Document of

The World Bank

FOR OFFICIAL USE ONLY

Report No. P-6949-UA

REPORT AND RECOMMENDATION

OF THE

PRESIDENT OF THE

INTERNATIONAL BANK FOR

RECONSTRUCTION AND DEVELOPMENT

TO THE

EXECUTIVE DIRECTORS

ON A

PROPOSED AGRICULTURE SECTOR ADJUSTMENT LOAN

IN AN AMOUNT EQUIVALENT TO US$300 MILLION

TO

UKRAINE

September 13, 1996

This document has a restricted distribution and may be used by recipients only in the performance oftheir official duties. Its contents may not otherwise be disclosed without World Bank authorization.

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CURRENCY EQUIVALENTS

Currency unit: Hryvnia (Hrv)'

Exchange rates: Hrv per U.S. dollarSeptember 2, 1996 1.76 Hrv = US$1

August 22, 1996 177,500 Krb = US$1November 1, 1995 181,000 Krb = US$1

Weights and MeasuresMetric system

FIscAL YEARJanuary 1 to December 31

Abbreviations and Acronyms

ADT Agribusiness Development TeamAIS Agro-Industrial SectorAMC Anti-Monopoly CommitteeASAP Agricultural Sector Assistance ProgramCPI Consumer Price IndexEBRD European Bank for Reconstruction and DevelopmentEDAL Enterprise Development Adjustment LoanEU European UnionFSU Former Soviet UnionGNP Gross National ProductGOU Government of UkraineMFER Ministry of Foreign Economic RelationsMOAF Ministry of Agriculture and FoodMOE Ministry of EconomyMOF Ministry of FinanceNARD National Agency for Reconstruction and DevelopmentPGF Pre-Export Guarantee FacilityPHRD Policy and Human Resources DevelopmentSCLR State Committee for Land ResourcesSPF State Property FundSTF Systemic Transformation FacilityTACIS Technical Assistance for the Confederation of Independent StatesUSAID United States Agency for International DevelopmentWTO World Trade Organization

1/ On September 2, 1996, Ukraine introduced its new currency, the Hryvnia. Its former currency the Karbovanets (Krb) is being exchaged fir the Hryvnia aIOO,OO Krb - I Hry.

UKRAINE FOR OFFICIAL USE ONLYAGRICULTURAL SECTORAL ADJUSTMENT LoAN

TABLE OF CONTENTS

LOAN AND PROJECT SUMMARY.1i-iii

INTRODUCTION.1

I. BACKGROUND.1The Macroeconomic Climate.1The Agricultural Sector ................................... 3The Agricultural Sectoral Adjustment Loan in the Bank's Assistance Strategy . . 5

II. THE GOVERNMENT'S AGRICULTURAL REFORM PROGRAM .................. 6Agricultural Reform Goals Set By Ukraine and Measures Implemented ... ... 6Further Reform Steps under the Agricultural Sectoral Adjustment Loan ... ... 7Other Supporting Projects and Support From Bilateral Donors ... ....... 12

II THE PROPOSED LOAN ...... ..... ........................... 13Rationale for Bank Involvement ............................. 13Project Objectives and Description ........................... 13Conditions for Appraisal, Negotiations, and Second Tranche ... ........ 14Loan Administration and Tranching .......................... 18Procurement ......... . 18Disbursements ......... 18Reporting, Accounting, and Auditing .18Monitoring Arrangements ................................ 19Environmental Aspects .19Benefits and Risks .20Recommendation .20

ANNEXES1. Letter to James Wolfensohn from Roman Shpek .1

Attachment - Memorandum of Agricultural Reform Policies. 32. Matrix of Agricultural Reform Policies. 63. Timetable of Key Processing Events .......................... 114. Status of Bank Group Operations .......................... 125. Terms of Reference for Supporting Technical Assistance and Training ... .. 146. Summary of Ukraine Report: Agricultural Trade and Trade Policy ... ..... 187. Summary of Land Reform and Farm Restructuring in Ukraine ... ....... 248. Summary of Ukraine: The Agricultural Sector in Transition ............ 319. Ukraine at a glance .................................... 35

This report is based on the findings of pre-appraisal missions in May-September 1995 and February-April, 1996, whichincluded Mark R. Lundell (Task-Manager), Hans Binswanger (Agricultural Policy Advisor), Csaba Csaki (Agricultural Adviser), and lainShuker (Agricultural Economist). The proposed project was identified by a Bank mission in June 1994. Project preparation was carriedout a Bank mission in January/February 1995 led by the Task Manager. Peer Reviewers included Gottfried Ablasser and Gershon Feder.The Division Chief is Geoffrey Fox and the Department Director is Basil Kavalsky.

This document has a restricted distribution and may be used by recipients only in the performance of theirofficial duties. Its contents may not otherwise be disclosed wiLhout World Bank authorization.

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UKRMNE

AGRICULTURAL SECTORAL ADJUSTMENT LOAN

LOAN AND PROJECT SUTMMARY

Borrower: Ukraine

Executing Agencies: Ministry of Agricuiture and Food and Ministry of Finance

Beneficiaries: Primary agricultural enterprises, individual farms, and agricultural inputsupply, output marketing, and processing firms

Loan Amount: US $300.0 million equivalent

Terms: Standard interest rate for LIBOR-based US dollar single currency loans,with 17 years maturity including five years of grace.

Commitment Fee: 0.75 percent on undisbursed credit balances, beginning 60 days aftersigning, less any waiver

Objectives: The objective of the Loan is to support the growth of a market-basedagricultural system as described in the Government of Ukraine'sMemorandum of Agricultural Reform Policies. In particular, the Loanwould support instituting agricultural and trade reforms aimed atincreasing market competition and encouraging private ownership andinvestment in land and other productive assets. It would also provideshort term balance-of-payments support for financing critical imports. Itis expected that the policy reform program that the Loan supports wouldimprove agricultural terms of trade, increase input flows to farms, expandagricultural exports, and increase rural income and employment.

Description: The proposed Loan would provide balance-of-payments support (US$ 300million) for Ukraine's import needs, thereby increasing the availability offoreign exchange, interalia, for crucial imported inputs.

Benefits: The Loan's major benefits would be the development of markets toreplace the past administrative system and to increase rural welfare andreinvestable profits for future capital formation. By promoting land refornand farn restructuring, a sector of viable farm management units wouldbe developed. By reducing state procurements and restrictions onagricultural exports, more farm output would flow through commercialchannels to export markets and domestic markets for higher qualityproducts. These markets will offer higher real prices than the State haspaid in the past, thereby raising farm-level income and output. Bypromoting privatization and demonopolization of existing agribusinessfirms, the Loan would encourage market entry to take advantage of theseincreased opportunities.

-. 1.-

Risks: The primary risk associated with this Loan is the possibility of policyslippage due to political opposition to specific agricultural policy reforms.This risk has been minimized first by extensive discussion with theGovernment of Ukraine based on a review, analysis, and dissemination ofthe main benefits of policy reform for Ukrainian agriculture. This risk ofpolicy slippage has also been partially mitigated by policy benefits in theGovernment's reform program which promote the interests of a widescope of political actors: the farm sector, the industrial lobby, economy-wide reformers, rural poor, and those responsible for macro-economicstability.

The other main risk is that, owing to the lack of working capital at thefarm level, the recovery of the agricultural sector will be too slow tomaintain a policy regime of limited distortionary interventions. This riskwould be partially mitigated by creating a tandem operation to the AgSECAL, the Pre-Export Guarantee Facility, to increase the flow of financeand working capital inputs to the agricultural sector. As free-marketagricultural and trade policies are maintained in Ukraine, foreigninvestment will be able to provide a large share of the capital needed tofuel recovery of the agricultural sector.

Environment: In accordance with the Bank's Operational Directive on EnvironmentalAssessment (OS 4.00, Annex A), the proposed operation has been placedin Category C and would therefore not require an environmentalassessment.

Est. Project Cost: US $ 300.0 million

Financing Plan: IBRD US$ 300.0 millionTotal US$ 300.0 million

Est. Cumulative Disbursements: FY97 US$ 300.0 million

Closing Date: December 31, 1997

Poverty Categorv: N.A.

Project I.D. Number: PA 9113

Economic Rate of Return: N.A.

Vice President: Johannes F. Linn, ECADirector: Basil G. Kavalsky, EC4Division Chief: Geoffrey B. Fox, EC4NRStaff: Mark Lundell, EC4NR

REPORT AND RECOMMENDATION OF THE PRESIDENTOF THE IBRD TO THE EXECUTIVE DIRECTORS

ON A PROPOSED AGRICULTURE SECTOR ADJUSTMENT LOANTO UKRAINE

INTRODUCTION

1. I submit for your approval the following memorandum and recommendation on aproposed Agriculture Sector Adjustment Loan to Ukraine for the equivalent of US$ 300 million. Theloan would be at the Bank's standard variable interest rate with a maturity of seventeen years, includingfive years of grace.

2. The Agriculture Sector Adjustment Loan (Ag SECAL) would provide balance-of-payments support (US$ 300 million). The aim of the proposed project is to introduce key agriculturalpolicy reforms which will remove the main systemic impediments to a market-oriented agricultural sectorin Ukraine. The focus is placed on policy reforms because the residual policies of the pre-reform systemare the main obstacles to the recovery of Ukrainian agriculture. Once in place, the new policies wouldprovide a framework under which capital investments, both public and private, and improved access toinput and output markets can play a role in raising the efficiency of the sector.

3. The loan would facilitate implementation of the key elements of the Government'sagricultural sector adjustment program and would complement policy reforms initiated in late 1994 anddeepened under the Government's Rehabilitation Program supported by the Bank's Rehabilitation Loan(Loan No. 3831-UA approved by the Board in December 1994). The Rehabilitation Program progressedsatisfactorily toward achievement of the liberalization of prices and foreign trade, reduction of statepurchases, and the acceleration of privatization. Key steps still need to be taken under the agriculturalreformn program supported by the Ag SECAL to promote intermediary activities and market formation(including markets for land and other real estate), to increase the ease and attraction of forming privatefarms, and to accelerate enterprise restructuring through privatization and demonopolization. The mainimpact of these policy changes would be to increase the growth of exportable production (for which thereis strong import demand in the FSU countries), thereby raising agricultural income and rural welfare.

I. BACKGROUND

The Macroeconomic Climate

4. Economic conditions in Ukraine worsened dramatically after independence from theSoviet Union in 1991 - GDP per capita declined from US$ 2,340 in 1991 to US$ 1,572 per annum in1994. The cumulative decline in output of 50 percent from 1990 through 1994 was accompanied byhyperinflation during much of this period. Particularly hard hit were the energy intensive industries andthose facing shrinking markets for their products such as defense-related activities. In 1991, industryaccounted for 41 percent of GDP, with a large production base in metallurgy, machine building, miningand steelmaking. Defence related production accounted for approximately 25% of the industrial base.Agriculture constituted 26 percent of GDP, reflecting Ukraine's position as the "bread basket" of theUSSR.

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5. The external trade of Ukraine, of which three quarters was with the FSU, came underserious strain as the transactions mechanisms between countries collapsed and the prices of importedgoods from the FSU rose to world levels after 1992. This was particularly severe for energy imports,where Ukraine depends on imports from Russia and Turkmenistan for 50 percent of its energy needs.Despite a large drop in the volume of energy imported, the share in value terms of gas and oil importsincreased from 12 percent of FSU imports in 1991 to 50 percent in 1994. At the same time exportvolumes declined, with an estimated fall of 25-30 percent from 1992 to 1994. Ukraine's total externaldebt reached $7.2 billion by the end of 1994, from a zero base in 1991.

6. In October 1994, the government, under the leadership of a new President, adopted astabilization and structural adjustment program developed with the assistance of the IMF and the WorldBank. This program focused on immediate measures to reduce the budget deficit to 3.3 percent of GDPin 1995, limit credit expansion, strengthen the external debt position, and reach a monthly inflation targetof 1 percent per month. Much has been achieved since October 1994. Fiscal and monetary policies weretightened considerably and inflation sharply reduced from 20 percent per month in early 1995 to around5 percent during April-August, 1995. Foreign exchange restrictions were largely abolished and anti-export incentives diminished. Many key public sector prices were adjusted to increase the share of costsrecovered, and most domestic prices decontrolled, reducing government subsidy payments.

7. In the second half of 1995, however, there were slippages in implementation of both thestabilization and structural reform programs. The GOU renewed various forms of financial support toenterprises and overruns in government budget expenditures occurred. Although the general governmentbudget cash deficit was only 0.75 percentage points (of GDP) higher than programmed, banking .systemcredit exceeded programmed levels by a considerable margin, and external payment arrears occurred.In early 1996, the GOU renewed its commitment to stabilization in the following ways: settling most ofthe external payment arrears, tightening monetary policy, and raising communal service tariffs, publictransportation fares, and household energy prices to cover 60 percent of costs. This paved the way toreaching agreement with an IMF mission in April 1996 on a re-phasing of the Standby Arrangement(SBA), subsequently approved by the Fund's Board on May 10, 1996. Under the new program, fiscalpolicy has been tightened to prevent the cash deficit from exceeding the 1996 target of 3.5 percent ofGDP. Monetary policy is being brought under tighter control in order to reduce inflation to 1-2 percenta month by the end of the year and to increase gross international reserves by about US$600 million.An IMF mission in August 1996 found that the program was on track: monthly inflation has remainedlow (0.1 percent in June and July) and all end-July performance criteria were met. The introduction ofUkraine's new currency, the hryvnia, was initiated on September 2, 1996.

8. Another major concern is the pace of structural reform and the performance of the realeconomy. The pace of large and medium enterprise privatization was slower than planned in 1995, withonly 13 percent of the privatization target being met. Similarly, the pace of privatization in agriculturehas also been slow with only 1.5 percent of land currently in the hands of private farmers. However,the pace of small scale privatization picked up significantly in the last few months of 1995, and large andmedium enterprise privatization has accelerated significantly in 1996. Another encouraging sign is therapid growth of the informal private sector. While official statistics indicate that the formal private sectoraccounts for only 10 percent of GDP, unofficial estimates are that the private sector, including theinformal sector, could be contributing as much as 45 percent of GDP.

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9. Structural reform measures for the next few years will continue to promote private sectordevelopment by focusing on the following issues: (i) improvement of the competitive, regulatory and legalframework; (ii) reduction of state interventions that inhibit private sector development; (iii) transformationof state enterprises into commercial entities; and (iv) hardening the budget constraint on state ownedenterprises. Together, the GOU's policy reforms supported by the Enterprise Development AdjustmentLoan (EDAL, scheduled for Board presentation in June 1996) and those of the Agriculture SectorAdjustment Loan are aimed at achieving objectives (i)-(iii). Maintaining a stabilization programsupported by the IMF will be key to hardening state enterprise budget constraints. To ensure sustainedgrowth, there will also be a need to initiate longer term structural reforms such as: (vi) restructuring ofgovernment administration and functions and public services; (vi) reinforcement of the social safety net;and (vii) restructuring of the financial sector. These objectives will be supported, respectively, by thePublic Sector Reform Adjustment Loan (FY97), the Financial Sector Adjustment Loan (FY97), and theSocial Protection Adjustment Loan (FY98).

The Agricultural Sector

10. The food and agricultural sector has greater economic potential in Ukraine than in anyother country of the Former Soviet Union (FSU). This potential is extensively examined in the Bank'sreport Ukraine: Agricultural Sector Review, discussed with the GOU in summer 1994 and issued in latefall 1994. The Bank has also participated in the preparation and publication of Ukraine Land Reform andFarm Restructuring (December 1994) and a study of Ukraine's comparative advantage in agriculturalproduct exports (in Agricultural Trade and Trade Policy - Ukraine Country Report, June 1995). Thesethree reports formed the basis of the policy reforms agreed with the GOU under the Agriculture SectorAdjustment Loan. Sunmmaries of each of these reports are included in Annexes 6-8.

