A Long Night Is Coming To An End

For S.C. Johnson & Son Inc., a Racine (Wis.) maker of cleaning products, the five years it has spent setting up in Ukraine have been a very tough haul. After the 1991 Soviet collapse, the new nation plunged toward economic chaos, with inflation soaring as high as 90% monthly and the currency falling to less than 1% of its previous value in dollar terms. Johnson officials say they prayed for the day they would see some return on the $10 million they put into their Kiev factory.

Now, the prayers are paying off. After years of delays and wrong turns, reform in Ukraine is finally on track. Led by President Leonid D. Kuchma, who took office last July, Ukraine has embarked on a program to turn its economy around and attract foreign investment. Investor interest--and S.C. Johnson's sales--are picking up. Says Franck E. Benhamou, S.C. Johnson general manager: "I have always tried to be an optimist about Ukraine, but at last I have some reasons for it."

Among the key reasons is that Kuchma, 57, has slashed inflation from a monthly rate of 72% last November to 6% today. He has also stabilized the currency, liberalized foreign trade, and cut state subsidies. He still has a long way to go on privatization and has only begun to stem indebtedness in the energy sector. But he has restored order to the economy. And attracting President Clinton to visit Kiev in May was a diplomatic breakthrough that could generate new U.S. interest in Ukraine.

To understand how far reforms have come, take a stroll down Deribasov Street, the main thoroughfare in Odessa, a merchant city in czarist times. A year ago, Deribasov was bare, with almost nothing in its state-owned shops. Now, entrepreneurs sell everything from Nike sportswear to Italian designer dresses in stores they leased or set up in converted cellars. Local executives sit in new sidewalk cafes, chatting on cellular telephones.

IDENTITY CRISIS. Nor has progress been limited to the economy. Kuchma has also begun to resolve Ukraine's national-identity crisis. Since independence, strident Ukrainian nationalists and the large Russian ethnic minority have clashed over issues ranging from whether Russian or Ukrainian should be the national language to secessionist pressures in the all-Russian-speaking Crimea. Nationalists expected Kuchma, who once ran a Soviet ballistic-missile manufacturer, to bow to the Kremlin.

But the President has stunned critics by learning Ukrainian well enough to give speeches and by standing up to the Russians on the Crimea, home of the Black Sea Fleet. Such realpolitik paid off on June 9, when Kuchma and Russian President Boris Yeltsin agreed to a 50-50 split of the fleet's 300 ships. Russia will keep a naval base at Sevastopol in the Crimea, and Ukraine may sell some vessels back to Russia to lessen its energy debt. All this puts Ukraine in its strongest position yet to play a key role in Eastern Europe.

From the beginning, Kuchma's reforms have been masterminded by Viktor Pynzenyk, 41, a free-market economist who was Kuchma's deputy in 1993, when Kuchma served an ill-fated stint as Prime Minister under President Leonid M. Kravchuk. Both Kuchma and Pynzenyk resigned when it became clear there was no chance of reform under the former communist.

When Kuchma succeeded Kravchuk last year, he reappointed Pynzenyk. After launching his policy of slashing subsidies and balancing the budget, he eliminated artificial fixed exchange rates and allowed the rate of the Ukrainian karbovanetz to be set on a market basis by daily currency auctions. He also turned the corporate tax, based on total sales, into a profits tax, cutting the burden on foreign investors.

Such measures have impressed international financiers. Last year, the International Monetary Fund (IMF) lent Ukraine $370 million and has started handing over an additional $1.8 billion. The World Bank has promised $600 million this year for infrastructure improvements, while Washington may pony up $500 million in credit lines and investment guarantees through the Export-Import Bank and the Overseas Private Investment Corp.

BIG HOLE. What worries Western aid officials is that pressure from suffering state enterprises may undermine Kuchma's progress. Says Graeme Justice, IMF representative in Kiev: "Ukraine has a reform program in place. But it has to go on and establish a track record."

One big hole in the reform program so far is privatization of state properties. Ukraine is far behind neighboring Russia and Poland. In Kiev, for example, only about 10% of stores are in private hands. And even though Ukraine established an industrial sell-off program similar to Russia's in 1992--distributing vouchers to the public--the planned privatization of some 8,000 large and midsize businesses has hardly begun.

The reason: The parliament has prevented the government from putting valuable properties on the block. State factory managers also bitterly oppose sell-offs. As a result, only one-third of Ukraine's eligible population bothered to pick up their vouchers.

The lack of progress on privatization slows down foreign investors. For example, Kraft Jacobs Suchard, a division of Philip Morris Cos., recently bought a chocolate factory in eastern Ukraine, promising to invest $25 million. But it can't find a distributor. The state-owned distribution system, which lives on government handouts, doesn't want the job--and there are few private wholesalers. Says Herbert Hauswirth, Kraft's manager in Eastern Europe: "I don't know how to interest merchandisers."

Another key test for Kuchma is Ukraine's energy mess. After Russia, Ukraine is the most industrialized,

energy-dependent republic in the former Soviet Union. It relies upon Russia and Turkmenistan for almost 100% of its oil and natural gas. But Ukraine has been unable to pay its bills and owes Russia $2.5 billion for fuel alone.

No longer content to subsidize its neighbor, Russia has hiked prices of energy exports to Ukraine almost to world levels. Ukraine recently signed a 12-year rescheduling deal with Russian gas monopoly Gazprom on its $1.8 billion gas debt. And Kiev has rolled over $800 million of its gas debt from Turkmenistan.

KICK-START. But the hard part is ahead. Ukraine still needs to cut back consumption and create a market-driven system that pays for itself. Although the government has jacked up domestic energy prices to world levels, many factories have stopped paying their bills. In response, the government has cut back energy supplies to 10,000 enterprises in arrears.

The government's long-term hope is that foreign investment will make for more efficient energy use. The World Bank has already provided a $114 million loan to refurbish hydroelectric power stations. And ABB Asea Brown Boveri (Holding) Ltd. announced a consortium to build a $400 million gas-fired power plant near Chernobyl, which will be closed with help from the Group of Seven nations. In turn, energy reform could kick-start much of the Ukrainian economy.

While it's too early for Kuchma's reforms to have attracted many new investors, some pioneers are expanding existing businesses. AT&T is boosting its investment in Utel, a Ukrainian phone system. Alliant Techsystems of Hastings, Minn., has a $16 million loan from the Overseas Private Investment Corp. (OPIC) to dispose of leftover Soviet munitions and export nonexplosive parts.

Owing to a money crunch, Ukrainian imports from the U.S. have dropped sharply. But exports to the U.S., notably of steel, ball bearings, and metal pipe, have doubled in the past year. Kuchma is asking the U.S. and Europe to lift trade barriers and reconsider scores of antidumping actions filed against Ukrainian exports before prices were freed.

For Kuchma, as he starts his second year as President, the challenge is to enhance his reforms while balancing the interests of nationalists, ethnic Russians, and his parliament all at once. If he succeeds, he'll not only open the rich market of 52 million people but solidify Ukraine's role as Eastern Europe's biggest new market democracy.

The Turnaround in Ukraine


-- Cut inflation from 72% to 6% monthly

-- Slashed state subsidies

-- Rescheduled vast Russian energy debt

-- Pushed tight budget through parliament

-- Improved foreign investment climate

-- Get privatization moving

-- Collect domestic energy debt

-- Resolve tensions splitting nationalists and Russians

-- Fight off a backward parliament

-- Persuade West to drop trade barriers