukraine's Industrial Union of
Donbass.

Ukraine's Avtozaz already buys up almost all of FSO's output, using the
parts from the Polish plant in the assembly of Daewoo models at Avtozaz car
works in Ukraine.

FSO produces Daewoo Lanos and Matiz model cars and car parts. There has
also been media speculation over whether a new-model Lanos or perhaps even
a General Motors-made Chevrolet model may be introduced to the FSO product
line. US carmaker GM took over part of South Korea's insolvent Daewoo which
had previously controlled 80 percent of FSO.

The FSO plant currently employs more than 2,000 workers who have lived in
uncertainty since the company hit hard times in 1999 when Daewoo became
insolvent. The company then handed over control of its 80 percent share in
FSO to Poland's State Treasury.

The presidents also pre-sided as officials from Ukraine's Industrial Union
of Donbass last Thursday sealed the deal for Poland's state-held Huta
Czestochowa steel mill.

Donbass had managed to out-manoeuvre Indian-owned titan Mittal Steel
which dominates the Polish steel market with seven million tonnes of annual
production. Mittal Steel fell out of the running for Huta Czestochowa after
failing to agree on a labour package with the mill's unions. Donbass
succeeded in subsequent labour negotiations.

Kwasniewski also called on other EU states to adopt free visas for
Ukrainians similar to those granted by Poland which joined the EU in May
2004. "I am convinced that we as the European Union should adopt the
standard which for many months has been in force in Polish-Ukrainian
relations - no visas to Ukraine and free visas for Ukrainians to all EU
countries," Kwasniewski was quoted by the Polish PAP news agency as
saying. "This is our postulate, which I am putting forth vocally to our EU
partners and I believe that it will be accepted," he said.

Kwasniewski also backed Ukraine's drive for closer ties with NATO and its
drive for closer ties and eventual membership in the European Union. "I
trust that no one will lack the energy, conviction and determination that
will strengthen an independent Ukraine and a sovereign Poland and build
our strong position in Europe," he said.

Poland, both at the political and social level, was the strongest European
backer of Ukraine's recent pro-democracy "Orange Revolution" and has
since demonstrated consistent diplomatic support for Ukraine's drive for
closer integration with Western European institutions.

Yushchenko, a key leader of the Orange Revolution and enthusiastic
pro-market reformer, echoed Kwasniewski. "Today we clearly say we are a
country which is aiming for European integration. We are an integral part of
European integration," he said.

Yushchenko also told Polish and Ukrainian business leaders gathered at
the bilateral business forum they should be a driving force in the further
integration of Europe. -30-
===============================================================
12. UKRAINE: THE LONG ROAD WEST
So the road West is long - but it is open for Ukraine.

Stabilisation of investor confidence and inflows of new foreign
direct investment (FDI) will hinge decisively on the EU's reaction
to the new political era in Kiev.

By Moritz Schularick, Current Issue
Deutsche Bank Research, Deutsche Bank
Frankfort, Germany, 27 May 2005

o The "orange revolution" has put Ukraine back on the European map.
The country's prospects for economic development have improved visibly.
This report looks at Ukraine's economic outlook after its political rebirth
and presentsscenarios for its medium-term growth prospects.

o With a population of 50 million, Ukraine has considerable economic
potential. On a medium-term horizon it could achieve economic growth in
excess of 5%, provided the investment environment improves noticeably.
Whether Ukraine will be able to fully exploit its growth potential will
depend above all on economic diversification, an increase in the investment
ratio and stepping up the pace of institutional reforms.

o The reform window is wide open. Robust growth and the great popularity
of both President Yushchenko and Prime Minister Tymoshenko offer a
favourable environment for far-reaching structural reform. But the
population has equally great expectations. A critical mass of reforms must
be initiated in the coming months. Ukraine still has substantial catching-up
to do, especially as regards the quality of its legal system and its public
administration.

o The government in Kiev is well aware of the manifold political and
economic obstacles that could get in the way of quick progress. Taking a
careful, consensus-oriented and pragmatic approach, the government will
have to strike a balance between the interests of West and East Ukraine as
well as the influential "clans". Also, it will need to consider the
country's close economic, political and cultural ties to its neighbour,
Russia.

o The new political leadership intends to link the economic reform process
over the long term to preparations for potential membership in the EU. An
external anchor- the prospect of joining the EU - would considerably
increase the chances of success for the reform efforts. The powers of
transformation related to EU membership represent one of the most
important lessons learned from the last fifteen years of transformation in
eastern Europe.