11. Ukraine's agricultural potential is due primarily to Ukraine's favorable agro-climaticconditions, which are not only well suited to the production of grains, oilseeds, root and fiber crops, andlivestock but also to the cultivation of a wide variety of temperate fruits and vegetables. Comparisonsof historical data prior to reform (the late 1980's through 1991) indicate that Ukraine was the lowest costproducer in the Central Europe and the Former Soviet Union for wheat, corn, sunflower seed, andsugarbeet. Evaluating Ukrainian costs of production for these conmmodities, usillg world market pricesfor the material inputs, shows that Ukraine's greatest absolute advantages are in wheat and sunflowerwhile corn and sugarbeet costs are still below average costs in most other major producing countries.

12. Though Ukraine was one the lowest cost producers of beef and pork in the FSU prior toreform, it appears not to have an absolute advantage in meat production compared to major worldproducers (when evaluating Ukrainian materials costs at world market prices). In addition, its meatproduction suffers from quality problems and its slaughter plants are not certified for most developedcountry markets. Nevertheless, it could continue to be a competitive supplier of lower quality cuts to theFSU market (mainly Russia).

13. Indeed, Ukraine has traditionally has been a large exporter of food and agriculturalproducts (with net agricultural and food exports of US$ 2.5 billion in 1988-90). However, performanceof the sector during the latter years of the Soviet Union was still below potential. In the late 1980's, cropyields were only 60% to 75% of those in Western Europe, fertility yields of livestock were 25-30%lower, and feed conversion ratios were less than 60 % of Western levels. Waste was high throughout the

4

food chain caused by large losses in transport from the field and in on-farm storage, as well as lowefficiency and spoilage in food processing, owing to outdated technology. In addition to high losses ofraw product in processing, energy-intensity is very high compared to world standards. Thus, Ukraine'scomparative disadvantage in food processing can offset its absolute advantage in the production of rawcommodities: this appears to be the case for refined sugar and canned fruits and vegetables.

14. From 1990 to 1995, the agricultural sector's output declined by more than 30%. Thisdecline in agricultural and food processing output is partially the result of factors outside the agriculturalsector: high inflation and erosion of working farm working capital, increased real costs of agriculturalinputs, overall decline of real wages and domestic demand, and the breakdown of payments channelswith FSU countries.

15. However, this decline also reflects the impact of unsustainable agricultural polices thatare a legacy of the past. Collectivized agriculture and routine covering of enterprises losses eroded laborincentives and rewards to management for containrment of costs and resulted in low levels of factorproductivity. High investment levels in field mechanization and livestock raising facilities in the 1970'sand 1980's did not improve efficiency, and output growth slowed as the marginal increases in output dueto increased use of fuel, fertilizer, feed, and other variable inputs declined to very low levels. Moreover,the cumbersome mechanisms of central planning and control resulted in monopolistic and inefficientdistribution systems for agricultural inputs and outputs. The availability of imported variable inputs suchas fertilizers, agro-chemicals, and seeding and spraying equipment was severely rationed, leading toinsufficient use of these high quality imported inputs.

16. In the 1990's the state supply and purchasing system has been continually eroding. TheGOU ceased in 1992 to officially set most agricultural output and input prices, but maintainedconsiderable control over prices through state contracts and state orders. Monopolistic state tradingagencies exerted substantial pressure on farms to sell at low prices by making these sales a condition forsupply of otherwise-hard-to-get inputs and credit. The rise of input prices to largely world market levelsin 1993-94 was not accompanied by a similar rise to border price levels for farm outputs. Since stateorders and contracts have dropped substantially in 1994-95, the depressed level of farm gate pricesstimulated the growth of buying activities by private and foreign wholesaling and exporting firms.Moreover, farms deal more often than in the past directly with enterprises who process commnoditiesfurther or retail them. Still, the uncompetitive nature of state procurement enterprises and exportlicensing, quotas, and taxes caused poor transmission of border prices to the farm level until late 1995.The end result was a sharp worsening of agriculture's terms of trade. Addressing this problem requiresimproved linkages to international markets, privatization and demonopolization of the agricultural inputsupply, marketing, and processing enterprises, and land reform and farm restructuring.2

17. Until 1995, there was a widespread misconception in the GOU that agriculture's problemswere transitory; that they could be overcome through advanced technology, better management, and themaintenance of large-scale production systems, and that subsidization of inputs could be continued duringthe transition. Monetary emissions by the central government to finance input supply and outputmarketing operations in early spring and late summer served to raise inflation and to perpetuate the heavy

2/The analysis and background to the policy changes to be fostered under the Ag SECAL are discussed in detail in the Bankpublications: Land Reform and Farrn Restructuring Study, Ukraine Agricultural Sector Review, and Agricultural Trade andTrade Policy - Ukraine Country Report.

5

involvement of state enterprises under ministerial direction in agricultural marketing. The combinationof heightened inflation and payment delays by these state enterprises consistently eroded farm income.

18. As economic recovery proceeds in Russia and other FSU countries. restoring anddeveloping markets and business relations with the other FSU republics may offer the best opportunitiesfor Ukrainian agricultural exports. Expansion into developed country markets will be hampered byperceived quality problems and, in some cases, import barriers that inhibit access and reduce prices forUkraine's agricultural products in hard-currency markets, particularly in the European Union (EU). WhileUkraine's eventual membership in the WTO will give it increased world market access, restrictions onagricultural imports by many countries will limit Ukraine's ability to boost agricultural exports.Nevertheless, many developing countries (particularly in the Middle East, Gulf states, and Pacific Asia)offer significant market opportunities for expanded agricultural and food exports by Ukraine.

The Agricultural Sectoral Adjustment Loan in the Bank's Assistance Strategy

19. Ukraine has embarked on an historic and courageous effort to transform its economyfrom a centrally planned to a market-oriented system. This reform will be, under the best ofcircumstances, a long process accompanied by economic, social, and political difficulties. To ensure thatthis transition is efficient and effective, and to minimize the transition problems, external assistance isessential. The IMF and World Bank operations of late 1994 and 1995 (Systemic Transformation Facilityin November 1994, Rehabilitation Loan in December 1994, Standby Arrangement in April 1995) haveprovided the support needed by Ukraine to take the first major reform steps and prove to the internationalcommunity that Ukraine is serious about market reforms. These operations have been oriented largelyto meeting macroeconomic targets but have included important sector wide and sector-specific conditions.The most important conditions affecting the agricultural sector have been those liberalizing export trade,removing pricing restrictions, reducing state purchases, and accelerating large enterprise privatization.

20. The agricultural sector assistance program (ASAP, to be supported by a series ofBank adjustment and investment loans) complements the reform strategy supported by the IMF and Bankoperations mentioned above. The goal of the ASAP is to provide a policy framework and investmentsthat promote the Government's agricultural reform program. The primary short term goal of the ASAPis to boost agricultural growth. The ASAP is expected to help Ukraine double most agricultural exportsin five years.3

21. The ASAP is currently made up of mutually supporting programs supported by fiveagriculture-related Bank loans: the Seed Development Project, the Agriculture Sector Adjustment Loan,the Pre-Export Guarantee Facility, the Agribusiness Development Project, and the Title RegistrationProject. Since Ukraine is in the first phase of its stabilization program, these programs focus on keypolicy reforms and investment in critical areas.

1) Seed Development Project - US$ 32 million loan, which became effective in July1996. Ensuring the stability and quality of local seed supply was identified as a necessary condition forthe continued functioning of the agricultural sector during the economic adjustment period and as well

3/Agricultural import demand is sufficiently high in the FSU countries to absorb most of these exports.

6

as an important long term strategy for maintaining a viable agricultural sector. This loan providesinvestment capital for the rehabilitation of privatized seed production and processing operations.

2) Agriculture SECAL - US$ 300 million loan, with Board presentation expected inOctober 1996. It supports policy reform in the areas of market and trade liberalization, privatization andland reform through conditionality on balance-of-payments support. By having it early on in the ASAP,the Project establishes supporting policy conditions under which the Pre-Export Guarantee Facility andthe two investment loans can be effectively implemented.

3) Pre-Export Guarantee Facility (PGF) - US$ 120 million guarantee, with Boardpresentation expected in October 1996. The PGF is being processed in parallel with the Ag SECAL andprovides support for the policy reforms made under the Ukraine Rehabilitation Loan and the Ag SECALthrough the Bank's underwriting guarantees that specifically identified liberalized trade and marketingpolicies will not be rolled back by the GOU to the detriment of suppliers' and investors' outstandingcommitments.

4) Agribusiness Development Project (Agriculture I) - $20 million loan, with Boardpresentation expected in March 1997. In tandem with the significant policy changes promoted by the AgSECAL, the restructuring of agribusiness firms and collective agricultural enterprises (former collectiveand state farms) has been identified as the next critical constraint to the development of a market basedagricultural economy. To assist the restructuring process, this project will provide management supportto agribusiness managers and to the members of collective agricultural enterprises undergoingreorganization. The project would also support the development of a low cost market information systemthat supports traders and commodity producers.

5) Title Registration Project (Agriculture 11) - $50 million loan, with Boardpresentation expected in FY98. This project would support the development of land registrationprocedures, training and equipment. The registration system is expected to substantially reduce the costof property transactions, thus increasing the efficiency of land and property markets. It would alsoprovide a basis for low cost mortgage lending and to increase the security of land tenure. All of thesefactors will have a significant impact on improving the efficiency of land use and agricultural production.

II. TIlE GOVERNMENT'S AGRICULTURAL REFORNM PROGRAM

Agricultural Reform Goals Set by Ukraine and Measures Implemented

22. In 1994, it became apparent to the GOU that a faster transition to a free market in theagriculture sector would be required to restore this sector to profitability. In particular, greaterliberalization of export markets is now understood to be critical in a country that has a comparativeadvantage in agricultural production and is traditionally a net exporter of agricultural products.Recognition by the Government of Ukraine (GOU) that the financing of seasonal peaks in agriculturaloperations must be market-based also represents a key realization in redefining agricultural policy. InOctober 1994, the agricultural reform directions announced by the President of Ukraine, Leonid Kuchma,initiated the first comprehensive reorientation of agricultural policies. They support the creation oftradeable private property rights in agriculture and the rest of the agro-industrial sector (AIS) a) tomotivate farms and other AIS enterprises to pursue profitable activities, and b) to generate competitive

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mechanisms which indirectly regulate these enterprises' profits and promote efficiency. The specificmeasures declared by the President of Ukraine as integral to agricultural reform include: i) liberalizationof food prices, ii) agricultural export liberalization, iii) development of agricultural comnmodity exchanges,iv) distribution of land plots to farm workers and other eligible beneficiaries, and v) privatization ofagricultural supply, marketing, and processing enterprises.

23. Ukraine took major steps in implementation of the reform measures emphasized byPresident Kuchma with the support of the IMF Systemic Transformation Facility (STF) and the WorldBank's Rehabilitation Loan (negotiated and signed in November-December 1994). The GOU'sRehabilitation Program removed most food price controls4, abolished all export quotas on agriculturalproducts (except grain5), and agreed to make at least half of state purchases of agricultural commoditiesthrough the commodity exchanges and other competitive tender mechanisms. The GOU now limitsagricultural purchases financed from the state budget to levels consistent with the needs only of socialsector organizations (schools, hospitals, the armed forces, etc.). This amounts to a substantial reductionof state agricultural procurements. To promote land reform, the GOU has introduced draft legislation andto eliminate the moratorium on sale of agricultural land, to mandate the delineation of land plots to thoseentitled to land under the Land Code, and to institute a registration system for land and other real estate.Agreement was also reached to initiate the privatization of agricultural infrastructure, including grain silosand elevators, in 1995.

Further Reform Steps under the Agricultural Sectoral Adjustment Loan

24. The agricultural reform steps implemented by the GOU in 1994-95 and supported by theSTF and the Rehabilitation Loan need to be supplemented by a wider set of agriculture-related policyreform measures which would be supported by the Ag SECAL. The policy reform measures beingimplemented by the GOU and supported by the Ag SECAL focus on increasing efficiency within theagricultural sector and promoting market development. Taken as a package, these measures will increasefarm gate prices, allow more elastic response to price changes, and lay the foundation for increasedaccess to credit through the banking system. They should facilitate a growth of net agricultural outputof 15-20% over the period 1996-2001 6 The main measures being implemented are in the following areas:

(a) agricultural market liberalization, including changing government procurement methodswhich impede the development of private intermediary activities and the removal ofremaining profit and marketing margins in the grain and bread sub-sectors;

(b) trade liberalization, including rescission of grain export quotas and discontinuation of theimposition of indicative prices on trade contracts;

4/Maximum profit and marketing margins for bread products remained in place, but implicit consumer subsidies on theseproducts were reduced after fixed prices were abolished.

5/ The export quota on grain was abolished in February 1996.

6/ The crop sector is expected to expand by 4-5% annually as it represents the area a) of greatest untapped potential, and b)historically most taxed by state pricing policies. The livestock sector is expected to grow only 1-2% per annum, given the dualchallenge of substantially improving the herd's genetics and penetrating strong export markets.

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(c) land reform encouraging the development of a sector of viable farm management unitsby establishing the legal basis for division and privatization of large farms;

(d) privatizing, demonopolizing, and encouraging market entry in production, processing,and marketing of agricultural inputs and outputs;

(e) establishing a framework of agricultural market information services and restructuringstate agricultural institutions to focus on the role of market facilitator.

25. Market and price liberalization would be continued by the GOU by removing remainingprofit and marketing margins in the grain and bread products sector, making government procurementcontracts open to a wider scope of private intermediary enterprises, and actively reducing the trade policyand macroeconomic risks which input supply and marketing enterprises face. Above all, this meanscontaining and reducing inflation by ensuring strict adherence to the Presidential decree limiting budgetaryexpenditures for state procurements to only those purchases (including those of agricultural goods)necessary to meet the needs of social sector organizations such as hospitals, educational facilities, and thearmed forces. To promote agricultural markets in which both private and state-owned enterprises canparticipate, all state agricultural procurements would also be executed on a competitive basis, throughopen tenders and purchases on commodity exchanges. Intermediaries and marketing enterprises wouldbe encouraged to participate more widely in the agricultural commodity exchanges to increase competitionfor output from agricultural enterprises, which do not usually have the trading expertise to access thecommodity exchanges directly themselves.

26. An anomaly exists in the tax code such that the rate of profit tax on intermediary activitiesis currently 45 % compared to 30% for most other sectors of the economy. By reducing this high rateof profit tax to the rates assessed on other activities, the creation of private wholesalers, a wider set ofconmmodity exchanges, transport and trade companies, and service and marketing enterprises would befacilitated. Traders operating in the informal sector would also be encouraged to enter the formal sector,thereby increasing the profits tax base. These developments would give agricultural producers alternativesources of supply for inputs and alternative buyers of their output which they could access if stat-ownedenterprises (both suppliers and customers) offered them unattractive prices.

27. Greater opportunity for private input suppliers and output marketers is clearly growingas state procurement of agricultural products were reduced significantly in 1994-95. State purchases in1994 measured as a share of total marketed production were roughly 40% of average 1989-1992 levels.They fell to 10-20% of these average levels in 1995. At this level (roughly $750-850 million) statepurchases represent 5-7 percent of net agricultural output. Similarly, advances of working capital by theGOU to farms (traditionally through the procurement enterprises) have been curtailed. Thus, farms havebecome less tied to the state suppliers from whom the state used to arrange input deliveries. Sincetraditionally these advances have been interest free (or at least at highly preferential interest rates), creditsubsidies to farms and procurement enterprises fell from over $500 million in 1994 to $250-350 millionin 1995'. The volumes of agricultural output formerly purchased through the state are now finding their

7/ In 1996, these credit subsidies are expected to fall to less than an equivalent in karbovantsi of US$130 million as working capital isadvanced to farms almost entirely through state "forward" contracts whose price is discounted from the expected spot price at harvest time(both expressed in US dollars).

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way directly to enterprises (both private and state-owned) at higher prices and on commnercial terms(including more prompt payment).

