Many thousands of Ukrainian metallurgists support the course of reform and transformations pursued in our country. However, we feel anxious about the current worsening of the economic situation in the Ukrainian mining and metal sector and possible future

METALLURGISTS ADDRESS TO THE PRESIDENT

METALLURGISTS ADDRESS THE PRESIDENT

Many thousands of Ukrainian metallurgists support the
course of reform and transformations pursued in our country. However, we feel anxious
about the current worsening of the economic situation in the Ukrainian mining and metal
sector and possible future consequences if the present negative trends continue their
development.

Proceeding from the analysis of the current situation at
metal-making enterprises in the fourth quarter of 2000 and the forecast of their
performance for 2001, heads of these enterprises feel the obligation to offer a complex of
measures that are called forth to prevent development of the negative factors, which now
become more powerful thus bringing to naught the positive results.

Mining and metal accounted for over 27% in the country’s
industrial output in 2000. Products made by this sector bring in up to 40% of
hard-currency revenues, significantly contributing to stability of the national currency.

In 2000, physical output of iron ore added 17%, that of
manganese ore 38%, coke 12%, ferroalloys 36%, and rolled metal 16%.

Most of the enterprises have fully paid out the arrears on
wages salaries. They now make timely current payments to the budget, which have nearly
doubled, and gradually redeem the deferred tax liabilities. In 2000, many metallurgical
enterprises were able to secure a stable rate of return, which improved the situation with
their current assets. These mills made money payments for consumed raw materials and
energy and were able to drive the share of their barter transactions from 24% down to 7%
(at some enterprises, even below 3%). It is only today that most of enterprises have
started to pay significant attention to modernization and technical upgrade of the
operating equipment and improvement of the social sphere.

The following factors weightily contributed to the
mentioned improvements:

- A new economic experiment that is currently underway in
the metallurgical sector. It is aimed at creating conditions that would stimulate growth
of output as well as that of budgetary tax revenues. Many enterprises have successfully
achieved these goals.

- Enterprises pursued a reasonable pricing strategy, which
was the primary factor that impeded the price growth throughout the year.

- Usage of the US dollar equivalent in transactions between
Ukrainian resident entities was abolished.

However, beginning from October and, especially, in
December, the domestic market exhibited a stable tendency towards growth of prices for
energy and raw materials. For example, as of December 1, 2000, prices for the following
commodities added on average: natural gas +60%, coking coal +15%, blast-furnace coke +22%,
refractories and a number of ferroalloys +15%, tariffs for electric power +5% to +70%.
(This difference was a result of the situation when not all the enterprises could purchase
electric power on the prepayment terms at reduced tariffs. The reduced tariffs have been
made generally void beginning December. However, some enterprises could not use the
reduced rate beginning November. This is why, they indicated a 70% growth of the energy
tariff, as of December 1). This growth of prices for energy and raw resources
significantly increased the cost of rolled metal, which made some manufacturers’
products noncompetitive as early as in November.

Another, even more significant price upswing is expected in
the first days of the new year. Order No.549 of the Ministry for Fuel and Energy dated
December 12, 2000 recommends new, higher prices for coking coal. Taking into account the
new price, the cost of coking charge has already added 9.5%, although some suppliers have
increased their prices even more than that. An up to 25% price increment is reported by
mining enterprises. Another 30% increase in electric power tariffs has been offered by the
National Energy Resources Committee and the Ministry for Fuel and Energy. It is noteworthy
that in this situation, all the participants – gas suppliers, electric power suppliers,
mining enterprises, and the railway companies – require payments only to be made in
cash.

Notwithstanding the constant growth of prices for energy
and raw materials in 2000, metal-making enterprises practically did not rise the offered
prices for metal. However, owing to low solvency of the domestic market, Ukrainian
consumers account for only an insignificant portion of the total amount of money paid to
metal-making enterprises. Just as before, the lion’s share of revenues comes from
exports. However, beginning September 2000, the global ferrous market has been exhibiting
a decline in demand and prices for flat-rolled steel, billets, slabs, and wire rod (down
30% and more). It is impossible to compensate = the dropped export revenues with increased
sales on the domestic market, because this market is next to extinct owing to the payment
crisis.

Because metallurgical enterprises have to pay wages to
employees and taxes to the budget in the first place, money payments to suppliers of raw
materials and energy will go down.

This is why, an increase in prices for raw and energy
resources will first of all worsen the economic situation in the raw material and energy
sector. By the way, a similar situation was observed back in 1992-1994, when the crisis in
the country’s coal industry and energy sector and in the economy in general began with a
growth of prices for coal and electric power.

It also should be noted that, being the enterprises with
the highest paying capacities, Ukrainian metallurgical mills support a significant part of
the social infrastructure of the towns and even regions where they are located.
Development of many programs aimed at social and economic development of the Ukrainian
regions is based on financial resources of metal-making enterprises. Will the State be
able to finance the social infrastructure and regions’ development if the economic state
of these enterprises worsens thus disabling them from bearing these expenses?

Naturally, Ukrainian machinery building, construction and
other industries should be the domestic consumers of metal products. However, in fact,
nearly all the enterprises of the mentioned industries cannot make payments in cash. In
order to support the domestic market for metal products, favorable economic conditions
must be created for Ukrainian producers, in particular, for machinery manufacturers and
any other enterprises that are potentially capable of making competitive products.

