Growth Potential

Ukraine's expected admission to the World Trade Organization presents both new opportunities and challenges to the country's farm sector. Ukraine's rich, well-watered soils, labor force, agricultural history and traditions, transport and industrial infrastructure and the reputation of Ukrainian foods and drinks in neighboring markets could sow the seeds of success for the country's farms - if national and foreign investors see fertile ground for investments. Now the ball is in the court of the Ukrainian government, which has to demonstrate the political will to make the farm sector a field of growth and prosperity.

Death and taxes are inevitable, they say, but add to this the need to eat and drink - the drivers of the production and supply of food. Moreover, a country's farm sector is not only a supplier but also a large consumer of goods, machinery, services, and financial resources. Thus, the vibrancy of the agriculture sector is an important indicator of the health of a country's economy. It is no less than a question of national security for any government to see that a nation has enough food at prices that people can afford to pay.

Ukraine's farming sector has a large potential for development, and promises reasonable profits for farmers and the economy due to the gap between what is currently produced and what could be produced if crop yields and livestock productivity were pushed up to European levels. According to the Ukrainian Ministry of Economy, the grain yield in Ukraine is between 35% and 50% of the average grain yield in more developed countries. Ukraine posted a harvest of 38 million tonnes of grain in 2005, which was hardly a record harvest, and it exported more than 10 million tonnes of grain this marketing year. However, the grain harvest would have almost doubled and grain exports would have quadrupled if Ukrainian farms had been as productive as their counterparts in other nations.

The great potential for Ukrainian livestock breeding can be seen if one compares the data from 1985 with that of 2005. According to the State Statistics Committee of Ukraine, there were about 27 million head of cattle, including 9 million cows in Ukraine in 1985, and about 7 million cattle, including 4 million cows in 2005, 20 million pigs in 1985 and 6.5 million in 2005, 9 million sheep and goats in 1985 and 1.8 million in 2005, 251 million head of poultry in 1985 and 152.8 million in 2005. The statistics committee also says that Ukraine produced about 4 million tonnes of meat and poultry, 23 million tonnes of milk, 17 billion eggs, and 29,000 tonnes of wool in 1985, in comparison with 1.6 million tonnes of meat and poultry, 13.7 million tonnes of milk, 13 billion eggs, and 3,200 tonnes of wool in 2005.

Ukraine inherited their production facilities and its farming sector from the former Soviet Union, the distinctive features of which were low cost energy, command-style economics (as opposed to market economics) and production processes split among the 15 republics of the union. Although the Soviet Union was the largest country in the world in terms of area, it was a large net importer of grain and other farm products from the 1960s on. Many attributed this to the climate, which in most of the Soviet Union was unfavorable to agriculture. However, the total area where the climate was favorable to agriculture exceeded the total area of several European countries, and those areas alone could have supplied more than enough food if productivity had been closer to the actual capacity of the farmlands.

It was the absence of private ownership in agriculture rather than unfavorable climate that prevented growth in he crop yields and more efficiency in the sector. The only possible way for the Soviet government to increase farm production was to put more land under the plough, but by the beginning of the 1980sall the available farmland had been utilized. The Communist Party was forced to examine the issue of the efficiency of its State-owned farms - the kolkhoz and sovkhoz farms - and in 1982 passed a Food Program designed to boost efficiency. The program, however, failed, because for obvious ideological reasons it could not address the core of the problems facing Soviet agriculture – the lack of private ownership of land.

Besides, the scientific resources of the Soviet Union were concentrated in the defense establishment and there were no enough resources left to maintain or boost the efficiency of agriculture by introducing innovations.