28. Thus, in the area of market intervention and financial policies, the GOU recognizes thatUkrainian agricultural markets are beginning to respond to export liberalization with higher farm gateprices and that these prices will increase further as remaining market restrictions are removed. Paritywith pre-reform relative prices of outputs to inputs will not be achieved in future since total inputsubsidies exceeded implicit taxes on farm gate prices in the pre-reform period. Nevertheless, substantialimprovements from current relative prices of agricultural outputs to inputs are clearly possible for mostproducts (excepting some livestock products) if the market is allowed to work. For goods of whichUkraine is a low cost producer, the GOU's concern is not one of stagnant prices but rather how to securea social safety net to support those most affected by food price increases. For agricultural products forwhich domestic markets have contracted and for which foreign markets remain generally restricted(especially meat and dairy products), supply reduction, improved productivity, and the market would berelied on to solve these products' currently adverse terms of trade.

29. Increasing the level of international trade is crucial to improving farm-gate prices forUkrainian agricultural output. Without strong links of agriculture to export markets, the prices whichfarms receive for their output will continue to be out of balance with the world market prices they payfor inputs. Allowing real farm-gate prices to increase through greater access to foreign markets wouldbe more successful than attempts to support agriculture through subsidized credit to state agriculturalprocurement enterprises and input subsidies. This is because these subsidies have not supportedagricultural terms of trade since they have been offset entirely by implicit taxes imposed throughrepressed farm-gate prices (Para. 16). Moreover, these subsidies have fueled inflationary expectationsand distorted input use.

30. Ukraine has a regional comparative advantage in agricultural production which hashistorically made it a net exporter of agricultural products to the Soviet Union and, prior to 1930, tomuch of Europe. Ukraine's future economic growth is also expected to be partially dependent onagriculture to boost exports and reduce balance-of-payments shortfalls. However, this will require thedevelopment of private trading institutions and agencies, financial and payments arrangements, and tradepolicies and systems that facilitate trading transactions and encourage the integration of domestic andexternal markets. This will be particularly important for expanding exports to convertible currency areas.

31. The removal of virtually all export quotas on agricultural products in December 1994 wasan important step in righting the imbalance between Ukrainian farm-gate prices for outputs and the pricesof agricultural inputs (which have risen to world market levels). This will likely be the most importantsource of higher profits and greater working capital for farms in the short term. The positive impact ofremoving export quotas on agricultural products was very nearly almost offset in early 1995 as theimposition of a registry system for barter transactions was narrowly averted.8 Moreover, by maintainingexport quotas on grain in 1995, the producer price of a key agricultural output was kept low, therebyreducing income for virtually all farms.'

8/ Agricultural exports usually are the method by which input supply firms receive payment for the inputs which they have supplied monthsearlier to agricultural enterprises on credit in kind.

2/More than 30% of agricultural land in Ukraine is used for grain crops.

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32. Registration and imposition of indicative prices by the Customs Service on barter dealshas imposed excessive implicit taxation on the use of barter transactions. In February 1996, the GOUremoved the remaining agricultural commodities from the export registry system and abolished theimposition of indicative prices on agricultural products. In the medium-term, barter trade will be reliedon less once international payment mechanisms evolve for the execution of export contracts in an efficientand timely manner. Therefore, the restructuring of the financial sector and strengthening of commercialbanks are critical to progress in this area.

33. Land reform and farm restructuring, including the privatization of land and theestablishment of independent private farms, have progressed slowly to date. The Land Code of March1992 clearly laid out farm members (both current and retired) of collective and state farms as the ultimateowners of most of the land of Ukraine's farms. The transfer into private ownership of land and otherfarm assets is specified (in the Land Code and supporting legislation) as a legal right of these farms'members but a right that can be exercised only upon withdrawal from the farm membership. Given thisstipulation, the lack of defined procedures'" for withdrawing ones' shares of land and non-land assets fromthe farm enterprise, and the opposition of many farm directors to withdrawal of such assets, less than 1percent of farm members have withdrawn from their farm enterprises and taken their assets with them.

34. As of late 1995, new private farmers controlled only 1.5 % of Ukraine's agricultural land.An additional 11.8% of Ukraine's agricultural land was also farmed privately in 5 million hectares ofsubsidiary plots and gardens. Despite the approval by the Ukrainian Parliament's Agricultural Conmmitteeof amendments to the Land Code to facilitate privatization of land and other farm assets, the principleof unrestricted private land ownership and private agriculture is still viewed by some political entities asa supplementary component of a farming structure based primarily on collectively-owned large-scaleunits. Uncertainty about future legislation on land ownership and the risks involved in private farminggiven the absence of a competitive input/output marketing and credit system have substantially limitedthe establishment of independent private farms.

35. The restructuring of collective agricultural enterprises (former collective and state farms)would focus on three major principles: i) freedom of decision to farm members about future organizationof production and the distribution of the ownership of land and other assets; ii) explicit procedures forthe distribution of land and other productive assets to the members in physically recognizable form andnot as anonymous shares; iii) promotion of competitive input distribution and marketing enterprises whichserve restructured farms.

36. To introduce these principles, additional legislation has been drafted and would beimplemented to facilitate withdrawal of land and non-land assets from collective agricultural enterprisesby those who have been allocated rights to this property under the Land Code. These withdrawals wouldnot be able to be legally impeded by either farm management or the farm members' council. This willenable those working in agriculture to formally exercise claims to the land and farm assets to which theyare entitled under existing law and to establish viable private farms individually or in cooperation withother private owners of agricultural assets. In addition, the importance of establishing private propertyrights and a proper title registration system is crucial to introducing market relations in agriculture. Itwould allow buyers, sellers, lenders and others to establish with certainty their rights to real estate and

10/ These procedures were finalized in December 1995 and adopted by the GOU in the first half of 1996.

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facilitate the use of real estate as security for investment. Procedures for mortgage of land and other realestate would also be implemented under the Ag SECAL.

37. Legislation would be adopted by the GOU enacting a title registration act. This lawwould contain the following features: (a) combination of record keeping for both land, buildings, andother real estate in a legally recognized report format"; (b) accessibility by all interested legal entities andphysical persons to this information on owners of land and other real estate and on transactions relatedto the disposal of this property; and, (c) state guarantees of accuracy and reliability of this informationfunded partially by means of modest fees for the registration of these transactions.

38. Privatizing the agricultural distribution and processing system has been initiated inUkraine, but restructuring in this sector needs to be expanded beyond its current scope. Of roughly4,000 large and medium scale non-farm enterprises in the agro-industrial sector, about 10 percent hadbeen privatized by early 1996. Many of these enterprises were privatized through the "lease-with-buyout-option" method, through which they have become closed joint-stock companies owned by workers andmanagers. Fewer option joint-stock privatized agricultural enterprises were formed and even fewer withinfusions of capital for restructuring from foreign participation. Given the slow pace of agro-industrialsector (AIS) privatization, a number of Presidential decrees on accelerating this process have been issued:there aim was to give farm enterprises which have supplied processing plants with raw product apreferential right of access to the AIS enterprises' shares (purchase at book value as AIS enterprisesworkers and managers are allowed to purchase). This is a legitimate principle to follow, as long as itis not taken to an extreme'2 and as long as it does not generate legal conflicts between farmers and AISenterprise workers that further delay the privatization process.

39. Like many sectors in the Ukrainian economy, the agro-industrial sector is characterizedby a high decree of monopoly. These are not firms which for technological and cost reasons could beconsidered natural monopolies. On the contrary, they are artificial monopolies which have beenadministratively created from separate firms to facilitate the execution of central plans. Having beenfreed from a centrally planned pricing structure, they try to compensate for their low productivity inprocessing and marketing by offering low prices (below border prices ) for farms' commodities andcharging comparatively high prices for agricultural inputs sold to farms. The GOU recognizes that priceliberalization and reduced government intervention in commodity markets will not be fully successful intransmitting world price levels into Ukraine for agricultural commodities unless input supply and outputmarketing is substantially demonopolized. The Anti-Monopoly Committee has begun activelydemonopolizing AIS enterprises deemed to be monopolists rather than simply regulating their prices.

40. Thus, the expanded agricultural policy reform program supported by the GOU wouldinclude three main components. First, the methods of privatization of AIS firms would be adjusted topermit earlier recapitalization of these firms with new investment through open joint-stock enterprises.Second, and equally important, is the acceleration of the pace of privatization of AIS enterprises via

I 1/The inclusion of moveable property in the registry is also being contemplated by the GOU as the use of agricultural vehicles ascollateral may prove to be of importance for new private farmers.

12/ If a May 1996 Ukrainian Parliament law on AIS privatization had gone into effect, farm members would have been given rights to 51percent of the assets of AIS enterprises without making any payments. This was widely perceived as disregarding the equity considerationsof AIS enterprise workers and the general public, which can also use its privatization vouchers to purchases shares in AIS enterprises. ThePresident of Ukraine vetoed this law.

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explicit GOU targets for the number of firms to be privatized in the short and medium term. Withoutthese measures, too many AIS enterprises would be decapitalized and go bankrupt over the next two tothree years. Third, the GOU would institute rapid demonopolization of agro-processing, input supply,and product marketing systems immediately and enforce current regulations which define permissiblelevels of concentration in the agro-industrial sector.

41. New roles for government are being introduced to take the place of the past role of directmanagement of agricultural enterprises. The Ag SECAL preparation activities which focus on developinga monitoring framework for the policy reforms support the development of the GOU's ability to provideagricultural market information in a timely manner. This information will serve as the basis for sub-sectoral analysis in agriculture and provide the foundation for the GOU to execute its policy makingfunction soundly. The principal reduction of government responsibility in the agricultural sector wouldbe the dismantling of the current "agro-industrial complex" governmental management structure. Whatis needed is not merely changing the names of the various ministries, but radical modification and/ormerger and downsizing. Units related to central command and direct interventions would be dismantled,while those remaining would be reorganized, streamlined, and managed to meet the needs of a freemarket economy. These further steps will be supported by the GOU's Public Sector Reform Program,and the Bank's Agribusiness Development Project and the Title Registration Project.

Other Supporting Projects and Support from Bilateral Donors

42. The IBRD agriculture sector assistance program in Ukraine is closely coordinatedwith Bank lending in other sectors and other donors' lending providing assistance in the following areas:

i) Balance-of-payments support will assist the importation of critical agricultural inputs(IBRD Enterprise Development Adjustment Loan and IMF Standby Arrangement).

ii) Credit to the agricultural sector will be provided through the IBRD Export PromotionProject and the Financial Institutions Development Loan and an EBRD loan to thefinancial sector. While this credit is not specifically targeted to agriculture, it will addto the general pool of credit available to the sector.

iii) Technical support and capital investments for the development of an emerging systemof commodity exchanges (USAID).

iv) Technical assistance to the Ministry of Agriculture, State Property Fund and the Anti-Monopoly Committee to help implement a consistent program of privatization anddemonopolization in the food and agriculture sector, including support for legal trainingand drafting of legislation (PHRD, IBRD EDAL, IFC, and USAID).

vi) Technical assistance for land reform focused at farm level restructuring,encouragement of private farming and the establishment of service organizations such asmarketing or input supply cooperatives (IFC, TACIS, UK Know How Fund).

vii) Technical assistance that provides agribusiness advisory services and facilitates theformation of joint ventures, thus encouraging foreign capital investment and transfer of

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technology (EU TACIS, Government of the Netherlands, UK Know How Fund, CitizensNetwork, and others).

viii) Technical assistance and capital investments for the development of a public marketinformation system, thus reducing information asymmetries and high individualtransactions costs associated with information gathering in an emerging market (USDepartment of Agriculture, TACIS).

III. THE PROPOSED LoAN

Rationale for Bank Involvement

43. The Ukrainian agricultural sector is making the transition to a market economy in the faceof many residual policies of a planned economy. The rationale for the Agricultural Sectoral AdjustmentLoan is to establish a policy framework that would promote greater efficiency in the agricultural sectorby accelerating the growth of market-based relations. The proposed policy reform package would havepositive medium and long-term effects on the farm sector, agro-industrial sector, food consumers, andthe national budget. However, the policy reforms to be supported under the Ag SECAL would have anumber of short-term negative macro-economic impacts that create a need for balance-of-paymentsfin>,ncing. First, trade liberalization will transmit higher border nrices for agricultural commnodities intoUkraine: this will cause increases in consumer food prices and tlie inivestmen. saviigs gap. Second, bypaying higher prices for agricultural procurements and by reduchig taxes on agricultural intermediaries,the GOU will experience an increase in the budget deficit. These increase;l pivate savings and publicsavings gaps may lead to an increase in the current account deficit in the short-term. Lastly, a substantialamount of incremental farm income will be spent on imported equipment (owing to the frequent lack ofdomestically produced equipment). This will put further pressure on the current account deficit.

Project Objectives and Description

44. The objective of the Ag SECAL is to support the growth of a market-based agriculturalsystem. This would be achieved by instituting agricultural and trade reforms aimed at increasing marketcompetition, encouraging private ownership and investment in land and other productive assets, andproviding short term balance-of-payments support for financing critical imports. The reform programthat the Ag SECAL supports would improve agricultural terms of trade, increase input flows to farms,expand agricultural exports, and increase the efficiency of farm management.

45. The Ag SECAL encompasses policy reforms and balance-of-payments financing. Thepolicy conditionality would focus on the agricultural sector and address the following: i) reduction in theexport restrictions allowing increased access to export markets; ii) development of a well functioning landmarket; and iii) enabling privatization and demonopolization of existing agribusiness firms andencouraging new entrants. The negative short-term adjustments associated with these policy changeswould be cushioned by balance-of-payments financing. The funds provided under this component of theAg SECAL would be used to finance general imports. The funds would be channeled through theNational Bank of Ukraine, and allocated through the established market system for auctioning foreign

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exchange. While balance-of-payments support is not expected to be targeted at financing imports for theagricultural sector it is expected to improve the availability of agricultural inputs.

Conditions for Appraisal, Negotiations, Board Presentation, and Second Tranche

A. Prior to Appraisal

Trade Liberalization

46. The Cabinet of Ministers (CM) would issue a CM resolution to rescind the currentpractice of making grain exports subject to the receipt of an export quota and a license. This resolutionhas been issued.

47. The Cabinet of Ministers would issue a CM resolution to rescind the sections of Article15 of the CM Resolution #109 (February 13, 1995) which empowers oblast governments (and the citygovernments of Kiev and Sevastopol) to place profit margin controls on grain procurement and storageand trade margin controls on bread, flour, and bread products. A Presidential Decree (October 20,1995) has repealed the profit margin controls on grain procurement and storage, and the relevantparagraphs of CM Resolution #109 concerning the trade margin controls on bread products wereamended on May 13, 1996 by Cabinet of Ministers' Resolution #499. The power to impose profitand trade margin controls in the grain and bread sector has now been rescinded.

Land Reform

48. The State Committee for Land Resources (SCLR) will issue normative acts and theMinistry of Agriculture and Food (MOAF) will issue recommendations, respectively specifyingprocedures for the exchange of land shares for land plots and property shares (in farms' non-land assets)for farm assets. The normative acts submitted by the SCLR were approved by the Cabinet ofMinisters and were registered by the Ministry of Justice. For property shares, MOAF has workedout and published its recommendations.

49. The office of the First Deputy Prime Minister for the Agro-Industrial Complex woulddraft an Action Plan to undertake a publicity exercise in each oblast to inform the stated beneficiariesunder the Land Code of the procedures available to them for exchanging their land and property sharesfor land plots and other farm assets. This Action Plan has been drafted and submitted to the Bank.Its implementation at national and oblast level has been initiated.