As early as in the first quarter of 2001, the significant
price growth on the markets for energy and raw materials will lead to a rise in the cost
of metal products, which is already high. To make the situation worse, the stable tendency
towards a cutback of prices for exported rolled metal will lead to a drop of the rate of
return and the resulting low competitiveness of Ukrainian-made metal products. Beginning
January 1, not only individual enterprises but the whole metal-making industry may become
unprofitable.

Table 1. The forecast rise of the cost of end
products beginning January 1, 2001*

* Calculations were made without taking into account
the forecast decline of prices on the global market, which will further strengthen the
negative trends in economic performance of Ukrainian metal-making enterprises.

Another problem, which negatively affects the financial
state of export-oriented enterprises, is a long-time delay in reimbursement of VAT
credits. As of January 1, 2000, budget indebtedness for VAT reimbursement totaled UAH 122
mln., as concerns metal-making enterprises, whereas as of January 1, 2001, this figure
went up to UAH 454 mln. (3.7 times up not to take into account the sums accrued in
November and December 2000). For some enterprises, the indebtedness already exceeds 50% of
their average financial monthly turnover and continues growing. However, article 10 of the
Law of Ukraine "On the state budget of Ukraine for the year 2001" provides for
the right of the national tax service to include the reimbursable VAT amount as payment
for a portion of earlier-restructured and deferred VAT debt.

This state of affairs quickly renders the financial system
of metallurgical mills lifeless, and the Ukrainian metal-making is now close to the
critical level of paying capacity, which had been observed in the previous years.

One of the consequences of the current situation may be
curtailed production, after which the State will face not only the urgent social problems
of many thousands of metallurgical workers but also the similar problems in other adjacent
companies, e.g. ore mines, chemical-recovery plants, coking coal mines, and other
enterprises. Most of the companies that provide materials for operation of metallurgical
mills have been able to support themselves so far solely due to the financial means
received from metallurgical enterprises.

The need to increase wages to metallurgical workers is a
no-less important problem today. However, enterprises cannot completely resolve this
problem owing to a number of reasons.

As of December 10, 2000, metal-making mills had the
unpaid-wages debt totaling UAH 51.2 mln., which is a twofold reduction against the January
figure. It is notable that current wages and salaries are now paid on time.

In spite of the constant augmentation of production in 2000
and an improvement of the economic indicators, metallurgical mills cannot make an adequate
raise in wages, because, pursuant to Decree of the President of Ukraine No.958 dated
August 31, 1998, wages cannot be raised until the enterprises’ indebtedness to workers
is 100% cleared. Taking into consideration the fact that the inflation in the country
continues and the living standards are going down, this decree, in some instances, became
a tool for some heads of metal-making enterprises to artificially suspend repayment of
debts and increase in wages.

In addition, the existing high personal income tax rates
negatively affect the situation practically bringing to naught any raise in wages.

In order to avoid the payment crisis and production
lay-off, we deem the following measures necessary:

1. A moratorium effective from January 1, 2001 until July
1, 2001, should be imposed on a growth of prices for resources, which are not to exceed
the following proposed limits (on the condition that 100% payment in cash is made for
these resources):

- natural gas – USD 50 (VAT and transportation costs
included);

- electric power – UAH 0.09 per 1 kWh;

- coking coal – UAH/t 175.

2. Reduced tariffs for gas transit and railway
transportation should be approved on the condition of 100% payment in cash.

3. In cooperation with the State Tax Administration of
Ukraine, the Cabinet of Ministers of Ukraine should resolve the problem of timely VAT
reimbursement to export-oriented enterprises, as is provided for by the Ukrainian
legislation and IMF recommendations.

4. The effect of the Decree of the President of Ukraine
No.958 dated August 31, 1998 should be suspended, as regards prohibition of wages raise
until the full redemption of enterprises’ wage arrears. Enterprises should be empowered
to raise wages, in accordance with the Industry Agreement for 2001-2002.

5. Taking into account Russia’s positive experience, the
rate of personal income tax should be lowered in Ukraine.

6. In order to create the domestic metal market with a high
paying capacity, and with the purpose of lessening dependence of the country’s economy
on the global market, the economic experiment, which is currently underway in the
Ukrainian mining and metal sector, should be expanded to other industries with high rates
of metal consumption, which are potentially capable of making products competitive on the
world markets (for example, enterprises of heavy engineering, shipbuilding, and
metalworking).

7. The Ministry of Economy and the Antimonopoly Committee
should exercise stricter control over the ban on usage of US dollar equivalent on the
domestic markets.

8. Owing to export orientation of the Ukrainian mining and
metal-making enterprises, and with the purpose of prevention of anti-dumping inquiries, a
special department should be established within the Ministry of Economy. This department
should be responsible for rendering methodical, legal, and political assistance to
Ukrainian exporters during anti-dumping inquiries, as well as for forecasting the
situation on world markets in order to warn exporters of possible inquiries.

Signed by the director general of Metallurgprom
Association, heads of 15 metallurgical enterprises and the head of the metallurgists and
miners’ trade-union.