MR. IVAN BISIUK THE CHIEF SANITARY INSPECTOR OF UKRAINE DISCUSSES AVIAN FLU AND RESTRICTIONS ON THE MOVEMENT OF MEAT AND DIARY PRODUCTS    Avian flu is a global problem, which challenges not only our country, but also the entire international community.     The disease has been registered in 55 countries across the globe, and in the face of outbreaks around the world we have done, and are doing everything possible not to let the disease break out in Ukraine.     However, regretfully, on December 2, 2005, an avian flu outbreak was confirmed in the Autonomous Republic of Crimea. The same day, a group of veterinary medicine specialists and scientists were sent to Crimea to contain the situation.   On establishing that it was an actual case of bird flu, the chief veterinary inspection informed the International Epizootic Bureau on December 5. The disease was recorded in 25 settlements in Crimea (including 3 poultry farms) across nine administrative districts. A total of 236,000 head of poultry were confiscated and destroyed, including 69,600 birds owned by households.   We fully observed the recommendations of the International Epizootic Bureau while undertaking measures to contain the disease. International experts from the International Epizootic Bureau, the Food and Agriculture Organization of the United Nations (FAO), and the European Union who inspected the outbreak sites in Ukraine confirmed the correctness of our actions.   On March 9, 2006, quarantine restrictions were lifted from the last affected settlement in Crimea.      However, as avian flu remains a serious problem in the world, we are applying a number of measures to prevent further outbreaks.   In order to harmonize avian flu diagnosis procedures with the requirements of European Union directives and to increase their effectiveness a three-tier diagnosis system is being created. Specialized equipment is being supplied to regional labs and poultry disease labs. Screening labs along bird migration corridors and a national reference lab for the diagnosis of bird flu are also being set up.   It is planned that these measures will be financed by grants from the World Bank. International experts, jointly with specialists form the Veterinary Service of Ukraine, are studying the situation in order to endorse a $33 million program related to the problems of avian flu.   The Ukrainian government has allotted financing to compensate farmers for the poultry that was confiscated and destroyed in Crimea. In 2005, the general public received UAH 1.5 million in compensation.   Today, the bird flu situation in Crimea is stable, and there have been no new cases of avian flu on the peninsula. In our opinion, avian flu poses no threat to the resort season in Crimea.   As avian flu remains a serious problem in the world, we are applying a number of effective measures not to allow the disease to break out in Ukraine. This concerns preventive measures, monitoring how poultry is kept and other research and measures. The department of veterinary medicine is not considering a vaccination program against avian flu, as the situation is currently under control. However, Ukraine is working on its own vaccines and is studying imported vaccines.   As the Russian service for veterinary and sanitary supervision of Russia's Agriculture Ministry banned Ukrainian meat and diary imports in Russia on January 20, the Ukrainian government has conducted a series of talks to settle the issue.   Also, the Ukrainian central authorities have asked the Russian executive bodies to cancel restrictions on the import of Ukrainian meat and meat products on the whole or, at least, on imports from companies with certificates from the Russian standards service.    In answer to the negative consequences of the introduction of the ban on Ukrainian meat imports to Russia, the Ukrainian government is working to diversify the export markets for Ukrainian meat and meat products.   Following inspections at Belarusian meat processing companies, Ukraine has excluded some companies from the list of foreign companies permitted to export meat to Ukraine, as these companies did not observe the veterinary and sanitary requirements of Ukraine. In particular, the Belexpomos Company and the Baranovichi meat packing plant are prohibited from exporting their products to Ukraine.

From breadbasket to basket case

When Ukraine obtained independence in 1991 it inherited a farming sector in a far better condition than it is now. In 1990, Ukraine harvested over 51 million tones of grain and produced 4.3 million tones of meat and poultry, as well as about 17 million eggs, 30,000 tones of wool, and 24.5 million tones of milk. Production shrank only slightly in the next two or three years. The cooperative farm companies that started to replace the old kolkhoz and sovkhoz farms operated with high profitability. The average profitability of farm enterprises was 37% in 1990, 54% in 1991, 99% in 1992, 92% in 1993, 46% in 1994, and 10% in 1995. The traditional markets were still open for the Ukrainian farm products and goods in the first years of independence, the quantity and quality of farm machinery was adequate, and the cost of energy and fuel remained low.

But Ukraine's first independent government failed to see the need for urgent and radical reforms in the countryside even though some experts at the time had voiced their concerns as they perceived an impending crisis. The modernization and innovation of the farm sector needed major investment and that could only be obtained through liberal reforms and the establishment of real private ownership of land, with owners gaining the right to buy and sell farmland.

Agriculture reform ended up in limbo for the next four years after the parliamentary elections of 1993, when the communists won a large number of seats in the Ukrainian parliament, the Verkhovna Rada.

As if on cue, the agriculture sector started to move in the wrong direction. In the mid 1990s, the output of most crops, livestock and poultry started to slide. The average profitability indexes of farm entities went into the red during the period of 1996 - 1999.

 The reduction in agricultural output and profitability can be attributed to several factors:

• The general crisis in the Ukrainian economy;

• The parallel crises in former Soviet Union countries that were Ukrainian food export markets;

• The gradual closure of the CIS markets to Ukrainian goods through the introduction of trade barriers, as well as competition between Ukrainian foods and imports from countries outside the former Soviet Union in Ukraine's traditional export markets;

• The reduction in the consumption of foods in Ukraine due to the large-scale emigration, the reduction in the income of the general public, and the withdrawal of 1.5 million Soviet Army troops from Ukraine;

• The appearance of low-cost imports on the Ukrainian market;

• The growth in energy prices and the price of machinery, equipment, fertilizers, and other products;

• Farmers lack of experience in how to operate under market conditions;

• The lack of financial resources to meet the new challenges;

• The lack of an adequate and clear-cut policy of the government and legislative support from parliament.