B. Prior to Negotiations

Trade Liberalization

50. The Ministry of Finance (MOF) would clarify that profits taxes on intermediary activitiesin the agricultural sector are assessed at the same rate as on most other types of economic activity(currently this rate is 30%). The current Cabinet of Ministers resolution (#682, August 27, 1995) whichassesses taxes on the increase in the nominal value of grain stocks would be rescinded, leaving the value

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of these stocks to be taxed under the normal provisions for profit taxes. On profits taxes - the TaxInspectorate under the Ministry of Finance (MOF) has issued an internal memo (circulated to theMOAF) which clarifies the tax status of sellers of agricultural produce. This memo states thatsellers and traders who are reselling output they have purchased are taxed at the rate of 30%,including sales at the agricultural commodity exchanges. In addition, on July 22, 1996, a draftamendment to the Law on Taxation of Enterprise Profits (1995) was submitted by the Cabinet ofMinisters to the Ukrainian Parliament. This amendment would reduce the profit tax rate oncommission sales on commodity exchanges to 50 percent. On commodity stocks - it has beenclarified that CM Resolution #682 is not longer in effect (it applied to transactions in 1995 only).

51. The Ministry of Foreign Economic Relations and Trade (MFERT) would cease the settingof obligatory indicative prices for export contracts for products whose export is not subject to contingentintergovernmental agreements with Ukraine or to anti-dumping cases. On February 10, 1996,Presidential Decree #124/96 ("On Measures to Improve Price Policy in Foreign Trade") abolishedthe imposition of indicative prices on the above mentioned contracts.

Land Reform

52. The State Committee for Land Resources (SCLR) would execute land share registrationand issue land share certificates to all entitled beneficiaries in 100 restructured collective agriculturalenterprises. Roughly 500 farms had completed the land share calculation process for their membersby February 1996. By May 1, the SCLR had assisted more than 100 farms to distribute land sharecertificates to entitled beneficiaries (with an average distribution rate of 86%).

Privatization and Demonopolization

53. Privatization of agro-industrial enterprises would be streamlined so (i) that thesubscription process for agro-industrial enterprises would be reduced to a period comparable to that forother medium and large enterprises in other sectors; (ii) that there would be no reversal of privatizationtransactions previously completed in the agro-industrial sector; and, (iii) that shares of agro-processingenterprises that are to be offered to primary producers (suppliers) of raw product would be transferredto the individual members of these suppliers. This conditionality was met by the combination of: a)a Presidential veto of the May 1996 law on agro-industrial privatization; b) the issuance ofinstructions by the State Propeity Fund to speed up agro-industrial privatization; and c) theissuance of a Presidential Order (May 28, 1996) to the Cabinet of Ministers to prepare normativedocuments to further streamline the agro-industrial privatization process. The Presidential Orderinstructed the Cabinet of Ministers to ensure the implementation of points (i), (ii), and (iii) aboveby their inclusion into appropriate GOU normative acts to streamline agro-industrial privatization.

Agricultural Subsidies

54. The MOAF would submit a plan to the Ministry of Finance (MOF) to: a) limit totalagricultural credit subsidies to less than an equivalent of US$ 130 million in 1996; and, b) to phase outthese subsidies according to a reduction schedule developed for 1997-1998. The subsidy levels implicitin the draft 1996 Budget are within the US$ 130 million limit. At Negotiations, the GOU agreedto establish the current karbovantsi equivalent of US$ 130 million (23 trillion karbovantsi) as theannual ceiling for these implicit credit subsidies for 1997-98.

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55. The MOAF would submit a plan to the MOF to limit total state purchases of agriculturalproducts financed in the 1996 State Budget to an equivalent of US$ 550 million. The purchasing levelsimplicit in the draft 1996 Budget (135 trillion krb) were within the US$ 550 million limit.

C. Prior to Board Presentation

56. At Negotiations, the GOU presented to the Bank copies of the State Property Fund Orderdated August 9, 1996 (the SPF Order) regulating the process of agro-industrial privatization on the basisof the Law "On Peculiarities of Privatization in the Agro-Industrial Complex" (July 10, 1996) and a copyof the legal opinion from the Ministry of Justice of Ukraine regarding retroactivity of the Article 21 ofthe Law. After reviewing the documents, the Bank concluded that the SPF Order still leaves a possibilityfor collective agricultural enterprises as legal entities to acquire shares of privatized agro-industrialenterprises for free and at the nominal share value for cash. In order to resolve these issues, the Bankdelegation proposed and the Ukrainian delegation agreed , that as a condition of Board presentation, thefollowing measures be taken:

a) SPF Order be amended to provide that free shares be transferred to individual farmmembers in proportion to the shares which they have purchased with privatizationcertificates, cash, and compensation certificates so that the full 51 percent allocation ofshares is fully distributed;

b) SPF Order be amended to eliminate the right of collective agricultural enterprises topurchase shares of agro-industrial enterprises at the nominal share value;

c) Provision of further clarification that the process of transformation into open jointstock companies described in Article 21 of the Law "On Peculiarities of Privatization inthe Agro-Industrial Complex" (which provides for the sale of 51 % of shares of closedjoint stock agro-industrial enterprises to collective agricultural enterprises) conferspreferential share purchase rights to individual farm members and not to collectiveagricultural enterprises.

d) receipt of legal opinion from counsel acceptable to the Bank that the SPF Orderincluding amendments and clarifications described in (a), (b) and (c) are legally valid.

D. Prior to Availability of the Second Tranche of BOP Support

57. These conditions should be met as soon as possible after loan signing, but before theclosing date of the project on December 31, 1997. It is expected that they would be met by June 1997.Agreement on the general timetable for actions was reached with the GOU during Negotiations.

Trade Liberalization

58. Export duties and indicative prices on agricultural sector goods (i.e., those imposed onthe livestock sector in May 1996) would be eliminated.

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Land Reform

59. Amendments to the Land Code would be enacted to: (a) abolish the 6-year moratoriumon sale of land; and (b) limit to three months the time within which co-owners can exercise theirpreferential right to buy the share of land being sold by a co-owner.

60. Legislation or normative acts would be enacted that would: (a) give a right to two or moremembers of a collective agricultural enterprise to withdraw adjacent plots; (b) limit to three months thetime period within which the farm members' council of the collective agricultural enterprise has toconsent to the plots of land requested for withdrawal; and, (c) give withdrawing members the right to i)appeal if the farm members' council fails to consent within three months, and ii) receive ownership ofthe plot to be withdrawn within 12 months after consent is received.

61. The Office of the First Deputy Prime Minister for the Agro-Industrial Complex wouldfinalize an Action Plan (with measures, budget, and ministerial competence) to undertake a publicityexercise in each oblast to inform the stated beneficiaries under the Land Code of the procedures availableto them for exchanging their land and property shares for land plots and other farm assets. It would thenexecute the Action Plan for the publicity exercise in each oblast.

62. The Cabinet of Ministers would issue a CM resolution to establish a single registry ofrural and urban land and other real estate.

63. The SCLR would complete the registration process for land share certificates in 2,000collective agricultural enterprises and issue land share certificates to at least 75 % of entitled beneficiariesin these enterprises. The SCLR would also complete the process of exchanging land shares for physicallyidentified land plots on at least 75 collective agricultural enterprises.

Privatization and Demonopolization

64. The MOAF and the MOF would demonstrate that all agricultural procurements by stateagencies, starting in November 1996, are carried out on a competitive basis through open tenders and/oragricultural commodity exchanges in a manner facilitating private sector participation.

65. The SPF would implement streamlined agro-industrial privatization procedures as setdown in its amended Order (receipt of which was a condition of Board Presentation) in order toaccomplish the streamlining goals set forth in the Presidential Order of May 28, 1996.

66. The State Property Fund (SPF) would privatize a minimum of 1000 AIS enterprises(which does not include state farms).

67. The Anti-Monopoly Committee (with the SPF, MOAF, and the State Committee of FoodIndustries) would devise and execute demonopolization plans for 100 agro-industrial regional or nationalmonopoly enterprises or enterprise associations, including at least five state-owned national monopolyenterprises or associations engaged in the processing of agricultural products and in input supply.

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Macroeconomic Stabilization

68. The Government of Ukraine will continue to maintain a macroeconomic frameworkconsistent with the objectives of the Ag SECAL as determined on the basis of performance criteriaacceptable to the Government of Ukraine and the Bank.

Loan Administration Amount and Tranching

69. Upon Loan effectiveness, US$ 150 million of the balance-of-payments support wouldbecome available. The balance of the Loan (US$ 150 million) would be released upon fulfillment of theSecond Tranche conditions. The loan will be a single currency loan in US dollars at a variable interestrate (LIBOR plus LIBOR Total Spread), with a maturity of 17 years including a grace period of 5 years,and level repayment of the principle.

Procurement

70. In accordance with the February 8, 1996 Operational Directive on the Simplification ofDisbursement Rules under Structural Adjustment and Sectoral Adjustment Loans, the proposed AgSECAL proceeds will be disbursed against satisfactory implementation of the adjustment program,including compliance with stipulated tranche release conditions and achievement of a satisfactorymacroeconomic framework. Disbursements will not be linked to any specific purchases: hence, evidencewill not be needed to support disbursements, nor will procurement requirements be needed.

Disbursements

71. The GOU will open and maintain an account with the National Bank of Ukraine uponWorld Bank notification of the release of each tranche. Proceeds of the Loan will be deposited by theWorld Bank in this account at the request of the GOU by the submission of a simplified withdrawalapplication. If after deposit in this account, the proceeds of the Loan are used for ineligible purposes(i.e., to finance items imported from non-World Bank member-countries or goods or services on thestandard negative list), the Bank will require the GOU either (a) to return that amount to the account foruse for eligible purposes, or b) to refund the amount directly to the Bank, in which case the Bank willcancel an equivalent undisbursed amount of the Loan.

Reporting, Accounting, and Auditing

72. The Ministry of Finance, who would be the executing agency for the Loan, would appointa Project Manager who would maintain all project accounts. Although the Bank will not routinely requirean audit of the Deposit Account, it reserves the right to require an audit by independent auditorsacceptable to the Bank. In addition, audit reports would be submitted to the World Bank not later thansix months after the close of each fiscal year, or the date of final disbursement.

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Monitoring Arrangements

73. The Ministry of Finance will be responsible for monitoring the implementation of theprogram. The appointed Project Manager would prepare quarterly progress reports detailing theimplementation of the reforms outlined in the policy matrix and in the letter of development policy. TheBank will also monitor the implementation of the reform program through semi-annual reviews, as wellas in the context of the preparation and supervision of other projects. The National Agency forReconstruction and Development (NARD) will evaluate the progress reports prepared by the Ministry ofFinance's Project Manager.

74. In addition to monitoring the fulfillment of the various policy conditionalities, the NARDwould examine the performance of a number of economic indicators designed to gauge the impact of theimplemented policy conditionalities. The base values of these indicators, taken from the work that theBank has executed with the GOU through the Institute of Agrarian Economy and the Ministry ofAgriculture and Food, would include the following (in addition to other variables to be worked out priorto Board presentation): ratios of domestic commodity prices to border prices; comparisons of processingmargins in the agro-industrial sector compared to similar margins in developed agro-industries worldwide(expected to fall as the AIS is privatized and demonopolized); similar measures of wholesaling andretailing margins in the food sector (expected to rise as full deregulation is implemented); measures ofthe growth of private and individual farming and the growth of privatized agro-processing; measures ofagricultural and food exports (both volumes and values); evaluation of the issuance of land titles and thedegree to which collateral is used to secure loans to the agricultural sector; and measures of de-concentration in the AIS, with particular focus on the number of enterprises supplying agricultural inputs.The NARD would prepare (with the assistance of the Institute of Agrarian Economy and the Ministry ofAgriculture and Food) a semi-annual report presenting and discussing the measures and their link to theimplemented policy conditionalities.

Environmental Aspects

75. In accordance with the Bank's Operational Directive on Environmental Assessment (OS4.00, Annex A), the proposed operation has been placed in Category C because of its focus on sectoralpolicy reform and would therefore not require an environmental assessment. Environmental issues relatedto the agricultural sector were described in a 1993 Bank study prepared in cooperation with the UkraineMinistry for Environmental Protection: Ukraine.- Suggested Priorities for Environmental Protection andNatural Resource Management. The results of that study, including those concerned with the agriculturalsector, were discussed at a workshop for local authorities and interested external experts in Ukraine inNovember, 1993. A major area of concern identified by the study was agricultural runoff affectingsurface and ground water, caused by sometimes inappropriate soil management measures, poorfertilizer/pesticide application and management, poor waste management on livestock farms, and lack ofsuitable equipment. The structural reforms supported under this operation would help to set the stagefor improved on-farm management and more responsive input markets (e.g. farm equipment supply).Direct support for improved on-farm management would be a likely element of potential investmentoperations in the future. Meanwhile, the Bank is cooperating with bilateral donors which are supportingdemonstration activities concerned with on-farm resource management.

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Benefits and Risks

76. The Project's major ben, fits would be the development of markets to replace the pastadministrative system and to increase rural welfare and reinvestable profits for future capital fornation.By promoting land reform and farm restructuring, a sector of viable farm management units would bedeveloped. By reducing state procurements and restrictions on agricultural exports, more farm outputwould flow through commercial channels to export markets and domestic markets for higher qualityproducts. These markets will offer higher real prices than the State has paid in the past, thereby raisingfarm-level income and output. By promoting privatization and demonopolization of existing agribusinessfirns, the Project will encourage market entry to take advantage of these increased opportunities.

77. The primary benefit of the balance-of-payments support component is the increasedavailability of foreign inputs which are critical for a quick supply response in the sector. This is a keygoal in the Government's overall program to halt the decline in output in agricultural output, with theultimate goal of increasing agricultural incomes and exports.

78. The primary risk associated with this Loan is the possibility of policy slippage due topolitical opposition to specific agricultural policy reforms. This risk has been minimized first byextensive economic and sector work with the Government of Ukraine and subsequent discussion anddissemination of the ESW's main conclusions about the benefits of policy reform for Ukrainianagriculture. The policy slippage risk has also been partially mitigated by building policy benefits intothe Loan's reform program which promote the interests of a wide scope of political actors: the farmsector, the industrial lobby, economy-wide reformers, rural poor, and those responsible for macro-economic stability. The other main risk is that owing to the lack of working capital at the farm level, therecovery of the agricultural sector will be too slow to maintain a policy regime of limited distortionaryinterventions. This risk has been partially mitigated by creating a tandem operation to the Ag SECAL,the Pre-Export Guarantee Facility, to increase the flow of finance and working capital inputs to theagricultural sector. As free-market agricultural and trade policies are maintained in Ukraine, foreigninvestment will be able to provide a large share of the capital needed to fuel recovery of the agriculturalsector.

Recommendation

79. I am satisfied that the proposed loan would comply with the Articles of Agreement of theBank, and I recommend that the Executive Directors approve it.

James D. WolfensohnPresident

by Caio Koch-Weser

Washington, D.C.September 13, 1996

ANNEX 1

NATIONAL AGENCY OF UKRAINE FOR RECONSTRUCTION AND DEVELOPMENT

No. 10-6-72 August 30, 1996

Mr. James WolfensohnPresidentInternational Bank For Reconstruction and Development1818 H Street N.W.Washington D.C. 20433

Dear Mr. Wolfensohn,

Please find attached the Memorandum of Agricultural Reform Policies, which determinesthe program of structural reform being implemented in the agricultural sector.

The agricultural reform directions announced by Ukrainian President L. 1>;uchma in acomprehensive program of economic reforms in October 1994 support the creation of private propertyrights in agriculture and the rest of the agro-industrial sector (AIS). Their main purpose is to motivatefarms and other AIS enterprises to pursue profitable activities and to generate competitive mechanismswhich indirectly regulate these enterprises' profits and promote efficiency. The specific measuresdeclared as integral to agricultural reform include liberalization of food prices, agricultural exportliberalization, development of agricultural commodity exchanges, distribution of land plots to farmworkers and other eligible beneficiaries, and privatization of agricultural marketing and processingenterprises.

