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Dashed Ikea Dreams Show Decades Lost to Bribery in Ukraine

Almost half of Ukrainians say they desire Ikea products more than any other global brand, yet the largest home-furnishings retailer hasn’t been able to crack the market in a decade of trying. The reason: it won’t pay a bribe.

As Prime Minister Arseniy Yatsenyuk’s government rushes to fend off Russia’s expansion and raise the $35 billion it says it needs to avoid default, the country of 45 million faces the more basic problem of rampant graft that no leader has been able to tackle in 23 years of independence.

Stuck between the European Union and its former imperial master Russia, Ukraine has emerged as the most corrupt country on the continent, according to Transparency International. That and “incompetent” leadership are the reason a nation endowed with most of the ingredients needed to create a vibrant economy fell so far behind its peers, according to analysts including Erik Nielsen, chief global economist at UniCredit SpA in London.

“Even before this latest crisis, Ukraine was a mess beyond description,” Nielsen said in a research note. Successive governments “must take collective responsibility for what has been one of the worst-managed countries in modern history,” Nielsen said, adding that many officials and their family members “became immensely wealthy along the way.”

Case in point is Oleksandr Yanukovych, 40, son of deposed President Viktor Yanukovych. The younger Yanukovych, who’s in hiding after his father fled to Russia, went from being a dentist to a businessman with a net worth of $510 million after his father came to power in 2010, according to Forbes Ukraine.

‘Empty, Robbed’

Yatsenyuk told lawmakers in Kiev last month that Yanukovych and his allies had moved $70 billion into offshore accounts, leaving state coffers “empty and robbed.” That’s an amount equal to about 40 percent of gross domestic product. Swiss prosecutors opened a probe into Yanukovych and his son last month for possible “aggravated money laundering” and raided a company registered to the younger Yanukovych.

Compared with Ukraine, Russia, the most corrupt major economy, “is whiter than snow,” Lennart Dahlgren, the retired Ikea executive who spearheaded the company’s entry into Russia, said in an interview with Russkiy Reporter magazine in 2010. Dahlgren said he met with every Ukrainian president and prime minister since 2004 and all of them said they wanted to help Ikea enter the market.

“But we weren’t able to make a deal because Ikea’s system didn’t have any money for bribes,” Dahlgren told the magazine.

Left Behind

After the Soviet Union collapsed in 1991, most former Warsaw Pact nations, including Ukraine and its neighbors Poland and Russia, had GDP per capita of about $5,000, adjusted for purchasing power, according to UniCredit. While Poland and Russia have more than quadrupled their wealth since, Ukraine’s has risen to just $7,000.

The poorest EU states, Bulgaria and Romania, and even authoritarian Belarus are all now twice as rich as Ukraine, where total output is about the same as New Zealand, a country of 4.4 million people.

The country’s new leadership, in office since Yanukovych’s ouster in an uprising last month that left more than 100 dead, has the immediate task of securing a financial lifeline.

Whoever wins the presidency in May will face longer-term challenges such as cleaning up the courts and putting in place checks and balances that will help eradicate corruption and attract the likes of Ikea, according to Lilit Gevorgyan, senior analyst at IHS Global Insight in London.

No Time

“A consistent policy of building institutions is the only way out,” Gevorgyan said by e-mail. “The byproduct of the lack of these institutions has been corruption, poor protection of business rights and overall a weak business environment. The trouble is that it takes time, which is something Ukraine does not have. The IMF can wire loans but not institutions.”

The country has yet to recover from 2009, when output in current dollars plunged a record 35 percent from its $180 billion peak the year before, World Bank data show. The government expects GDP to shrink another 3 percent this year in real terms, as it cuts spending, begins overhauling state companies and Russia imposes trade restrictions.

Yatsenyuk began his premiership pledging to implement unpopular measures, shunned by previous administrations, to obtain emergency funding and avert default, describing his task as a “kamikaze” mission. The IMF has urged Ukraine for years to allow a flexible exchange rate, reduce the budget deficit and raise household gas prices to phase out subsidies it estimates equal 7.5 percent of the economy.

Bankruptcy’s Edge

So far, he’s been successful, striking a deal with the IMF last week to unlock $27 billion of international support, including a two-year loan of $14 billion to $18 billion from the Washington-based lender. The IMF’s board must still sign off on the package, Ukraine’s third since 2008, which will probably happen in April, the IMF said in an e-mailed statement.

“The country is on the edge of economic and financial bankruptcy,” Yatsenyuk said in Kiev before lawmakers approved draft legislation prepared as part of the IMF deal. “This package of laws is very unpopular, very difficult, very tough.”

Securing the IMF package and committing to overhauling the economy was key to unlocking further aid pledged by the U.S. and the EU. The talks concluded a week later than planned, showing “the scale of the challenges Kiev is facing,” Gevorgyan said. IMF-endorsed austerity campaigns during the euro debt crisis fueled protests and toppled some governments, including in Greece and Spain.

Putin ‘Depression’

A more immediate threat to the economy, though, is Russian President Vladimir Putin, who’s annexed Crimea and amassed troops along Ukraine’s border, Alexander Valchyshen, head of research at Investment Capital Ukraine, said by phone from Kiev.

Not knowing what Putin will do next may trigger a “depression” as businesses and consumers curtail output and consumption, Valchyshen said. With about 70 percent of the $176 billion economy coming from household spending and only a fifth from fixed investment, the country desperately needs foreign capital and Putin’s land grab is making that harder, he said.