Stabilisation of investor confidence and inflows of new foreign direct
investment (FDI) will hinge decisively on the EU's reaction to the new
political era in Kiev.

o The EU, though, has not yet decided whether it is prepared to support
Ukraine's membership possibly even in spite of Russia's reservations and
welcome Ukraine into the European fold. This question of principle, which
would markedly change Europe's geopolitical landscape once again, has
yet to be answered. Expectations linked to Mr. Yushchenko's presidency
must be realistic. The road West is long - but it is open again for Ukraine.

The "orange revolution" has put Ukraine back on the European map.
Among Ukrainians there is a strong conviction already today that the
political and economic future of their country lies in the West, in Europe
- not with Russia or in the no man's land between Russia and the EU.
The impressive economic performance of Ukraine's western
neighbours, which joined the EU last year, and Russia's political
orientation both acted as catalyst for the change of direction that found
its expression in the "orange revolution" of December 2004.

In the preceding years the 50 million-strong population had been
threatened by economic stagnation and political isolation. Economic
reforms progressed only slowly - if at all. Ukraine's efforts to establish
closer ties with western Europe's institutions by and large remained
vague declarations of intent. It was Russia, rather than the European
Union, that pursued an active policy of enlargement, designed to lead
to the establishment of a "single economic area" comprising Russia,
Ukraine, Belarus and Kazakhstan. Following its victory in the "orange
revolution", though, the new government in Kiev shelved these plans
and aims now to gear its economic policy to Brussels and the West.

Financial markets are forward-looking and react sensitively to an
improvement in a country's economic prospects. The upturn in the
Ukrainian financial market leaves no room for doubts that a positive
economic development has been regarded as conceivable since the
"orange revolution": Ukrainian Eurobonds carry almost the same
spread as Russian bonds and are considered much less risky than
Turkish paper.

Some experts think Ukraine will become a preferred location for
outsourcing - shaped after the Chinese model - on the eastern edge of
Europe. With wage costs of currently less than 10% of the EU average,
Ukraine could turn into an attractive production location for Europe's
industry, provided the framework conditions can be brought up to the
standards of a market economy and investor confidence can be
stabilised.

But such upbeat scenarios still give rise to a number of questions.
Experts frequently point out that the sustainability of the current
development is not yet ensured, despite the achievements of
the past months. Rather, to use the words of Michael Emerson, the
country is stuck "between the elephant and the bear".1

INCOMPLETE TRANSFORMATION: A DIFFICULT LEGACY

Following its independence in 1991, Ukraine launched the process of
transformation with high hopes. Many experts believed the country's
starting position was good - at least compared with other former Soviet
republics: a well-educated population and the highest density of
engineers in the entire Soviet Union suggested this economy had
remarkable technological potential. Still today, Pivdenmask in
Dnepropetrovsk is the largest rocket factory of the world. In addition,
Ukraine's fertile, black earth soil forms an optimal basis for modern
agriculture. Its geographic position between Russia and the West
makes it an interesting location for trade and transit.

Ukraine serves as the perfect example that politics is a focal,
independent factor in the transformation process. A long series of bad
political decisions or non-decisions has set back the country's
economic development by roughly a decade. As in Russia the
privatisation process, in particular, failed to have the desired positive
effects on competitiveness. Insider trading and "latent privatisation", i.e.
when financial claims against allegedly insolvent state enterprises were
used to transfer stakes in the companies, were commonplace.

Only a few months ago, the largest state-owned steel company -
Krivorizhstal - was sold for roughly half of its estimated value to the son-
in law of the then president, while considerably higher offers from foreign
investors were ignored. Even though the reliability of such estimates is
hard to gauge, it is believed that roughly half of Ukraine's economy is
controlled by only a few industrial "clans".

Ukraine's gross domestic product (GDP) reflects political shortcomings
during the transformation process: Following the pronounced slump in
GDP in the early years - a widespread phenomenon in the
transformation countries of Eastern Europe - even by 2004 Ukraine's
GDP had still not managed to climb back to its 1990 level. This is due
mostly to the fact that Ukraine's old industrial combines have not yet
been completely replaced by newly founded companies, which could
have supported real economic growth since 1990 as was the case in
the Central European accession countries.

As its transformation is as yet incomplete, Ukraine is split in half not
only politically but also economically - and with apparently opposing
forces within these two halves: as the industrial combines are located in
the Russia-oriented East Ukraine, the East of the country continues to
account for a large part of national income.