Implementation of the reform measures has been supported under the Rehabilitation Loanconcluded with the World Bank in December 1994. The GOU has removed most food price controls,abolished all export quotas on agricultural products, and agreed to make state purchases of agriculturalcommodities through the commodity exchanges and other competitive tender mechanisms. The GOU nowlimits agricultural purchases financed from the state budget to levels consistent with the needs only ofbudgetary organizations (schools, hospitals, etc.). To promote land reform, the GOU has introduced draftlegislation to eliminate the moratorium on sale of agricultural land, to mandate the delineation of landplots to those entitled to land under the Land Code, and to institute a national registration system for landand other real estate. The privatization of agricultural infrastructure through mass privatization procedureswas initiated in 1995.

Over the next two years, the Government of Ukraine will continue to implement thesereforms by: maintaining the implementation of agricultural reform steps described above which havealready been initiated; removing remaining price restrictions in the agricultural sector; removingremaining impediments to agricultural exports; establishing the institutional basis for division andprivatization of large farms to promote land reform and encourage the development of a sector of viablefarm management units; privatizing, demonopolizing, and encouraging market entry in production,processing, and marketing of agricultural inputs and outputs; and establishing a framework of informationservices and restructuring government institutions to focus on their new role as market facilitator.

2

At the same time, Mr, Wolfensohn, I would like to confirm approval of the results of thenegotiations (and respective documents) between the delegations of Ukraine and the World Bankregarding the Agriculture Sector Adjustment Project which took place in Washington, on August 13-17,1996.

We ask for the support of the World Bank by means of the Agricultural SectoralAdjustment Loan in the amount equivalent to US$ 300 million.

Sincerely,

Roman ShpekChairman of the National Agency for Reconstruction and Development

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UKRAINE AGRICULTURE SECTOR ADJUSTMENT LOAN

Memorandum of Agricultural Reform Policies

The decline of Ukrainian agricultural output in 1992-1995 was largely the result ofunsustainable agricultural polices that were a legacy of the past. Collectivized agriculture and routinecovering of enterprises losses eroded labor incentives and rewards to management for containment ofcosts and resulted in low levels of factor productivity. (High investment levels in field mechanizationand livestock raising facilities in the 1970's and 1980's did not improve efficiency, and output growthslowed as the marginal increases in output due to increased use of fuel, fertilizer, feed, and other variableinputs declined to very low levels.) The cumbersome mechanisms of central planning and control resultedin monopolistic and inefficient distribution systems for agricultural inputs and outputs. Though the GOUceased in 1992 to officially set most agricultural output and input prices, it still maintained considerablecontrol over prices through state contracts and state orders. Monopolistic state trading agencies exertedsubstantial pressure on farms to sell at low prices by making these sales a condition for supply ofotherwise-hard-to-get inputs and credit. These practices and export barriers caused poor transmission ofinternational prices to the domestic market. The end result was been a large erosion of agriculture'sterms of trade. Addressing these problems will require land reform and farm restructuring, privatizationand demonopolization of the agricultural input supply, marketing, and processing enterprises, and theimproved linkages to international markets.

Market and price liberalization will be continued by the Government of Ukraine (GOU)by removing remaining restrictions which impede the development of private intermediary activities indomestic and foreign trade and actively reducing the trade policy and macroeconomic risks which inputsupply and marketing enterprises face. Above all, this means containing and reducing inflation byensuring strict adherence to the Presidential decree limiting budgetary expenditures for state procurementsto only those purchases (including those of agricultural goods) necessary to meet the needs of social sectororganizations such as hospitals, educational facilities, and the armed forces. To promote agriculturalmarkets in which both private and state-owned enterprises can participate, all state agricultural purchaseswill also be executed on a competitive basis, such as through open tenders or on the commodit,exchange. Intermediaries and marketing enterprises will be allowed to fully participate in the agriculturalcommodity exchanges to increase competition for output from agricultural enterprises, which do notalways have the trading expertise to access the commodity exchanges directly themselves.

The creation of private wholesalers, commnodity exchanges, transport and tradecompanies, and service and marketing enterprises, will be encouraged by reducing currently high levelsof taxation on intermediary activities. This will give agricultural producers alternative sources of supplyfor inputs and alternative buyers of their output which they could access if agro-industrial sector (AIS)enterprises offered them unattractive prices.

Increasing the level of international trade is critical to utilizing Ukraine's regionalcomparative advantage in agricultural production which has historically made it a net exporter ofagricultural products to the Soviet Union and, prior to 1930, to much of Europe. Ukraine's futureeconomic growth is also expected to be partially dependent on agriculture to boost exports and reducebalance-of-payments shortfalls. To ensure the growth of agricultural exports, the GOU will promote thedevelopment of commercial and private sector trading institutions and agencies, financial and payments

4

arrangements, and trade policies that facilitate trading transactions and the integration of domestic andexternal markets.

The removal of all export quotas on agricultural products is viewed as an important stepin righting the imbalance between Ukrainian farm-gate prices for outputs and the prices of agriculturalinputs which have now risen to world market levels. Increasing the level of international trade is crucialto improving farm-gate prices for Ukrainian agricultural output, to alleviating the sector's dependenceon implicit credit subsidies, and to increasing farm incomes. By early 1996, the GOU had removed theremaining agricultural commodities from the export registry system and abolished the imposition ofindicative prices on agricultural export contracts.

Land reform and farm restructuring is viewed as an essential step in establishing acompetitive private sector agricultural system in Ukraine. Restructuring of collective agriculturalenterprises will focus on three major principles: (a) distribution of land and other productive assets to themembers in physically recognizable form and not as anonymous shares; (b) freedom of decision tomembers about future organization of production after the distribution of the ownership of land and otherassets; and (c) promotion of competitive input distribution and marketing enterprises which serverestructured farms.

To introduce these principles, legislation has been drafted and will be implemented tofacilitate withdrawal of land and non-land assets from collective farm enterprises by those who have beenallocated rights to this property under Ukrainian legislation. Measures will be taken to ensure that thesewithdrawals will not be impeded by either farm management or the farm members' council. This willenable those working in agriculture to formally exercise claims to the land and farm assets to which theyare entitled under existing law and to establish viable private farms individually or in cooperation withother private owners of agricultural assets. In addition, the importance of establishing private propertyrights and a proper title registration system is crucial to introducing market relations in agriculture. Itwill allow buyers, sellers, lenders and others to establish with certainty their rights to real estate andfacilitate the use of real estate as security for investment. Procedures for mortgage of land and other realestate will also be implemented.

The Government of Ukraine will introduce necessary measures in order to adopt andimplement a law on unified national registry of land and other real estate. Introduction of the abovesystem will focus on the following: (a) combination of record keeping for both land, buildings, and otherreal estate in a legally recognized report format; (b) accessibility by all interested legal entities andphysical persons to this information on owners of land and other real estate and on transactions relatedto the disposal of this property; and, (c) state guarantees of accuracy and reliability of this informationfunded partially by means of modest fees for the registration of these transactions.

Privatizing the agricultural distribution and processing system has been initiated inUkraine, but restructuring in this sector needs to be expanded beyond its current scope. The expandedreform program would include three main components. First, the methods of privatization of AIS firmswould be adjusted to permit earlier recapitalization of these firms with new investment through open joint-stock enterprises. Second, and equally important, is the acceleration of the pace of privatization of AISenterprises via explicit GOU targets for the number of firms to be privatized in the short and mediumterm. Without these measures, too many AIS enterprises would be decapitalized and go bankrupt overthe next two to three years. Third, the GOU would institute rapid demonopolization of agro-processing,

5

input supply, and product marketing systems immediately and enforce current regulations which definepermissible levels of concentration in the agro-industrial sector.

New roles for government will be introduced to take the place of the past role of directmanagement of agricultural enterprises. The primary role will be the provision of agricultural marketinformation, policy making and sub-sectoral analysis. The principal reduction of governmentresponsibility in the agricultural sector will be the further dismantling of the current "agro-industrialcomplex" governmental administrative structure, typified by production departments and associations ofstate enterprises. While this restructuring is expected to take a number of years, the Government willinitiate this process by strengthening its institutional capacity in the area of policy analysis and theprovision of agricultural market information. Privatizing the agro-industrial complex will substantiallyreduce the role of Government in the direct management of agricultural enterprises.

The Government affirms that it will carry out the reform program and the various actionsreferred to in this letter in accordance with the matrix attached as an annex to this letter.

Specific policy actions to be included in the agricultural reform program wouldconsist of the Agricultural Reform Conditionalities agreed to under the Agriculture Sector AdjustmentLoan Agreement as well those described below which the Government of Ukraine will undertake tofurther accelerate the pace of market reforms in agriculture.

(a) The GOU would refrain from intervening in agricultural import and export markets (e.g.imposition of import and export quotas, export taxes, or export registration) with the exception ofinterventions acceptable under the WTO or voluntary export restraints under other multi-lateralagreements.

(b) The MOAF and MOF would continue to refrain from introducing subsidies associatedwith input prices or direct producer price subsidies.

(c) The MOAF and MOF would establish the current karbovantsi equivalent of US$ 130million (23 trillion karbovantsi) as the annual ceiling for these implicit credit subsidies for 1997-98.

(d) The MOAF would complete an Action Plan for bolstering the Agricultural MarketInformation System and initiate implementation of the Action Plan by January 1, 199i.

(e) The MOAF would work with oblast level agricultural administrations, private enterprise,and bilateral donors to promote the formation of agribusiness development teams to train farm and AISenterprise personnel on legal and entrepreneurial issues regarding plans for restructuring, privatization,and business development.

(f) Following the enactment of the legislation to establish the national unified registry (asecond tranche condition), the Cabinet of Ministers will issue a resolution to develop the implementationprocedures for the registry system in the course of 1997.

ANNEX 2 - Matrix of Agricultural Reform Policies

PROGRESS TO DATE FURTHER MEASURES ULTIMATE OBJECTIVES RESPONSIBLE

AGENCY

I. Domestic Marketing and Trade

Fixed prices abolished in 1994 for agricultural * Ensure that all agricultural procurements * Minimal government intervention in * Ministry ofcommodities. State agricultural purchases reduced in by state agencies, starting in November agricultural markets. Distortion-free Agriculture1994 to roughly 40% of 1989-92 average levels of 1996, are carried out on a competitive and competitive agricultural markets (MOAF) andshares of state purchases in total marketed production. basis through open tenders and/or Ministry ofIn 1995, these purchases fell to 10-20% of 1989-1992 agricultural commodity exchanges in a Finance (MOF)average levels. Total annual state purchases of manner facilitating private sectoragricultural products financed by the State Budget participation - 2nd Tranche. Continue tostarting in 1996 limited to an equivalent of US$ 675 refrain from introducing subsidiesmillion. associated with input prices or direct

producer price subsidies.

Taxes on intermediaries reduced from 70% to 45% in * Approval to amendment to Law on Profits 0 Functioning markets which are * MOF and itsearly 1995. Clarified by Tax Inspectorate that non- Taxes to be sought. accessible by all agricultural Taxcommission sales of agricultural commodities are to be enterprises either directly or through Inspectoratetaxed at 30%. Amendment to the Law on Profits Taxes intermediaries. Avoid discouragingsubmitted to the Parliament of Ukraine that would storage activities.reduce profits taxes on commission sales on agriculturalcommodity exchanges to 30%. Clarified that theCabinet of Ministers resolution (#682, August 27,1995) which assesses taxes on the increase in thenominal value of grain stocks is no longer in force.

PROGRESS TO DATE FURTHiER MEASURES ULTIMATE OBJECTIVE RESPONSIBLEAGENCY

11. Agricultural Foreign Trade Policy

Agricultural commodities removed from the export * Eliminate export duties and indicative * Market transparency * Ministry ofregistry system in March 1995. In February 1996, the prices on agricultural sector goods (i.e., Foreignsetting of obligatory indicative prices for export those which were imposed on the livestock Economiccontracts ceased for products whose export is not sector in May 1996) - 2nd Tranche. Relations andsubject to contingent intergovernmental agreements Trade (MFERT)with Ukraine or to anti-dumping cases.

All agricultural export quotas removed. * Refrain from intervening in agricultural * Promotion of Ukraine's comparative * Cabinet ofimport and export markets (e.g. advantage Ministersimposition of import and export quotas,export taxes, or export registration) withthe exception of interventions acceptableunder the WTO or voluntary export restraints under other multi-lateralagreements.

HI. Rural Financial System

Budgetary allocations and credit emissions for * Establish the annual ceiling for implicit * Eliminate distortionary credit * MOF inagricultural procurements were reduced significantly in credit subsidies in 1997-98 at 23 trillion policies. cooperation1995-96 under the reform programs supported by the karbovantsi (the current karbovantsi with MOAFIMF STF and Stand-By operations. Agricultural credit equivalent of US$ 130 million).subsidies were capped at US$ 130 million equivalent inkarbovantsi in 1996.

PR{OGRESS TO DATE FURTHER MEASURES ULTIMATE OBJECTIVES RESPONSIBLE

AGENCY

IV. Competitive Agro-Processing and Services for Agriculture

Wheat prices deregulated and bread prices have been * Complete an Action Plan for bolstering 0 Remove implicit taxation on * MOAFincreased to reflect the 1995 harvest costs and the agricultural market information system agricultural producers, processors,subsequent inflation. A Presidential Decree in October and initiate implementation of the Action and marketing firms.1995 repealed profit margins controls on grain Plan by January 1, 1997.procurement and storage. Oblast government powers toplace trade margin controls on bread, flour, and breadproducts were rescinded by a Cabinet of Ministersresolution May 1996.

Basic anti-monopoly regulations developed during * Devise and execute demonopolization 0 Facilitation of the emergence of new 0 Anti-Monopoly1993-1994. plans for 100 agro-industrial regional or and restructured firms, and the Committee,

national monopoly enterprises or growth of efficiency in both input State Propertyenterprise associations, including at least and output markets and in Fund, and cofive state-owned national monopoly agro-processing. MOAFenterprises or associations engaged in theprocessing of agricultural products and ininput supply - 2nd Tranche.

By early 1996, about 10 percent of roughly 4,000 large * Implementation of these streamlined * Accelerate AIS privatization and 0 SPFand medium scale non-farm AIS enterprises had been procedures for privatization of AIS stimulate the inflow of investmentprivatized. In May 1996, the President of Ukraine enterprises - 2nd Tranche. Privatize a capital.instructed the Cabinet of Ministers to develop minimum of 1000 AIS enterprises (whichprocedures for streamlining Privatization of agro- does not include state farms) - 2ndindustrial enterprises so (i) that the subscription process Tranche.for agro-industrial enterprises would be reduced to aperiod comparable to that for other medium and largeenterprises in other sectors; (ii) that there would be noreversal of privatization transactions previouslycompleted in the agro-industrial sector; and, (iii) thatshares of agro-processing enterprises that are to beoffered to primary producers (suppliers) of raw productwould be transferred to the individual members of thesesuppliers.

PROGRESS TO DATE FURTHER MEASURES ULTIMATE OBJECTIVES RESPONSIBLEAGENCY

V. Land Reform and Farm Restructuring

Law on Land Payments amended to remove the * Enact amendments to the Land Code to: * Secure transferable land use rights * State Committeerestriction which limits lease payments to no more than (a) abolish the 6-year moratorium on sale conducive to promoting long term for Landthe landholder's tax obligations on the land parcel. An of land; and (b) limit to three months the investment, access to financial Resourcesamendment to the Land Code to eliminate the 6-year time within which co-owners can exercise markets, and enhanced land mobility. (SCLR).moratorium on land sale has been introduced to the their preferential right to buy the share ofParliament of Ukraine by the Cabinet of Ministers and land being sold by a co-owner - 2ndpassed by the Agricultural Committee of the Parliament Tranche.of Ukraine.

Roughly 500 farms have executed the preliminary * Complete the registration process for land * Accelerate the privatization of * SCLR andwork for land share registration and some have share certificates in 2,000 collective agricultural land and restructuring of MOAFregistered their results. Land share registration and agricultural enterprises and issue land collective agricultural enterprises.issue of land share certificates to entitled beneficiaries share certificates to at least 75% ofin 100 collective agricultural enterprises was executed entitled beneficiaries in these enterprises -by May 1996 2nd Tranche. Complete the process of

exchanging land shares for physicallyidentified land plots at least 75 collectiveagricultural enterprises - 2nd Tranche.