The turnaround only came with the economic growth seen since 1999, as the growth in the incomes of the population boosted demand for farm products. Growth in revenues to the national budget allowed more subsidies from the State to the farming sector, while the formation of the Ukrainian banking system and the introduction of stable national currency, coupled ongoing reforms, assistance from the international financial organizations, and the first sign of private ownership in the farming sector, sowed the seeds for recovery in Ukrainian agriculture.

The current Ukrainian government is taking steps to facilitate growth in the sector. In February, the Economy Minister at the time, Mr. Arseniy Yatseniuk, said at an investment conference that the government views the development of agriculture as a priority, along with the development of the energy sector, transport, financial sector, industrial sector, and the high-tech sector. He said the Ukrainian agriculture sector was unique, as its products remain competitive on foreign markets - including the Russian market - even though subsidies to the sector are still extremely low.

The 2006 national budget of Ukraine allocated UAH 1.993 billion (USD 390 million) in subsidies to crop growers and cattle farmers. On March 2, 2006 the Cabinet of Ministers endorsed a resolution that estate subsidies of UAH 100 per hectare of land under winter crop cultivation would be provided to farming businesses in 2006.

At the same time, the Ministry of Economy said that the current low productivity of  the  Ukrainian agriculture threatens the competitiveness of its produce on world markets.

Growth in productivity in the sector could be achieved through upgrading and modernization, but this would require significant investment. Former Ukrainian Vice Premier Yuri Melnyk said in late March that between USD 200 million and USD 250 million in investment was pumped into the agriculture sector in 2005 and that foreign countries had invested between USD 300 million and USD 400 million in the sector over the past ten years. However, Ukrainian Agrarian Confederation President Leonid Kozachenko has said that the farming sector of the country needs more than USD 40 billion in investment.

Seeds of investment

Ukraine, which is on the threshold of entry to the World Trade Organization and eyeing the creation of a free trade zone with the European Union, does indeed need such investment - and soon. In order for the economy to grow faster, Ukraine needs access to foreign markets for their agricultural production. Of course, the opening up of markets cuts both ways, and Ukrainian goods may face increased competition from imports from abroad. Nevertheless, continued exclusion from the world's trade club would entail further stagnation and the threat of stunted growth in the future.

There are several possible sources for investment: the government, current owners, domestic and foreign private investors, international financial institutions, domestic and foreign commercial banks, and foreign governments.

The Ukrainian government will of course continue to invest in the sector, but the sum needed is too large for the Ukrainian budget to provide (the entire annual national budget is only half the size of the estimated investment needed) and there are many other urgent projects awaiting funds from the government. As for the current farmers, they will not be financially strong enough to invest significant sums for many years.

Foreign governments cannot be counted on to become large investors in the sector, as they have their own budget constraints at home. However, they could provide the sector with some technical assistance through various projects. One notable exception has come from a Middle Eastern country rich in energy resources, which has proposed to grow crops for itself on Ukraine's rich black soil in exchange for cooperation in the energy sector.

Long-term loans from the Ukrainian commercial banks are currently too expensive for farmers to consider as a source of funding. The government does have a program to pay part of the interest for such loans for farmers, but the budget funds for this are limited. As for foreign investment banks, the Ukrainian Agrarian Confederation on March 31 set the Agency for Investment and Development the goal of attracting investment into the farming sector. The agency has signed a number of memos with large investment banks from Western Europe, Russia, and banks in the Arab world. The memos stipulate that USD 1 billion could be attracted to the sector and up to 25 % of the sum could be transferred to Ukraine this year, according to Ukrainian Agrarian Confederation President Kozachenko.

Regretfully, direct investment from Ukrainian and foreign private companies in crop growing and cattle breeding is difficult at present because of the moratorium on the purchase and sale of farmland by Ukrainian residents, which will be in effect until January 1, 2007, at least. As for foreigners, they have been prohibited from buying farmland, a policy that looks set to continue for the indefinite future.

However, there are other areas in the agriculture sector where investors could earn significant profits. In 2005, the food industry and processing of farm produce increased production by 13.7% over 2004. Companies processing vegetables and fruit increased production by 30%, the production of drinks increased by 24%, and the confectionary industry grew by 11%.

There are several interesting examples of successful foreign investment in the food industry, breweries and distilleries. An international company in the mid 1990s invested USD140 million in a Ukraine brewing company. The money was used to build up capacity, modernize brewing facilities, and introduce new technology. As the consumption of beer was rising rapidly in Ukraine, the company decided to invest in the construction of a new brewery in 2002, which it completed in 2004. The share of the company on the market increased from about 20% to more than 30% in 2005. The company contributed to the national budget about UAH 1.5 billion in 2005 alone.