“Catching up with Bulgaria and Romania would be easy, Ukraine just needs a political anchor,” Valchyshen said. “The promise of EU membership should be clearly stated from the EU and this would be a very strong anchor for the economy. Otherwise, Ukraine will remain the same as in the last couple of decades -- a backyard of the Kremlin.”

Russian Cash

Ukraine’s foreign-currency reserves fell to $15.5 billion in February, the lowest in eight years. That compares with about $104 billion in Poland and $487 billion in Russia. The hryvnia weakened 3.3 percent to 11.3750 per dollar at 8 p.m. local time, pushing this year’s decline to 28 percent, the most among more than 170 currencies tracked by Bloomberg.

The price of the government’s Eurobond due in June rose 0.2 percent today to 97.92 percent of face value, corresponding to a yield of 20 percent, the lowest since Feb. 11. The yield has dropped 36 percentage points since surging to 56 percent on March 12 as Russia prepared to annex Crimea, according to data compiled by Bloomberg. The yield was 5.3 percent on Jan. 16.

The road to revolution in Ukraine, which has endured two recessions since 2008, started in Kiev in November, when Yanukovych pulled out of a free-trade deal with the EU, opting instead for $15 billion of Russian aid and cheaper gas. The ousted leader also pursued closer ties with Putin’s customs union with Kazakhstan and Belarus.

Orange Revolution

If Ukraine’s recent history is a guide, the change of leadership won’t guarantee a change of course. Hopes that the previous upheaval, the Orange Revolution that prevented Yanukovych from coming to power after a rigged vote in 2004, would usher in an economic overhaul were dashed as the camps of President Viktor Yushchenko and Prime Minister Yulia Tymoshenko split, paving the way for Yanukovych’s comeback.

Under Leonid Kuchma, a former Communist leader who came to power in 1994 vowing to restore Russia ties, the government was isolated by the EU and the U.S. for selling assets to loyalists and thwarting efforts to develop a free market.

“Yanukovych won the 2010 election more or less fairly because his allegedly more Western-leaning opponents, first of all, spent so much time fighting between themselves, and secondly, presided themselves over so much poor governance and corruption,” Ian Bond, director of foreign policy at the Centre for European Reform in London, said by phone.

Black Earth

Still, the next government has “tremendous” assets it can leverage to turn things around, said Valchyshen of Investment Capital Ukraine.

With the right changes, growth may reach 5 percent a year, mainly through investment in agriculture, the industry with the biggest potential, and information technology, where the country’s highly educated labor force gives it an advantage, according to Valchyshen.

Ukraine sits on some of the most fertile soil in the world, the so-called black earth region that makes it the largest sunflower oil producer, third-largest corn exporter and sixth-biggest wheat exporter. Cargill Inc., the largest U.S. agriculture company, employs more than 600 people in Ukraine and predicts the country will increase grain output by 4 percent to 5 percent a year as farming methods improve.

Heavy industry is concentrated in the predominantly Russian-speaking east, a legacy of Soviet times. Ukraine is among the world’s top 10 iron and steel producers and is rich in manganese, an element used in stainless steel.

Soviet Model

As a result, it makes everything from gas turbines and buses to civilian aircraft and military helicopters. It was the fourth-biggest arms supplier in 2012, exporting $1.34 billion of weapons, according to the Stockholm International Peace Research Institute. Recent orders include armored vehicles for Indonesia and the upgrade of MiG fighter jets for Croatia.

The economy remains dependent on Cold War industries because it moved away from communism by freeing prices and trade and selling state assets without building the institutions crucial to running a market economy, according to Bond of the Centre for European Reform.

That allowed graft to flourish and left the economy open to capture by Soviet-style industrial groups, which gave rise to the oligarchs, Bond said. It also spawned a dual gas-pricing system that the IMF is trying to end, through which favored companies buy fuel at subsidized rates meant for households, a practice that every government in Kiev has taken advantage of at the expense of the poor, Bond said.

Ikea ‘Symbol’

The investment climate is also poisoned by the practice of “corporate raiding” or hostile takeovers aided by corrupt courts, said Anton Usov, an adviser in Kiev to the European Bank for Reconstruction and Development, which was set up to help former communist countries adapt to capitalism.

EBRD clients often complain about “excessive pressure,” with endless safety, tax and other inspections, Usov said. It’s not uncommon for tax inspectors to demand payment from companies in advance for future financial years, Usov said. ‘Corruption is plaguing the economy and it’s one of the most important things for the new authorities to look at.’’

Yatsenyuk’s government is in the process of creating an anti-corruption task force and has opened several high-profile probes. Police raided offices of state energy company NAK Naftogaz Ukrainy as part of an investigation into $4 billion of missing funds. Investigators said they’re also probing former Agriculture Ministry officials for possible theft.

That may all change, though, depending on who emerges as president in May. Until then, foreign investors such as Ikea will probably stay on the sidelines to see how events develop. The Swedish company first planned to open a store in Kiev, then switched to Odessa before shelving the idea altogether.

Presidential candidate Petro Poroshenko, a chocolate-manufacturing tycoon who’s leading in opinion polls, has called Ikea’s experience a “symbol” of what’s wrong with the country.

“When Ikea is not allowed to enter the market, it is not Ikea that suffers, it is Ukraine’s image that suffers,”Poroshenko said in an interview in 2012, when he was economy minister.

(Updates with hryvnia rate in 22nd paragraph. For more on the conflict in Ukraine, go to EXT2.)