PROGRESS TO DATE FURTHER MEASURES ULTIMATE OBJECTIVES RESPONSIBLEAGENCY

A Presidential Decree specifying the agencies in charge 0 Enact legislation to establish a unified * Establish documented property rights 0 Cabinet ofof land registration has been drafted (indicates SCLR national registry of rural and urban land to facilitate lease, sale, and the use Ministersand the Ministry of Justice). and other real estate - 2nd Tranche of land as collateral.

Normative acts (guidelines) of the SCI,R and MOAF * Enact legislation or normative acts that 0 Remove doubts as to the legality of 0 SCLR, MOAF,have been issued to specify procedures for the would: (a) give a right to two or more farm restructuring and raise and Cabinet ofexchange of land shares and property shares for land members of a collective agricultural agricultural productivity by Ministersplots and physical assets. enterprise to withdraw adjacent plots; (b) promoting the formation of private

limit to three months the time period farms and other new corporatewithin which the farm members' council agricultural enterprises.of the collective agricultural enterprise hasto consent to the plots of land requestedfor withdrawal; and, (c) give withdrawingmembers the right to i) appeal if the farmmembers' council fails to consent withinthree months, and ii) receive ownership ofthe plot to be withdrawn within 12 monthsafter consent is received - 2nd Tranche.

Action Plan has been drafted to undertake a publicity * Execution of a finalized Action Plan with * Reassure the beneficiaries of the 0 Office of theexercise to inform the agricultural population in each specific measures, budget, and ministerial Land Code as to the practical Deputy Primeoblast of the procedures available to them for competence - 2nd Tranche. implementation of farn Minister for theliquidating their property and land shares and obtaining restructuring. Agro-Industrialaccess to the assets to which they are entitled under ComplexUkrainian legislation.

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ANNEX 3

UKRAINE

AGRICULTURE SECTOR ADJUSTMENT LOAN

Timetable of Key Processing Events

Loan Committee March 1996

Appraisal May 1996

Green Cover June 1996

Negotiations August 1996

Board Presentation October 1996

Planned Loan Effectiveness October 1996

MOP Schedule D

Run Date: 8/28/96

Data as of: 8/26/96

Status of Bank Group Operations in UkraineIBRD Loans and IDA Credits in the Operations Portfolio

Original amount in USS millionsProject Loaii or Fiscal

ID Credit No. Year Borrower Purpose IBRD IDA Cancellations Undisbursed

Number of Closed Loans/Credits: ;

Active Loans

UA-PA-34581 L39850 1996 UKRAINE HOUSING 17.00 17.00UA-PA-35814 L40570 1996 UKRAINE ENTER. DEV. ADJUST. 310.00 210.00UA-PA-38820 L38650 1995 GOVT. OF UKRAINE HYDROPOWER REHAB. 114.00 114.00UA-PA-44110 L40160 1996 GOVERNMENT OF UKRAINE COAL PILOT 15.81 15.81UA-PA-9106 L36140 1993 MINISTRY OF FINANCE, UKRA INSTITUTION BUILDING 27.00 22.92UA-PA-9117 L38910 1995 GOVT. OF UKRAINE AGRIC. SEED DEVELOPM 32.00 32.00

TOTAL 515.81 0.00 0.00 411.73

Active Loans Closed Loans Total

Total disbursed (IBRD and IDA) 104.08 500.00 604.08

Of which repaid 0.00 0.00 0.00

Total now held by IBRD and IDA 515.81 500.00 1015.81

Amount sold 0.00 0.00 0.00

Of which repaid 0.00 0.00 0.00

Total undisbursed 411.73 0.00 411.73

MOP Schedule D - IFC

MOP Schedule D

Run date: 8/28/96

Ukraine - Statement of IFC InvestmentsAs of 6/30/96

(USS millions)

Original Gross Commitments

Fiscal IFC IFC Held by Held by Undisb. incl.Year Obligor Type of Business Loan Equity Participants Totals IFC Participants Participants

1994 Ukraine Fund Financial Services 2.00 2.00 2.00 0.80

Total gross commitments b/ 0.00 2.00 0.00 2.00

Less cancellations, terminations, repayment & sales 0.00 0.00 0.00 0.00

Total commitments now held c/ 0.00 2.00 0.00 2.00 2.00 0.00 0.80

Pending Commitments

FUIB 10.00 6.50 16.50Ukraine Fund Financial Services 1.50 1.50

Total pending commitments 10.00 8.00 0.00 18.00

Total commitments held and pending commitments 10.00 10.00 0.00 20.00

Total undisbursed commitments 0.00 0.80 0.00 0.80

b/ Gross commitments consist of approved and signed projects.

c/ Held commitments consist of disbursed and undisbursed investment.

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ANNEX 5

TERMS OF REFERENCE FOR TECHNICAL ASSISTANCE AND TRAINING'

A. Agribusiness Development Teams

1. The Government of Ukraine has made great strides in moving from a command economyto an open-market system in 1995. Much of this initial work focused on policy changes at the macro-level in order to create a policy environment conducive to private investment. Now that Ukraine hasbegun to achieve many of its policy objectives it needs to begin providing assistance at the farm andbusiness level if privatization is to achieve its full potential. The aim of the Agribusiness DevelopmentTeam program will be to create 10 regionally based centers capable of designing and implement strategiesto provide private farmers, aspirant private farmers, kolhozes, and agribusiness firms with informationand training on privatization, private sector business management, and agricultural marketing. These willbe set up over the course of 1996 and financed for a total of three years using funds available frombilateral donors and loan funds from the future Land Reform and Agricultural Support Services Project.

2. 'The following workplan is a draft to serve as the basis for further refinement by theDeputy Prime Minister for the Agro-industrial Complex and his Policy Coordination Unit (PCU) whichwill coordinate the technical assistance and training to be undertaken through the ADTs. To meet thegoal of providing training in privatization, business management, and agricultural marketing, each ADTwould undertake three major activities. First the ADT will conduct a complete assessment of the existingresources available to farmers and businesses in the Ukraine, as well as possible participants of a trainingprogram. Second, the ADT will conduct training workshops for participants identified in task one.Third, the ADT will identify, hire, and train two local associates to assist in the workshops and operatean agribusiness information center.

3. Activity 1 In order to maximize the resources already available the first task of theADT will be to meet with appropriate organizations already working on privatization and businesstraining issues in the region which the ADT would work. The Managing Director can then identify areasof unmet need on which to focus the training and locate resources. Special focus will be placed on usingexisting organizations to help identify potential trainees who will be invited to participate in the first ADTtraining workshop.

4. Activity 2 The ADT will hold training workshops, with the focus of the eachworkshop dependent on the information gained during Activity 1. Topics will include issues concerningprivatization, the preparation of business and financing plans, and the development and implementationof marketing plans. The workshops will target providing private farmers, business owners, and aspirantfarmers and business owners the organizational and business skills needed to operate a private business.The curriculum used in the initial workshops will provide a starting point for the development of a modelcurricula that will be available for use in the agribusiness training centers set up as more bilateral donorsimplement their technical assistance plans in this area.

i/These technical assitance and training activities are not financed under the Ag SECAL. They are being financedthrough bilateral donor grants and would be further financed under a separate Ukraine Agribusiness DevelopmentProject currently under preparation by the Govermnent of Ukriane and the World Bank. The terms of reference areincluded here to further explain the activities included under point (g) of the Memorandum of Agricultural ReformPolicies.

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5. As new workshops are held throughout the Ukraine the curriculum will be adapted basedon input provided from the oblast regional workshops. Once the regional agribusiness centers areoperational a model curricula, based on inputs from various oblasts in Ukraine, will have been developedand available to all centers. In each ADT, a Technical Advisor and Training Associates will conduct theworkshops. The Managing Director will also participate in the planning and implementation of theworkshops, especially the contracting of expatriate experts on finance, privatization, businessdevelopment, and marketing who will train the Technical Advisor and Training Associates and elevatethe technical and practical level of the workshops' curricula.

6. Activity 3 The final task of the ADT will be to identify, hire, and train two businessdevelopment associates to assist in the development and delivery of all of the ADT services. Specialemphasis will be on the design and operation of an agribusiness information center. A preliminary setof objectives for the center will be to provide counseling on privatization issues, financing sources, thedevelopment of business plans, and the identification and targeting of selected markets. If the ADT issuccessful the agribusiness information center will continue to be operated by the two local associates andthe administrative assistant. The managing director and the technical advisor will then be free to widenthe geographic scope of the training workshops.

7. The proposed staffing for each of the ADTs would be as follows:

# of People Title Duration of Assignment

1 Managing Director 36 months1 Technical Advisor 34 months2 Training Associates 32 months (each)2 Business Development Associates 28 months (each)I Administrative Assistant 36 months3-4 Expert Trainers 21 months (2 months each per year)

B. Creating an Agricultural Market Information System

S. The availability of accurate market infortnation could help the Government of Ukraineformulate policies which promote rather than inhibit the development of free and open markets.Ukrainian officials are deeply concerned about maintaining food security but opt for highly interventionistpolicies based on inaccurate projections of supply and demand on domestic and foreign commoditymarkets. Technical assistance provided under this component in a two year period will focus onstrengthening the capacity of government institutions to collect, analyze, and disseminate information toenhance private and public decision making. The technical assistance will be implemented by twinninga group of experts from Ukrainian agricultural information and research institutions with experts fromsimilar foreign institutions. The program for this component has three major objectives: (a) to build acommodity economic information system and initiate the publication of regular reports providing anassessment of current market conditions and a short term outlook for important commodity markets; (b)to demonstrate how the information base that is developed can be used to respond to Ministry of

16

Agriculture requests for short turnaround analysis of high priority issues in agricultural policy; and, (c)to access and develop databases for economic analysis of major commodity markets or policy issues.

9. Commodity Market Reporting. The core of this sub-component will be periodic reportsdescribing supply, demand, and price developments and recent or forthcoming policy decisions. Thereports will focus on filling the country's market information void, cover time horizons of 6-12 months,and be published at least quarterly. Each report will include a summary and analysis of recent events,a short-term forecast, and relevant data. The reports will be distributed widely to Government officialsand private sector users in agriculture and agribusiness. The information base generated by the reportswill be made available to Ministry policy-makers and will serve as the analytical underpinning for policyanalysis. The in-country training will be hands-on in nature. Sessions will be divided between lectureson basic macroeconomic theory and workshops in the application of the theory to analysis of Ukraine'scommodity markets. Expatriate experts will lead their counterparts through all the steps in preparationof commodity reports: development of data sources, identification of private sector and public sectorinformation contacts, basic commodity analysis, preparation of supply, use and price tables, preparationof short-term commodity forecasts, and packaging information in concise, easy-to-read formats.

10. Expanded Information Collection System. Expatriate experts will work with theUkrainian team to assess the information being collected domestically and what is available frominternational sources. The goals would be to identify information gaps, evaluate potential remedies, andexamine alternatives for a more cost-effective data collection program. The final, and most important,objective would be to develop methods for organizing the information to facilitate its use anddissemination. The team of expatriate experts will make international agricultural data bases availableto the Ukrainian team and provide initial training on the computer software necessary to use the data. Asinformation gaps are uncovered, the teams will explore possibilities of collaboration with foreign statisticsagencies to help improve actual data collection.

11. Policy Analysis. The ultimate goal in this area is to develop a corp of analysts trainedto conduct short turnaround but high quality analysis and to deliver the results to policy makers in a clear,concise fornat that is readily understood. Experience has shown that development of a policy analysiscapability is most successful after an comrnodity situation and outlook program is fully in place. In thesecond year of the project limited training in policy analysis will be provided, primarily focusing on theeconomics of land valuation and the infrastructure needed for the development of land markets.

12. Developing channels for the dissemination of the information in the reports. To builda commodity reporting program which Ukraine can sustain after the technical assistance has beencompleted, every effort will be made to minimize publication costs and to disseminate the informationas widely as possible in order to generate demand for it. Reports will be brief and in a format that couldeasily be reprinted in agricultural newspapers. The expatriate team will work with the Ministry ofAgriculture and the Agricultural Academy to seek out institutes, local ministry offices, or producersgroups who can help disseminate the commodity information at the local level. Cooperation withinternational donor organizations working with local advisory services will also be pursued. Specialistsfrom these other donor groups would work with local staffs to "translate" this information into a formatthat will be useful for farmers and agribusiness in the region. The contacts that will be developed withlocal offices will provide the Ukrainian comnmodity analysts with in-depth insights into local marketconditions that will assist them in better meeting the information needs of the public and private sectors.

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13. Tranin Personnel A two-year program covering four commodities will requireapproximately 50 person-months of training implemented both in Ukraine and including visits of theUkrainian team to the headquarters of foreign agricultural information institutions. This would cover aUkrainian team of 8-10 analysts. The Ukrainian analysts would be drawn primarily from the Institute ofAgrarian Economy. However, implementation will involve close cooperation with the Ministry ofAgriculture, and training may include analysts from the Ministry of Agriculture or other institutes.Individual Ukrainian staff would be selected on the basis of technical skills needed for a particularcomponent of the training.

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ANNEX 6

SUMM'4ARY OF UIRAINE REPORT: AGRICULTURAL TRADE AND TRADE POLICY'

1. This report is part of a broader Agricultural Trade Issues and Opportunities Study forUkraine, Belarus, and Moldova that has been prepared by a team supported by the World Bank. Thisreport is a joint effort of the World Bank, the Center for Agricultural and Rural Development (CARD),and the Ukrainian Institute of Agarian Economy (UIAE).

2. The purpose of this report is to assess the issues and opportunities for expandedagricultural trade. Ukraine is a nation with a significant endowment of agricultural resources, and underthe FSU exported agricultural commodities to the other republics. Ukraine has traditionally produced anexportable surplus of grains (mainly winter wheat), sugar, sunflower oil and meat and dairy products.The question raised in this report relates to what might be expected in foreign trade potential as reformsin Ukraine evolve. The objective was accomplished by analysis of production, unit costs and outputprices trends for six major agricultural commnodities: winter wheat, corn, sunflower, sugar beet, pork,poultry, eggs and related processed products since the initiation of the economic reform (focusing on theperiod 1991-1994).

3. The assessment of agricultural trade potential is made using two methods. The firstmethod involves converting domestic prices at prevailing exchange rates to Russian rubles and U.S.dollars and comparing them to international commodity prices and those in Russia. This provides anindication of the price at which Ukraine could "profitably" sell commodities in the Russian orinternational market, given the prevailing domestic prices. The domestic prices, of course, reflect thecontinual heavy intervention of the government.

4. The second approach is to convert the prices to a 1991 basis. In 1991, Ukraine was onthe ruble standard. Thus, by adjusting for inflation and using 1991 prices, there is an opportunity tocompare real prices of major agricultural commodities between Ukraine and Russia without any referenceto the exchange rates of domestic currencies to the US dol]ar. If foreign exchange markets were perfect,one would expect these comparisons to be similar to those generated by the first approach, and they aregenerally.

5. The comparisons of relative prices calculated in US dollars or 1991 rubles must becarefully interpreted. Government is heavily involved in Ukraine agriculture and in the agriculture ofneighboring countries. Although, the relative prices indicate "competitiveness" in international markets,it could be existent on the basis of unsustainable low-interest credit and other agricultural input subsidies.To the extent possible, adjustments have been made for the subsidies in the comparisons of relative costsand prices. Thus, the study presents a variety of production cost simulations reflecting potential changesin agricultural input and output prices during transition period that may affect the direction and volumeof future trade flows. Even with these adjustments, however, the comparisons represent only guidelinesto indicate where the agriculture in Ukraine might be competitive in international markets, if Ukrainecontinues on its current course of agricultural reform.

1/Published in October 1995 as a World Bank Technical Report.