By contrast, Europe-friendly West Ukraine has so far failed to attract
new investment due to unattractive economic conditions, and is much
poorer than the East. The striking wage difference between the East
and the West of the country sets it apart from the Central European
countries, where wages are usually highest in the regions neighbouring
the EU.

THE ORANGE-COLOURED BOOM --------

Despite the manifold structural problems, Ukraine's economy has
performed remarkably well over the last five years. Real economic
growth reached roughly 12% yoy in 2004 (according to official
numbers); this is the highest rate of increase of all European countries.
The current year will likely see a slowdown of growth to 5%. Yet over
the last five years, growth averaged a respectable 7-8% p.a; this is the
result of a combination of three factors:

o Ukraine's currency, the hryvnia, has depreciated strongly in real
terms since 2002 in the wake of the financial crisis and the dollar
weakness, triggering a production boom for local industry. Imports
were substituted, and Ukrainian exports became much more
competitive in foreign markets. Thanks to the heavily undervalued
currency, the current account surplus came to 10% of GDP in 2004
and exports are growing at an impressive rate. Massive foreign
trade surpluses have led to rapidly growing forex reserves at the
central bank - interrupted by a temporarily decline during the
December political crisis.

o World market prices for Ukrainian exports - above all steel and steel
products, which make up around 40% of total exports - have risen
substantially. Thus the terms of trade have developed very
favourably for Ukraine. Like in Russia, the country's new wealth has
found its way into the domestic economy and given a remarkable
boost to investment activity in several regions, especially in the
building sector. Moreover, Ukraine is automatically insured against
high oil prices thanks to its revenues from the transit of oil and gas
from Russia.

o Finally, economic growth in Russia has also led to strong demand
effects on the Ukrainian economy. Trade relations between the two
countries remain close. Roughly 30% of Ukraine's exports and 40%
of its imports go to or come from Russia. At the same time, the
positive economic climate has reversed the capital flight from the
region.

For a realistic assessment of Ukraine's economic performance, however,
two additional factors must be considered. First, growth has
started from a low level and was made possible by increased utilisation
of existing capacities. This effect is due to bottom out in 2005. New
growth will be more difficult to engineer. Second, higher production is
taking place above all in the old heavy industries which are benefiting
from strong Asian demand for steel. The rapid development of new
steel capacities in these countries harbours considerable medium-term
risks for Ukraine's export industry.

So the economic upturn is not (yet) based on domestic and foreign
investment and massive productivity gains as is the case in the Central
European EU member states. Intensification and diversification will only
be possible if the country manages to raise its investment ratio and
becomes more attractive for foreign investors. FDI statistics reveal that
over the past ten years Ukraine was unable to attract a significant
amount of FDI and build up new industries.

FDI inflows have been relatively small so far. Despite the positive
macroeconomic data, Ukraine's high growth rates invite comparison
with the uncertain situation of the Russian economy and its dependence
on oil prices, rather than with the robust growth trend in Central Europe.

If we note the fact that economic growth in Ukraine depends strongly on
external factors, this does not mean we have overlooked the marked
improvement in many macroeconomic indicators which are a
consequence of the high growth rates registered since the year 2000.

External debt and public-sector debt ratios, in particular, have improved
noticeably, which will likely be recognised by the international rating
agencies in the next few months. Better country risk ratings could make
Ukraine more attractive to foreign investors.

In light of massive current account surpluses it is only a matter of time
before Ukraine becomes an international creditor. This year already, the
national bank's (NBU) forex reserves could exceed the country's
external debt. Thus Ukraine would have made the transformation from
default to net creditor status within the space of only a few years. We
witnessed the same development in Russia last year.

However, the comparison with Russia also underlines the problems
inherent in large current account surpluses as they are usually accompanied
by equally large capital exports abroad. In view of a lack of investment and
an old capital stock in the countries of the former Soviet Union, the long-
term economic benefit of massive capital exports is doubtful.

UKRAINE'S ECONOMY IN A REGIONAL COMPARISON ---------

Despite the positive trend of the past years, a comparison of key
structural indicators reveals how far Ukraine is lagging behind other
accession candidates in many areas. The EU itself has not yet granted
Ukraine the status of a market economy after more than ten years of
transformation. Besides the prestige for its economic policy, this would
bring important advantages to Ukrainian exporters in anti-dumping
lawsuits. To be sure, the private sector's share in GDP has meanwhile
risen to roughly 65% and thus to the level of other transformation
countries.