A Danish company has invested in a Ukrainian distillery. The distillery soon increased its share of the Ukrainian market and now is a large exporter of Ukrainian vodka. As Russia started to introduce new rules on the importing of alcoholic beverages in an effort to protect its domestic procedures, the brewery decided to build a distillery in Russia.

During a round table in May, then Agriculture Minister Okeksandr Baranivskiy said that Danish companies are interested in investing in pig breeding. Denmark also told the Ukrainian Agriculture Ministry through its embassy that the Danish side was interested in purchasing three meat-packing factories in Ukraine.

Ukraine's farm machinery is worn out and requires replacement with modern, fuel-efficient tractors, harvesters, and other machines. Although most farms in Ukraine cannot under current afford to buy these new machines, they have the means to lease them.

In addition, joint production of farm machinery could be launched in Ukraine, in the same way the production of foreign cars has been set up in the country.

Financial services, services related to the introduction of new technologies, and variety of other services - including the wholesale and retail trade have not yet come to the countryside. The introduction of a wide range of services in the farm sector could yield a wide range of investment opportunities and could provide new jobs for rural workers made redundant by the hoped-for improvements in farming efficiency and productivity.

Services related to the maintenance and restoration of the fertility of the land may be the biggest investment opportunity in the near future. The total area of the Ukrainian farmland is close to 42 million hectares, but large areas are facing the threat of soil erosion and degradation. Ukraine's soil has lost 30 % of its humus in the past 30 years. The quantity of humus in the soil has halved in the past 100 years 14% to 7% on average. The situation requires urgent measures from the government and large investments to preserve the nation's main asset - its famous black soil - for future generations.

There are various ways for foreign investors to establish contacts with new partners in Ukraine, including through the Ukrainian government and the Agriculture Ministry. The AGRO international agro-industrial exhibition and far in the village of Chubinske is a great opportunity to share experience for grain growers, cattle breeders, and agriculture science and industry experts, as well as to establish direct ties with new partners. This year alone, 1,200 Ukrainian companies and 300 foreign companies from 30 countries signed up to take part in the exhibition and fair. Last year, 2,000 contracts were signed at the exhibition. Moreover, the fair resulted in the sale of small and medium-size farm equipment with a combined value of UAH 50 million, and the signing of 800 protocols of intent for farming projects. In addition, 18 agreements for dealerships and the opening of offices by European companies in Ukraine were signed. Normally, over 120,000 people visit the exhibition, which takes place once a year and this year, was held in early June.

Roots of recovery

The economic crisis and collapse of production was the price Ukraine had to pay during its transition from a command to market economy. Now, the Ukrainian economy and its one of the most important sectors - the farming sector - looks set to continue seeing steady growth, regardless the political challenges facing the country. But that growth could be significantly boosted if the government takes several urgent steps.

One measure is to introduce clarity on the issue of buying and selling farmland. Uncertainly regarding the moratorium on the sale and purchase of land, which is due to expire on January 1, 2007, does not encourage either domestic or foreign investors.

Given that the government and parliament have already endorsed adequate supporting the moratorium legislation for the sale of farmland, the end of the moratorium may be one of the most important factors allowing rural Ukraine and farm procedures to face the country's future in the WTO environment with optimism.

By allowing the purchase and sale of farmland in a transparent and legal way, a realistic price for land will be set by the resulting market. The question is very important for banks and financial institutions, as the end of the moratorium will mean that the huge potential assets represented by land will start to play a part in financial turnover.

According to various estimates, Ukraine's land assets are worth between UAH220 billion (over USD 40 billion) and UAH 400 billion. It will be easier for Ukrainian farm producers to receive less expensive long-term credits if they can use farmland as collateral, which will give a huge boost to the sector. Moreover, the experience of the post-socialist countries of Eastern and Central Europe shows that the price of land could rise tenfold if Ukraine successfully integrates into the wider European economy. Farmland could become an asset able  attract large and long-term investment at lower rates, as credits backed by land pose lower risks to banks.

Given that such reforms are carried out in the sector, Ukrainian agriculture is potentially capable of doubling its output within a decade or two, making it, along with the steel and heavy industries, another powerful locomotive pushing the Ukrainian economy forward.

A wise government normally helps a country become better and better at what the country already does well: Ukraine has always been a major agricultural producer and an important exporter of foods and drink in this part of the world, and there are no objective reasons why it can not grow further to become one of the largest players on the world market for farm produce.

The only question is: will the Ukrainian government, recognizing this, do the groundwork to allow resurgence on Ukraine's farms, and let the country reap the benefits of a newly flourishing agriculture sector?

By Andrei Udovik

Commerce

July / August 2006

Page 20 - 26