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6. Finally, the comparisons do not deal with the problem of actually exporting agriculturalcommodities. Systems for export require sophisticated trading institutions, quality control, paymentsclearance, and other support activities. These are generally not present in Ukraine. Ukraine is more ableto trade with nations of the FSU than on international markets. In short, the system for support of trade,due to momentum accumulated in the past, still has many of the features that existed during the FSU era.This is yet another reason why the comparisons provided as indicators of competitiveness should becarefully interpreted in terms of their implications for international trade potential.

7. This study is unique in several ways. First, it uses cost data specific to the productionchain for the selected agricultural comrnodities. Previous studies have primarily relied on final productprices and variety of commodity to conimodity price ratios for assessing existing distortions, inefficienciesand the potential competitiveness of the different subsectors of Ukrainian agriculture and food industry.Second, this study covers the most volatile period of economic transition utilizing consistent methodsof deflating all prices and cost data to a pre-reform level. Third, the study uses the same data base andmethodology for estimation of basic deflators: nominal and real annual average exchange rates, andnominal and real annual average CPI for four transition economies: Belarus, Moldova, Russia andUkraine. Use of the same methodology to deflate all prices and unit production costs to 1991 level, whenall the above countries operated under the same currency regime, allowed for direct between countrycomparisons of the cost trends, of the different strategies that each country uses to reform its agricultureand other features relevant to the assessment of agricultural trade potential. Fourth, the same methodologyfor FSU countries has been used to make adjustments to potential changes in input and output prices thatcould occur at different stages of transition to the more liberalized economic and trade environment.

8. This report is primarily descriptive. Chapter 2 provides an overview of recent trends inagricultural production and trade, and discusses some relevant issues of agricultural and trade policy.Chapter 3 is the core of the report. Each section of this chapter provides relatively deep analysis ofproduction, unit cost and output price trends for each commodity that has been chosen for analysis. Themajor emphasis is given to the unit costs trends and to the changes in its components. This chapter alsoprovides a variety of cost simulations and discussion of potential competitiveness of each commodity inthe FSU and international market. Chapter 4 provides a summary of production, unit cost and pricestrends. It is also includes a summary table of conclusion on the potential international competitivenessof each commodity analyzed in the study. For those who are more interested in the "how" rather thanin the "what", a detailed information on methodology and methods is included in Annex 1.

Developments in Agricultural Production, Trade, and Policy

9. Ukraine has followed a very conservative course for agricultural reform compared tomany of the other European nations of the Former Soviet Union (FSU). Policymakers have found itdifficult to privatize the Ukrainian economy and develop policies that are consistent with a marketeconomy. Public ownership on means of production have continued to dominate the economicenvironment and have engendered significant government intervention at every level of production anddistribution.

10. The Government feared unemployment and social unrest, which it believed wouldjeopardize the existence of an independent Ukraine much more than high budget deficit, inflation or weakdomestic currency. Inflation rates, partly due to agricultural and consumer subsidies on food, have been

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above 1,000% for several years since 1991. To address inflation, budget deficits, and hard currencyavailability, Ukraine has tended to retain old inefficient methods, including government state orders,procurement of major agricultural commodities, government-controlled exchange rates, hard currencytaxes, nontransparent restrictions on trade, and subsidized interest rates. Combined with the consumersubsidies, these measures have driven Ukraine into even deeper economic and social crisis. In 1994 thereal GNP was only about 50% of the pre-reform level.

11. The agriculture and food sector of Ukraine has been considered to be a key to a smootheconomic transition to a market economic system and has continued to be a hope of economic recoveryin mid-90's. The agricultural sector has continued through 1994 to be one of the strongest sectors of theUkrainian economy. While industrial production, construction, transport, and trade has dropped byapproximately 50% from 1990 to 1994, agricultural production decreased by only 35 %. Moreover, from1992 to 1993 (considered the worst performance year during the transition of the Ukrainian economy),the level of agricultural production was stable.

12. On the other hand, the agriculture and food processing industry remain one of the mostregulated sectors of Ukrainian economy. State procurement of agricultural conunodities and the levelsof procurement prices has continued to be dominant factors in determining farm production from 1991to 1994. The Government of Ukraine has continued to control the procurement and distribution of mostagricultural outputs, and was the major player in the domestic food market. Price and margin controlspersist, the state order system has been retained, exports and foreign exchange markets remain controlled,and a large share of bank credit continues to be directed by the government. However, the distributionof power between the government and the farms in negotiating the quantities to be procured andprocurement prices has changed over the last four years. Currently, it is not so obvious whether thegovernment or the state and collective farms are more interested in state procurement and procurementprices. Due to significant political and economic pressure, there has been a tendency in agriculturalpolicy to replace direct methods of government intervention with more indirect subsidies and controls.

13. Our analysis indicates that the procurement prices for all selected crops were substantiallyabove the reported costs of production. For sunflower seeds, winter wheat and corn the differencebetween production costs and procurement prices was the largest among all other crops and livestockproducts. A huge difference between price/cost ratios for crop and livestock products is also one of thefeatures of recent developments in Ukrainian agriculture. It appears that farms2 are trying to compensatetheir losses in livestock production by relying on relatively stronger procurement prices for cropproducts.

14. The situation for livestock production is weaker for several reasons. The government hastaken important steps toward liberalizing this subsector and has made livestock production moreresponsive to input and output prices. The government has substantially reduced direct price subsidiesto pork and poultry producers and, at the same time, substantially reduced government procurement ofthese commodities, allowing the farms to deal directly with the meat processing plants. Due to thesignificant reduction in meat consumption, retail prices for pork, poultry, and other meats have increasedmore slowly than the procurement prices for crops. This has been one of the major reasons for thereduction in meat production.

2/Predominant share of the Ukrainian farms specialize in both crop and livestock production.

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15. Within the overall system of incentives that guide the agricultural enterprises in theirproduction decisions, taxation plays a secondary role, much less important than procurement prices,subsidized government loans for purchasing agricultural inputs, or limited profit margin requirements.This may explain why it has been relatively easy for the Government to introduce a different tax systemalmost every year since independence. At the same time, the debate on agricultural loans andprocurement prices, which can be seen as implicit taxation, has been intense and ongoing among allinvolved in agricultural production.

16. In 1993-1994, subsidization of agriculture shifted from explicit budgetary transfers toimplicit credit subsidies. The low interest loans to agriculture became a core of government support ofagriculture. However, coupled with a soft policy on returning these loans the new system of supportingagricultural enterprises was not much different from the system of direct subsidization of agricultureduring the Soviet era.

17. The slow pace of economic reform was coupled with unfavorable external economicenvironment: the collapse of traditional channels of inter-republican trade; decline in overall volume ofexchange of goods and services between Ukraine and other FSU countries. The importance of inter-republican trade has in general been underestimated by the Ukrainian government and the internationalconimunity. The first priority has been given to developing independent trade relations with the westerncountries at the expense of maintaining and reforming trade relations with the FSU countries. Especiallyfor Ukraine, which is poorly endowed with fuel resources and has to rely on imports, solid trade relationswith Russia and other suppliers of fuel from the FSU region has been a key to a much smoothereconomic transition. Unfortunately, political tensions between the neighboring FSU countries in the early90's have created very unfavorable trade environment for all FSU countries Introduction of quotas,licenses and export taxes, coupled with artificially low official karbovanetz/ruble and karbovanetz/dollarexchange rates, delays in payment clearance have made trade between companies extremely risky andunattractive.

18. Deep govermnent involvement in international trade has become another complication ofthe transition period and has had several negative consequences on almost all aspects of recent economicdevelopment. It has added up substantially to inflation and government budget deficit; prevented Ukrainefrom developing standard mechanisms of international trade; separated Ukrainian producers and tradingcompanies from international trading community and from knowledge this community could bring to thecountry. It has also justified a variety of nontransparent restrictions to trade such as so called"recommended minimum export prices" for long list of exportable commodities including all agriculturalcommodities included in this analysis.

19. The current administration in Ukraine is committed to a more rapid pace for the marketreforms, including complete price liberalization, significant subsidy reductions, and the privatization ofland and other production capacities in agriculture. It looks like that the new Ukrainian government ismaking serious steps in developing a sound monetary, exchange rate and trade policy. There are clearsigns of a more positive attitude towards the strengthening of commercial relations between Ukraine andother FSU republics (especially with Russia).

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Commodity-Specific Conclusions and Relevant Agricultural and Trade Policy Issues

20. Generally, the cost of production for the selected commodities, calculated in 1991 rubles,has been much less variable than agricultural input or output prices. In winter wheat, corn, sunflowerseed, and pork production, it has been decreasing in real terms. However, calculated in US dollars, thecost of all selected commodities showed a significant increase: nine fold in sugar beet; about fivefold inwinter wheat, sunflower seed and poultry and fourfold in pork production. The opposite dynamics ofthe cost of production calculated in constant rubles and US dollars reflects the fact of continuousappreciation of local currency calculated in real terms. Less variable dynamics of the cost of productiongive the impression that farms in fact, have been adjusting to relatively higher input prices by reducingthe use of inputs such as fuel, mineral fertilizers and herbicides and substituting them with relativelyinexpensive inputs such as labor. This is due to the reduction in subsidies for inputs, and domestic inputprices that are more reflective of international prices. The largest real cost of production increases haveoccurred in the livestock and poultry sectors, where the liberalization has been most pervasive. Still,there is evidence that even with the slower course of economic reform in Ukraine, prices of agriculturalcommodities are tending toward world market levels.

21. When evaluated simply in terms of prices converted at the present exchange rates or intothe 1991 ruble, all prices of the commodities selected for analysis (sugar beet and sugar, sunflower seedand oil, winter wheat and wheat flour, corn and formula feeds, hogs and pork meat, and poultry), are"low" relative to those in Russia and in broader international markets. However, these prices reflectsignificant input subsidies for most commodities supplied by government in the form of outright grantsand artificially low input prices or credits provided for purchase of inputs at interest rates that are farbelow the market interest rate.

22. Comparisons of the costs of production adjusted for input subsidies ("calculated cost' forshort) with the prices prevailing in the border international markets cast a significant doubt whetherUkraine has a comparative advantage in some of the commodities chosen for this study. Winter wheatand flour, corn and formula feed, and sunflower seed and oil have survived the test of adjustments ofinput prices to international level and again have shown a considerable export potential. Reduction ofconsumer subsidies on food have decreased overall consumption of food and increased potential for theexport of additional quantities of grains, sunflower seed and oil, and sugar for export. Ukraine alsoappears to be a comparatively cheap producer of sugar beet, but this advantage in raw commodity isoffset by very inefficient refining operations: the calculated Ukrainian production cost of sugar is abovethe international level. In our estimate, Ukraine would have to significantly modernize it sugar processingand refining industry to compete in the international sugar market.

23. The livestock sector is obviously less competitive and will likely develop competitiveness,only after the reform has been more fully implemented in the crop subsectors. Our calculations show thatwith existing technology and productivity levels, pork production is the least competitive commodityamong those selected for the study. In 1992-1994, the calculated unit cost of pork meat production was40%, 60%, and 44% higher the international market price, respectively. Relative stability and currentcost advantages of small scale private hogs operations is temporary, and will probably vanish as soon asgrain prices fully adjust3.

3/An estimated 30% of bread production is fed to hogs and cattle by private farmers.

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24. Although, Ukraine does not appear to be competitive internationally in pork productionUkraine remains the lowest-cost pork producer in the FSU region. However, the fact that the calculatedcost of pork production is above the international market price makes it unclear whether Ukraine willsupplant European and US exporters of pork to Russia. It is more likely that in the short run, Ukrainewill become a net importer of pork. However, in the long run, with successful adjustments in the cropsector Ukraine may become a sizable pork exporter, to at least to the FSU market.

25. Our analysis also suggests that the export potential of Ukrainian poultry industry is at leastambiguous if not low. In the short run, before the significant adjustments made in grain production andthe feed industry, Ukraine is unlikely to become an exporter of poultry meat to the international market.However, considering the fact that the unit cost of poultry meat production is the lowest within the FSUregion, there is a possibility of exporting poultry meat to Russia, Belarus and other FSU countries. Thesituation is somewhat different for egg production. Adjusted for input prices and subsidies, the unit costof egg production appears to be 40% below the international price level.

26. In the long run, it is anticipated that Ukraine will become a major exporter of most ofthe agricultural commodities selected; that livestock and poultry which now evince little competitivepotential will become more competitive. This will require adjustment in the livestock sector and in theprocurement and distribution system for feed. In general, the profile for Ukraine agriculture suggestedby the analysis of trade potential is that of a nation that is a producer of food grains for export, coarsegrains and oilseeds for export and feed use, and livestock for export. The sequence of the reforms to dateindicate that the first opportunities for export will come for sugar and food grains, followed by oilseedsand coarse grain, and then by livestock products.

27. The export potential can be realized if the reforms in agriculture are accelerated andsustained. Assuming that Ukraine will succeed in privatizing its agriculture, and that the law of supplyand demand will be the primary guideline for economic decision making in agriculture, it is reasonableto discuss some steps that will lead to a "normalization" of trade policy. Current taxes, restrictions onforeign currency, licensing, and quotas should be converted to tariffs. These tariffs can be reduced overtime as the sectors adjust to international markets and prices. However these type of recommendationswill be too general and generic if we do not mention a variety of nontransparent restrictions to trade thathave to be abolished in order to normalize trade policy and trade environment.

28. There is simply no rationale in the simultaneous liquidation of quotas and licenses andthe introduction of so called "recommended minimum export prices" for more than fifty differentcommodities including grains, sugar, sunflower seeds and oil, meats and milk products4 . Unless the tradepolicy is rationally formulated, there will continue to be difficulties in export. In fact, inconsistent andcomplicated trade policy represents one of the major reasons why Ukraine is at present not exportingmore wheat, sugar and sunflower oil. In a country that lacks a reserve of foreign currencies, these tradepolicies represent a major obstacle to economic development. Many of these trade policies have emergedto help protect the domestic market and the consumer and producer subsidy system. With the furtherwithdrawal of consumer subsidies and the phasing-out and decoupling of producer subsidies, there is littlejustification for continuing the current trade policy. Accordingly, a change to a transparent and moreopen trade policy should receive a high priority.

4/These prices appear to be more restrictive than any quotas or licenses and bring even more unfairness anduncertainty to trade than any other trade restrictions.

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ANNEX 7

SUMMARY OF LAND REFORM AND FARM RESTRUCTURING IN UKRAINE'

1. Under legislation adopted in 1992, Ukrainian law recognizes private ownership ofagricultural land, as well as collective and state ownership. Also in 1992, a program to transfer land fromstate ownership to collective and individual ownership was initiated on a large scale, along withprocedures to restructure collective and state farms. The transfer of land ownership and restructuring oftraditional farrns create opportunities for private farming to develop in Ukraine after decades of collectivemanagement of agriculture. The impact of these developments at the farm level is examined in the presentstudy by evaluating responses of 2500 participants in the process.

2. In July 1994, Ukraine had approximately 30, 000 private farmers cultivating 2 % ofagricultural land in 20-ha farms, with another 12 % of farmland cultivated individually by farnilies ofemployees in the forn of 0.5-ha subsidiary household plots in large-scale farms. In the sampled farns,almost one-third of the land in these two forms of individual cultivation was privately owned, with theremaining two-thirds still in the traditional forns of lifetime possession and usership. Functioning landmarkets have not begun to develop in Ukraine due to slow documentation of individual ownership anda moratorium on sales.

3. The share of state-owned land shrank from 100% in 1991 to only 35% in January 1994,but most of the land remains in collective tenure: 75 % of agricultural land is managed by collective farmsand by state farms that are subject to privatization in the future. Three-quarters of large farm enterprisesin Ukraine reorganized, but the preferred new form is that of limited liability partnership or collectiveenterprise, which in many cases involves little change from the predecessor, the state or collective.

4. Most employees at present do not seek to leave the collective to start a private farrn. Themain obstacles reported by the respondents are insufficient capital, difficulty obtaining machinery and farminputs, and legal and political uncertainty. Loss of social benefits is not an overriding concern, as privatefarmers do not experience particular difficulties in access to social services. Distribution of farm productsis still dominated by state procurement, which is the main outlet for both large-scale farms and privatefarmers. Alternative trade channels are not well developed. Input supply is similarly dominated by thestate, although private suppliers are beginning to emerge.