But the state's influence on prices remains strong in major
sectors, especially the energy sector. Among other things, the lack of
functioning bankruptcy legislation has so far prevented Ukraine from
fulfilling the EU criteria. The rising importance of foreign trade is
reflected in the degree of openness, which has soared over the past
years thanks to an export boom for metal products. Today, Ukraine is as
open to foreign trade as most other Eastern European economies.

Compared with other countries from the region and another accession
candidate, Turkey, one of Ukraine's most striking features is its
remarkably low per capita income. At EUR 1,200 at market prices,
income per capita is not even half as high as in Russia, Romania and
Bulgaria. This is less than 10% of the old EU-15 average. Measured in
terms of purchasing power parities, though, per capita income rises to
roughly EUR 5,000.

Ukraine then reaches roughly the same level as Romania and Bulgaria,
whose currencies (in relation to purchasing power) are less strongly
undervalued than the hryvnia. Monthly wages in Ukraine currently average
USD 80-100; this is only about 15% of the wage level of Poland or
roughly 50% of that of Romania. However, Ukraine has not yet managed
to play this card in international wage competition; despite its low wage
costs it has not yet attracted large numbers of manufacturing jobs.

The redirection of trade from the East to the West was a typical
phenomenon in the Central European accession countries in the
1990s. Over the last few years, first signs of a similar development
have also emerged in Ukraine. The EU's share of Ukraine's foreign
trade has risen above 30% in the last few years - and the trend
suggests a further increase. Nonetheless, Ukraine still lags substantially
behind the countries of southeast Europe. In the latter, 60% of both
imports and exports are with the EU.

Key economic indicators paint a positive picture. As regards price
stability, Ukraine has made progress with macroeconomic stabilisation
after the crisis years at the end of the 1990s - also in comparison with
other countries. Thanks to the peg of the hryvnia to the USD, inflation
was under control and amounted to 5% on average over the last three
years.

Even though Ukraine has registered rising inflation rates in the
recent past, the country is still well ahead of Romania and Turkey. The
budget situation is similar. With an average deficit of 1.6% of GDP,
Ukraine's budget is on a sounder footing than that of Croatia or Turkey,
which have posted an average 5% or over 11% of GDP, respectively,
over the last few years.

According to many investors and international rankings, the country's
real weak points lie in its institutional framework. In fact, as regards the
quality of its legal system and public administration Ukraine not only
lags considerably behind the Central European accession countries,
but also in many respects even behind Russia, its neighbour to the
east.

Ukrainian and foreign companies complain regularly about state
capture up to the highest offices - i.e. the "penetration" of government
institutions by organised interest groups preventing fair competition -
and daily "petite corruption" when licences are awarded or contracts
enforced. The Investment Climate Index compiled by the Kiev Institute
for Economic Reform also cited instability of the institutional framework
and a lack of law enforcement as the most frequent obstacles to
entrepreneurial activities.

THE REFORM WINDOW IS WIDE OPEN ---------

Thanks to robust growth, the macroeconomic environment is conducive
to far-reaching reforms. The two leading figures in the orange
revolution, President Viktor Yushchenko and Prime Minister Julia
Tymoshenko, are riding high on a groundswell of political approval. But
expectations are running high among the population as well. A critical
mass of reforms must be initiated in the coming months. The next
election campaign will probably begin as early as in autumn, as
parliamentary elections are to take place in February or March 2006.

In addition, the scope for the president to put his stamp on affairs will be
drastically restricted by constitutional amendments, which were part of
the deal struck with the former leadership. De facto, Ukraine will
become a parliamentary republic in the foreseeable future. Only next
year's parliamentary elections will show whether the Ukrainians have
succeeded in making a radical new start.

In the near future, the government will be faced with a number of
macroeconomic challenges. At the top of the list of economic priorities
are the preparations for the WTO accession planned for 2006. The new
budget for 2005 was signed on March 29. It foresees a pronounced
increase in social spending of roughly 50%. The beneficiaries are,
above all, pensioners and civil servants. The financing, however, has
not yet been totally secured.

The government intends to limit new debt and, at the same time, reduce
the tax load for companies in order to legalise part of the shadow economy.
So the finance ministry will therefore rely, first and foremost, on
additional income from the closing of tax loopholes and exceptions. The
remaining deficit of roughly UAH 7 bn or 1.6% of GDP is to be covered
entirely by privatisation proceeds.

The fiscal easing has served to increase the IMF's concerns over the
acceleration of inflation. As a result of the fiscal election gifts, the
rate of price increase climbed to double-digit figures and must now be
capped again.

As the central bank has only a limited number of monetary policy
instruments at its disposal, the NBU agreed to let the hryvnia appreciate
by roughly 3% in April. However, two-thirds of the consumer price index
are food prices, so this could send the wrong signals regarding
underlying price pressure in the economy. What's more, Ukraine's
industrial sector has little interest in a marked appreciation of the
currency, but would rather continue to ride the export wave, triggered by
the hryvnia's undervaluation.

Regarding future revaluations, the NBU is significantly more cautious
than Prime Minister Tymoshenko, the finance ministry and the IMF in its
assessment of inflationary pressure and the advantages of a change in
the currency regime (moving to a more flexible regime) or pegging at a
much higher rate. As the sudden revaluation in April already revealed
deep divisions among Ukrainian policy-makers, it is difficult to foresee
the future course of exchange rate policy. We think that the central bank
will continue to oppose bold moves in the short term. Yet a revaluation of
the hryvnia by roughly 10 percent remains conceivable over the medium
term, if favourable external trends prevail.

Floating the currency could make sense also with regard to the financial
sector as fixed exchange-rate pegs often lead to an excessive
concentration of currency risk in the banks' books. Even though the
country quickly overcame the liquidity crisis in December, Ukraine's
financial sector remains vulnerable to crises and currency risk
management is still underdeveloped. The banking system is
characterised by numerous small banks that are sometimes little more
than dubious financial vehicles for certain companies or pocket banks
of the industrial clans.

With the remonetisation of the economy, credit volume has risen by
over 50% per annum over the past few years; in an international
comparison it is still at a low absolute level, though. In light of the low
starting level of credit volumes Ukraine offers attractive growth
opportunities.

Foreign interest in the country's financial sector has jumped since
the "orange revolution". This is reflected, for instance, in the planned
takeover of Avalbank, Ukraine's second largest bank, by Raiffeisen
International from Austria. The equity market, by contrast, continues
to labour under the lack of protection for minority shareholders. New
impetus will likely ensure only if the planned law on joint stock
corporations is adopted and enforced.

ROCKY ROAD TO STRUCTURAL REFORM --------

The reform of the big public monopolies and privatisation of key state-
owned enterprises (Ukrtelekom, Ukrprom, Ukreximbank) and the
opening of so-called strategic industries to foreign investors will be the
most difficult tasks facing the new government. Major interest groups
are intent on maintaining the status quo. Also, re-examination of earlier
privatisation projects could collide with the interests of the powerful
clans.

In her dealings with Ukraine's industrial magnates Mrs. Tymoshenko
has a reputation as a hard-liner, while Mr. Yushchenko seems more
inclined to seek cooperation. At present the government intends to
reverse a number of privatisations which the old regime conducted
under dubious circumstances and without regard to higher bids from
foreign investors (Krivorozhstal, Ukrrudprom, Nikolaev Alumina).

There has been confusion over the total number of companies, whose
privatisation is to be reconsidered: PM Tymoshenko previously
mentioned a number of 3,000 companies, while a mere 20-30 are
considered more likely at the moment. The government intends to
present, in the near future, a final list of companies and wants to ensure
that the re-examination procedure is conducted properly and
transparently. Should the number of reprivatisations be excessively
high, there is a risk that in the end the old system will be revived -
albeit with new owners.

There will likely be many attempts to delay or block the policy of reform
entirely. After all, there can still be huge differences between what is
decreed by law and what laws are actually enforced. Several reports
suggest that, as in Russia, state institutions have, by and large, become
the tool of economic interest groups. At the regional and even at the
national level, the different "clans" have bought their way into
parliaments, law courts and public administrations and are hindering
new reforms and/or the enforcement of existing laws. The state, which
should be the tool used for pushing through with reforms, is itself in
urgent need of reform.

For a number of reasons, the new government will have to be careful,
consensus-oriented and pragmatic.

o West Ukraine's orientation towards Europe and East Ukraine's ties
to Russia will have to be balanced carefully. The street protests
against the reformers in Kiev that followed the removal from office of
the Donetsk region governor have made this quite clear.

o The government will have to find a way to deal with the powerful
industrial groups which allows sufficient room for political manoeuvre
to prepare for potential accession negotiations with the EU.

o At first it will have to rely on the old staff employed in the ministries.

There is a chance, though, that the powerful heavy industry magnates
might be prepared to buy into the reforms. On the one hand, the
opening of the Western European market to Ukrainian metal exports
would dovetail with the commercial interests of the "clans". On the other
hand, the much smaller Ukrainian oligarchs fear their powerful Russian
counterparts and the "siloviki" in the Kremlin. Even during the orange
revolution there was evidence that several groups openly supported
Yushchenko.

CLOSE ECONOMIC TIES WITH RUSSIA

Russia's attitude regarding Ukraine's possible westward orientation is a
decisive factor for the country's future development. The political and
cultural ties between the two countries go back several centuries.
Especially the relationship between East Ukraine and Russia is still
close. Few at present believe there will be a genuine geopolitical border
between the two countries in the foreseeable future. Rather, many point
to the fact that the collapse of the Soviet Union was relatively peaceful
precisely because the borders between the individual republics were no
real borders.

For various reasons, Russian President Putin took the side of the
"ancien régime" during the Ukrainian election campaign. This shows
that Moscow harbours an intuitive distrust of Ukraine's westward
orientation. Russia is only slowly getting used to the fact that it must not
see its relationship with Ukraine as a domestic policy issue. With the
opposition's victory in the elections, however, Russia's influence over
Ukraine's political course has shrunk considerably.

But economic ties with Russia remain close. The two countries'
business cycles continue to be strongly correlated. Especially industrial
production is very much in line in the two countries. This connection
would only loosen if new industries were established and if a decoupling
from the commodity cycles took place. Russia's share of
Ukrainian trade has declined and trade has been growing much faster
with the EU than with Russia for several years.

Nonetheless, Russian companies are among the biggest foreign investors.
While official statistics paint an incomplete picture, unofficial reports
find there are extensive capital ties with Russia in some sectors. Moreover,
Ukraine continues to depend on energy imports from Russia - just like the
EU itself. And Moscow needs Ukraine as it is the major transfer country for
natural gas and oil transported to Western Europe. So the dependence
is mutual.

EU PROSPECTS A REFORM ANCHOR?

The new government is Kiev is well aware of the manifold obstacles
that could get in the way of quick progress with modernisation. So it is
seeking to ensure continuation of the reform process: the
modernisation of the country is to be linked to EU accession
requirements. The President believes that the target of EU membership
can serve as an anchor for economic reform and help overcome
political resistance.

The Central European accession countries have proven impressively
that this strategy can work out. Ongoing reform efforts have a realistic
chance of success if they can be justified, again and again, by reference
to overarching foreign-policy goals (such as EU membership). Over
the medium term, this issue will decide whether Ukraine - like Poland
in the last ten years - will stick to its marketoriented course even if
governments come and go.

Ukraine's population expects Yushchenko to outline the country's EU
prospects in the near future. The EU, however, has not yet pledged full
membership for Ukraine even though this has been pressed for by
several new member states, e.g. Poland. It cannot be ruled out that
several member states will make their continued support of Turkish
membership dependent on an accession perspective for Ukraine, too.

So far, the EU's action plan foresees facilitating trade integration,
supporting legislative harmonisation, providing loans from the European
Investment Bank (EIB) and quickly granting "market economy status".

The EU action plan will likely give some boost to the economy even
without the hope of full membership, but only a credible prospect of
entry would give Ukraine and its new political leadership the external
reform anchor that it urgently needs for domestic policy reasons. Also,
the stabilisation of investor confidence and the associated massive
inflow of foreign direct investment (FDI) that drove real convergence in
the Central European accession countries over the past ten years will
only materialise quickly with a concrete accession perspective.

If the new government in Kiev achieves clear reform progress, it will be
difficult for the EU to deny Ukraine something that Turkey has already
been granted - candidate status. On a medium-term horizon, Ukraine
could be invited to join the circle of potential candidates for accession.
Prior to that, however, a fundamental political decision must be taken.

The EU must answer the question as to whether it is prepared to
support Ukraine's accession even in case of Russian resistance. For,
Ukraine's membership in the EU would once again markedly change
Europe's geopolitical map.

UKRAINE'S GROWTH OUTLOOK --------

In order to gain an insight into Ukraine's long-term growth outlook, we
have used a method combining scenario technique and empirical
growth theory2. In a first step, stylised future scenarios are drawn up. In
a second step, the performance of key economic indicators is forecast
under the different scenarios. These figures are then used in an
empirical growth estimate in order to calculate potential growth under
the various scenarios.

But estimating potential growth of an economy undergoing
transformation is a difficult endeavour. Complex time-series based
methods - such as DB Research's Formel-G3 - cannot be applied
because the time series available are too short. An alternative is to
identify the determinants of economic growth in a broad cross-section
of countries which is what we opted for. Additionally, we employ an
econometric specification that integrates the institutional environment
as an important factor determining growth.4

In our model, two factors will strongly determine Ukraine's medium-term
growth outlook. For one thing, the investment ratio - as only a
pronounced increase in investment volumes could create a broader
base for growth and reduce the economy's dependence on heavy
industry. For another, the establishment of a framework of marketeconomy
institutions will determine whether the number of company
start-ups will rise and overall productivity increases will be achieved.

Three different scenarios are to shed some light on Ukraine's potential
growth paths based on different assumptions regarding the
development of the investment ratio and the speed of structural
reforms. It is important to note that the following estimates refer to
longterm potential growth. Cyclical and external factors (such as strong
price fluctuations for major export goods) can lead to pronounced
deviations from the estimated figures.

SCENARIO 1 - "Rapid EU integration": this optimistic scenario is
based on the assumption of Ukraine's fast orientation towards the
EU, which in turn would quickly award candidate status to the
country. As a result, the speed of reforms in Ukraine would pick up,
the reform process would be firmly anchored and investors' future
expectations would be stabilised quickly. Massive inflows of foreign
direct investment, the return of flight capital and a speedy increase
in foreign investment activity would send the investment ratio up
from just under 20% to 30% of GDP. It would thus come to roughly
the level reached by the Central European accession candidates at
the end of the 1990s.

Fast institutional reforms would bring the country up to the legal and
political standards of the Central European candidates. Thanks to its
industrial know-how and low wage costs Ukraine would become a
magnet for FDI and a manufacturing powerhouse in the East of Europe.
Under these assumptions, we project average annual growth at over 5%
(or almost 6% on a per capita basis, factoring in the slight decline of the
population).

SCENARIO 2 - "Gradual progress": in this baseline scenario (with
the highest probability) there is gradual progress with reforms in
Ukraine. Even though the clocks will not be turned back in Kiev, the
high hopes of quick EU integration will not be fulfilled. The reform
process advances but without any spectacular achievements. In
particular, reforms of the legal system and the public administration
apparatus turn out to be more time-consuming than in the optimistic
scenario.

Under these circumstances the investment ratio rises more slowly,
to roughly 25% of BIP over the medium term.
Institutional indicators improve less quickly and reach the current
level of the southern European accession countries over the
medium term. Ukraine's growth potential would be slightly below 4%
in this environment.

SCENARIO 3 - "Stop and Go": the pessimistic scenario is based by
and large on the assumption that the trend witnessed over the last
few years will continue. There is a drive towards reform in certain
areas but only a standstill in others. The estimates correspond with
the average of the last five years. Should there be no improvement,
Ukraine's growth rate would remain unchanged at 2.6%. By
comparison: average growth in the years between 1996 and 2004
was 2.9% p.a.

In Scenario 2, the baseline scenario, which we regard as the most
likely, Ukraine would need roughly 20 years to catch up with Hungary's
current income level. Under the optimistic assumptions, this period
would be shortened to just under 15 years. Such projections reveal just
how backward the country is after nearly fifteen years of transformation.

CONCLUSION: WESTERN HOPES AND EASTERN REALITIES

With the "orange revolution", Ukraine has returned to the group of
countries in which sustainable growth is conceivable and actually
possible. It has achieved macroeconomic stabilisation in recent years.
Under the new government, structural reforms can now be tackled with
determination. Yet despite the positive changes that have taken place,
expectations linked to Mr. Yushchenko's presidency must be realistic.

There is no doubt that the economic outlook for Ukraine took a turn for
the better with the victory of the pro-Western democrats in the orange
revolution. The president and the prime minister are determined to push
for the Western integration of the country. However, Ukraine has to start
the reform process more or less from scratch in many areas.

Both domestic and foreign investors still need to be convinced of the
stability of the political and institutional framework. A special difficulty
lies in the fact that the state institutions have been weakened considerably
over the last ten years. The implementation of reforms is far from
guaranteed, even if political resistance can be overcome in the legislative
process.

For the foreseeable future the country will be torn between Western
hopes and Eastern realities. It will take great political skill to maintain
a broad consensus for reform over a number of years. An external anchor
- the prospect of EU accession - would considerably increase the
chances of success for the policy of reform. This is one of the most
important lessons learned from the last fifteen years of transformation in
Eastern Europe. The EU has not yet decided, however, whether it
wants to welcome Ukraine into the European fold. So the road West is
long - but it is open for Ukraine.

ENDNOTES:
1 Mentioned in Oleksandr Tschaly (2005). "Zwischen Bär und Elefant -
Optionen der Ukraine nach den Wahlen". Internationale Politik. January
2005
2 See Beck, Roland and Moritz Schularick (2003). Russia 2010: It's a
Russian bear, not a bull! In Deutsche Bank Research, special issue of
our Current Issues series, April 1, 2003. Frankfurt am Main.
3 See Bergheim, Stefan et al. (2005). Global growth centres 2020 -
Formel-G for 24 economies. In Deutsche Bank Research, Current Issues,
March 23, 2005. Frankfurt am Main.
4 Ali, Abdiweli M. and W. Mark Crain, (2002). Institutional Distortions,
Economic Freedom, and Growth. In Cato Journal, Vol. 21, No. 3 (Winter
2002).
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"THE ACTION UKRAINE REPORT- AUR" - SPONSORS
"Working to Secure & Enhance Ukraine's Democratic Future"

1. THE BLEYZER FOUNDATION, Dr. Edilberto Segura, Chairman;
Victor Gekker, Executive Director, Kyiv, Ukraine; Washington, D.C.,
http://www.bleyzerfoundation.com.
2. KIEV-ATLANTIC GROUP, David and Tamara Sweere, Daniel
Sweere, Kyiv and Myronivka, Ukraine, 380 44 298 7275 in Kyiv,
kau@ukrnet.net
3. ESTRON CORPORATION, Grain Export Terminal Facility &
Oilseed Crushing Plant, Ilvichevsk, Ukraine
4. Law firm UKRAINIAN LEGAL GROUP, Irina Paliashvili,
President; Kiev and Washington, general@rulg.com, www.rulg.com.
5. BAHRIANY FOUNDATION, INC., Dr. Anatol Lysyj, Chairman,
Minneapolis, Minnesota
6. VOLIA SOFTWARE, Software to Fit Your Business, Source your
IT work in Ukraine. Contact: Yuriy Sivitsky, Vice President, Marketing,
Kyiv, Ukraine, yuriy.sivitsky@softline.kiev.ua; Volia Software website:
http://www.volia-software.com/ or Bill Hunter, CEO Volia Software,
Houston, TX 77024; bill.hunter@volia-software.com.
7. ODUM- Association of American Youth of Ukrainian Descent,
Minnesota Chapter, Natalia Yarr, Chairperson
8. UKRAINIAN FEDERATION OF AMERICA (UFA),
Zenia Chernyk, Chairperson; Vera M. Andryczyk, President;
Huntingdon Valley, Pennsylvania
9. UKRAINE-U.S. BUSINESS COUNCIL, Washington, D.C.,
Chairman, Executive Committee of the Board of Directors, E. Morgan
Williams, SigmaBleyzer; Secretary/Treasurer, John Stephens, Cape
Point Capital
10. UKRAINIAN AMERICAN COORDINATING COUNCIL,
(UACC), Ihor Gawdiak, President, Washington, D.C., New York, NY
11. U.S.-UKRAINE FOUNDATION (USUF), Nadia Komarnyckyj
McConnell, President; John Kun, Vice President/COO, Washington,
D.C.; Markian Bilynskyj, VP/Director of Field Operations; Kyiv,
Ukraine. Web: http://www.USUkraine.org
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"THE ACTION UKRAINE REPORT - AUR" is an in-depth, private, non-
profit news and analysis international newsletter, produced as a free
public service by the non-profit www.ArtUkraine.com Information Service
(ARTUIS) and The Action Ukraine Report Monitoring Service The
report is distributed in the public's interesting around the world FREE
of charge using the e-mail address: ArtUkraine.com@starpower.net.
Additional readers are always welcome.

If you would like to read "THE ACTION UKRAINE REPORT- AUR"
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PUBLISHER AND EDITOR - AUR
Mr. E. Morgan Williams, Director, Government Affairs
Washington Office, SigmaBleyzer Private Equity Investment Group
P.O. Box 2607, Washington, D.C. 20013, Tel: 202 437 4707
mwilliams@SigmaBleyzer.com; www.SigmaBleyzer.com
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Director, Ukrainian Federation of America (UFA)
Coordinator, Action Ukraine Coalition (AUC)
Senior Advisor, U.S.-Ukraine Foundation (USUF)
Chairman, Executive Committee, Ukraine-U.S. Business Council
Publisher, Ukraine Information Website, www.ArtUkraine.com
& www.ArtUkraine Information Service (ARTUIS)
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Power Corrupts and Absolute Power Corrupts Absolutely.
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