5. Further progress toward improved efficiency in Ukrainian agriculture requires continuedrestructuring of farrn enterprises into smaller autonomous units based on private ownership of land andassets, clear formulation of procedures that allow exit of individuals and small groups with shares of landand assets, development of land markets, and establishment of functioning market infrastructure forcompetitive input supply, marketing services, and financial services.

'Published in December 1994 as a World Bank Discussion Paper

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Why monitor land reform and restructuring of farms in Ukraine?

6. Transfer of agricultural land and assets to private ownership and the creation of moreproductive farms are essential components of agricultural reform in Ukraine. Unless strongly market-oriented private commercial farms can be created, Ukraine's labor intensive agriculture will orient towardthe subsistence needs of producers and local markets, rather than specializing to take advantage of exportopportunities. The Government of Ukraine is responsible for designing and implementing a programthrough which producers will receive ownership of land and assets and create new kinds of farms. Thetask of privatizing land and restructuring farmns is intrinsically complex. The pace at which it proceedsdepends on a number of factors, each of which will likely require remedial intervention from thegovernment. Identification of the constraints and concrete opportunities for Government action andinternational support requires information on developments at the farm level.

7. The present study is based on three extensive surveys carried out in Ukraine in the winterof 1993-1994 by the Ukrainian Agricultural Academy of Sciences and the World Bank. The objectiveof the study has been to conduct a rigorous empirical and analytical assessment of changes in landownership andfarm structure from independence through Spring 1994.

Does the process of reform in Ukraine reflect a clear commitment to private ownership of land andassets?

8. The overall objective of the agricultural reforn is to create an internationally competitivesector with high returns to the rich endowment of land and skilled agricultural labor. The legal frameworkand implementation of reforms in Ukraine are still ambiguous as to whether agriculture in the fiuture willbe based predominantly on private ownership of land and assets, or on collective ownership under newand different management. This ambiguity is reflected in the laws and procedures that give equal legalstatus to private ownership and collective ownership, but constrain the activities and transactions necessaryto make private ownership fully functional. A stronger articulation of commitment to privatize ownershipof land and assets, rather than reform collective ownership, is needed. Collective enterprise in a varietyof forms will continue because many new owners will choose it, but the new collective enterprises shouldbe based on clear private ownership. The new Government's strong endorsement of the general reformprogram, as evidenced by the Fall 1994 agreements with the International Monetary Fund, provides anopportunity for articulation of commitment to private ownership as the basis for agricultural reform.

Why restructure and not simply privatize?

9. Privatization in industry in most countries stops at the transfer of ownership and explicitlyleaves restructuring to the new owners. Except for the case of parastatal monopolies that must bereconfigured prior to privatization, enterprise level restructuring is not in general a feature of industrialreforms. Privatization in agriculture follows a different path. The collective and state farms, like theparastatal monopolies, must be reconfigured as part of the privatization process, because they have noanalogue in agriculture in market economies. While it is sometimes argued that a collective or state farmscould be privatized directly as a corporate farrn, there is no ready counterpart in market economies fora 3,000 ha farm with 400 owner-employees. A simple transfer of ownership to members and employeesof state and collective farms would not directly create viable and competitive production units. For thisreason programs of land reform and farm restructuring include additional mechanisms through which

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owners can create new farming units, either within the former farm, or through exit. Privatization thusproceeds immediately into restructuring.

What is the current status of the reform?

10. The process of fundamental restructuring to improve the performance of Ukrainianagriculture has begun. Over 70% of all farm enterprises in Ukraine formally reorganized. The share ofstate owned land in farms in the survey dropped from 100 % before 1990 to 35 % in 1992, but 62 % ofthe land on surveyed large farms is in collective, not individual ownership. The average size of subsidiaryhousehold plots almost doubled from less than 0.3 ha to 0.5 ha, and approximately 30,000 private farmswere registered. Over 13% of farmland in Ukraine is now cultivated by users of household plots andprivate farmers. A state reserve of land intended for distribution to future private farmers was initiallycreated by transfer of 10% of the land of collective and state farms. Most of this land (nearly 2.5 millionha at its peak) is still cultivated by the large farms under loosely defined lease arrangements. The processof restructuring; that is, changing the internal form and organization of farms, is still in a preliminaryphase, and has not moved beyond the creation of shareholding farrns. The shareholding farn is similarto the traditional collective and state farms, and can be adopted with relative ease simply by registeringthe existing farm under a new category of organization.

11. The New Collective Sector. The sector is now in a kind of equilibrium of a low level ofrestructuring. There is no clear mechanism for creation of new production units other than theshareholding large farrn or the individual family farn. According to the survey, not many employeesdesire to leave the collectives and create new business units. A minimally reorganized new collectiveagriculture is unlikely to be internationally competitive. It continues to suffer from the inherent economicweaknesses of production cooperatives and labor-managed firms, which include a tendency towardoveremployment, poor labor discipline, and failure to meet financial obligations. The incentive structurein new collectives remains incompatible with market signals.

12. Private Farming: Private farming is growing, but remains a distant third player incontribution to aggregate production, after the new collective sector and traditional household subsidiaryfarm ing. Private farmers are engaged in commercial production for markets, and are not subsistencefarmers. In response to changing market conditions, private farmers have chosen a production mix thatemphasizes crop production to a greater extent than on farms that remain collective. Private farmers arebetter educated than employees on collectives. Private farmers report that owIn savings is the mostimportant source of start up capital, and that availability of financing for working capital and investmentis a major problem.

13. The Ukrainian private farmers provide evidence that when the legal framework createdopportunities for producers to function outside collectives, individuals welcomed the opportunity, andacted upon it. Private farmers at present are functioning between systems, and are using any possibilitiesthat arise to keep their operations functioning. That they exist at present and that their numbers areincreasing is testament to the firrnly held belief that land will in the future have value, and that privateproduction has a future. Private farning can survive and prosper in Ukraine in an appropriate institutionalenvironment. It is unlikely that private farming will be substantially strengthened as long as privatefarmers are forced to operate in the narrow and inhospitable gap between the command and marketsystems.

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14. Market services. Private suppliers of market services are emerging in Ukraine, but afunctioning market infrastructure still has not developed. Collective farms and private farmers continueto rely largely on state channels for input supply. Farm managers and private farmers report that inputsare available, but that prices are high. Purchased inputs, particularly fuel and chemicals, are moreexpensive relative to output than prior to the reforms, and farms have greatly reduced input use. Bartertransactions to secure inputs have increased. Employees who intend to remain in collectives fear that asprivate farmers they would not be able to secure inputs, would face high risks, and would have difficultysecuring sufficient capital. These concerns are much more prominent in the decision to remain incollectives than the fear of losing access to social services. State channels are also still dominant inmarketing of output, particularly for the important cash crops, such as grains and oilseeds. Private farnersand managers of large farms are dissatisfied with the prices and services they receive from state marketingfirms. Financial services are reported to be the most severe problems for private farmers and for thoseconsidering private farming.

15. Social Services and Benefits: There has been little change in the way in which socialservices are provided in rural areas. The new collective farms continue to be major providers for servicesother than health and education, for which they play a secondary role after the state. By law enterprisescan elect to transfer responsibility for provision of social services to the local council, along withownership of assets in the social sphere. Farm managers report that very little transfer to local councilshas taken place, and that they continue to provide a wide range of social benefits. The majority ofemployees, however, report that they do not receive many among the sixteen enumerated benefits providedby their enterprises, suggesting that except for health and education provision of social services even underthe traditional system may have been less than universal. For example, less than one half of theemployees reported that they enjoyed the use of subsidized vacation facilities, while 90% of farmmanagers stated that they provided this benefit. While 85% of managers indicated providing heating fuelto their employees, only one third of the employees reported that they received this benefit.

Why have the accomplishments been so modest?

16. Initial accomplishments in the reform have been modest for a variety of reasons:

Political and legal uncertainty: Controversy over the outline of the general reform program hasdistracted from the sectoral agenda, and frequent changes of legislation have created a sense ofuncertainty about the future course of reform.

Lack of a supportive environment. Functioning markets for farm inputs and products have notyet emerged, impeding successful operation of new privatized agriculture. The financial sectoris in disarray, few banks are able to give mortgages, and few land owners are willing to offer landas collateral. Mortgage finance is an important instrument of agricultural lending for privateinvestment, but its development requires security of tenure, legal title to land that can be used ascollateral, and existence of land markets to give objective valuation of land. Land markets do notfunction at present because sales of privately owned land are subject to a moratorium of six years,although draft legislation being considered proposes to reduce this period to two years. Fullyfunctioning land markets, including unconstrained purchase, lease, and mortgage will be necessaryif Ukraine is to develop the high yielding, high value agriculture consistent with its endowmentand needed to support rural incomes.

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Inadequate mechanismsfor restructuringand exit. Procedures for further restructuring at the farmlevel are inadequately developed, and individuals and farm managers lack basic information aboutthe options open to them. According to respondents in the study, the mechanism of exitingcollectives with land and assets is not yet operational. Mechanisms will have to be developedthrough which a group of shareholders can present a proposal of separation, includingspecification of the land and assets they would like to take with them. Procedures for adjudicationof disputes that arise when the remaining shareholders do not approve a separation proposal willhave to be devised.

High risk and lack of instruments for risk management. Political uncertainty, lack of clarity indesign of programs, and macroeconomic instability create a risky environment for private farming,and even such basic instruments as secure savings and insurance are lacking. Continued highinflation increases risk for agricultural producers, and exacerbates the retreat from markets intointernal distribution and accumulation of inventory. Participants in land reform and farmrestructuring are likely to choose to remain within larger units, where non-cash distributionsprovide a hedge against erosion of money incomes.

What must yet be done?

17. The current procedures for land reform and farm restructuring do not yet provide acomplete framework within which implementation can proceed. Nor is the environment created by themacroeconomic reform program yet supportive of strong agricultural reform. A number of changes inlaw and procedures should be considered.

18. Improvements in the market environment are of highest priority. Although creation of fullyfunctioning market institutions will take time, the regulatory environment can be improved quickly byremoving remaining export barriers and remnants of the state order system. Agreements in the fall of1994 with the International Monetary Fund and the World Bank lay the foundation for the creation of abetter market environment. Privatization of input supply, agricultural processing, and marketing shouldbe accelerated to provide an environment in which private producers and firms can function effectively.Formally privatization of processing and marketing is outside the purview of land reform and farmrestructuring, but is essential for the success of the latter. Reform in the financial sector should accelerate,and financial services for rural clients should be much improved. Strict financial discipline should beimposed on all farms, as well as all other enterprises, so that accumulating arrears do not undermine thereforms and distort incentives to which managers respond.

19. Distribution of ownership shares should continue. Clear individual ownership should beestablished for land and productive assets. Distribution of share certificates is the first stage of thisprocess, and it should be completed expeditiously. Land in the state reserve should be transferred toprivate ownership, not held indefinitely for future applicants. With removal of the moratorium on sales,future entrants into farming will be able to buy land through normal commercial transactions.

20. A number of changes should be made in the legal framework governing land ownershipand transactions. The moratorium on sale of land should be removed. The current prohibitions are anobstacle to creation of market-oriented farming through regrouping of land and assets. Prohibitions ontransactions in land also inhibit financing and investment. Leasing arrangements should be formalized andlessees should pay for land. At present, many lessees use land and pay for it indirectly or not at all.

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Much of the land leased comes from the state reserve fund, and the lease is in practice simply permissionto use the land, rather than a commercial agreement.

21. Upper limits on size of private farms should be eliminated after a short transition phase.Under present law private farmers cannot own more than 50 ha of arable land. Market mechanisms suchas taxation should be used to prevent large-scale accumulation of land by absentee owners for speculativepurposes.

22. Land tenure should be documented and made secure. Where land currently in private usecan legally pass into private ownership, this process should be accelerated and the land titled. Land inprivate use that cannot legally pass into private ownership should be leased to the user for the periodduring which its tenure status can reasonably be expected to be clarified. Operators who lease land shouldpay for it.

23. Procedures for exiting collectives with land and asset shares should be claimed and madeoperational Procedures for individual exit exist in theory, but virtually no respondents in the study reportedexit with land or assets. Procedures for exchanging and grouping shares among individuals prior to exithave not yet been developed, and are needed. The experiences in Russia under the Nizhnii Novgorodrestructuring pilot and in Hungary under the Cooperative Transition Act should be examined for relevantlessons. An approach to exchange and grouping of shares prior to exit should be developed for Ukraine.This is particularly needed because land shares are so small.

24. Pensioners, who are recipients of nearly half the land and asset shares in formercollectives in the sample, should receive special guidance on how to manage their land and asset shares,including options other than leaving shares under management of the existing collective. Mechanismsmust be developed to enable pensioners to sell their asset shares and lease their land to active producersin return for payment.

25. Restructuring of rural services currentlyprovided by the collective sector should be treatedas an independent process, rather than an adjunct off restructuring. Public services that will remain inthe public sector should be transferred to local governments in a mandatory process, after enhancementof the administrative and financial capacity of the local governments. Farms should be required to divesta portion of the assets used in provision of services that belong in the private sector. The rights andinterests of farmn shareholders should be protected in the divestiture process, and the ultimate objective ofdivestiture should be to enhance competition in provision of private services in rural areas.

26. Technical assistance and information programs should be implemented in order to guidethe rural population through the transformation. Much of the rural population at present is poorlyinformed about their rights and options, and farm managers also report a need for more information.

27. As these issues are addressed effectively, Ukrainian agriculture will be able to advanceto the second stage of the overall land reforn and farm restructuring program, which involves creationof market-oriented, profit-motivated structures based on clear individual ownership of land and assets andan incentive system encouraging individual responsibility and rewarding effort. The new farm structuresmay take a variety of forms. Some persons will exit individually with shares of land and assets andestablish private farns. Others will pool their shares and create small partnerships or cooperatives forfarmning. Yet others may choose to lease their land to more enterprising producers and assume the role

30

of "inactive investors" or alternatively focus on development of private farm-support services. The formnercollectives will thus gradually break up into individual farms or small fanning groups, where productionwill be based on privately owned land and assets. These new producers will be supported by marketservices, some of which will be provided by new private entrepreneurs (again individually or in groups)while others may be based on former collective management structures that will redefine their role asservice firrns or cooperatives.

28. Full implementation of the program already initiated (with changes indicated above) willthus result not in complete fragmentation of existing farms, nor enforced corporatization of the largetraditional units. Instead farms of a range of sizes reflecting the judgment and decisions of new ownersof land and assets will emerge over time. Because this will be a dynamic process with internalmechanisms for adjustment in farm size, it is especially important that leasing, purchase, sale, andmortgage of land be protected by law.

31

ANNEX 8

SUMMARY OF UKRAINE: THE AGRICULTURE SECTOR IN TRANSITION'

1. With the dissolution of the Soviet Union and the breakdown of previously establishedproduction and trading practices, Ukraine has been forced to confront the demands of a market basedeconomy. In the food and agriculture sector, this redirection of production facilities needed isconsiderable due to the legacy of distorted prices, government intervention in the production system,monopolistic input and output marketing, and inherent inefficiencies of the collective and state farmsystem.

Agricultural Performance and Structure

2. The food and agriculture sector has greater economic potential in Ukraine than in anyother region of the Former Soviet Union (FSU). This is due primarily to its favorable agro-climaticconditions. Ukraine is currently a major producer of grains, oilseeds, root crops and livestock, and hasthe potential to become a major producer of fruit and vegetables, however, performance in the sector hasbeen far below potential. Crop yields are 50% to 55% of those in Western Europe, fertility yields oflivestock are 33% lower, and feed conversion ratios are less than half of Western standards.

3. In addition to technical inefficiencies, Ukrainian agriculture still exhibits the majorhallmarks and inefficiencies of the Soviet system. Most of the production is organized in large-scale statefarms and collectives. The large bureaucratic administrative structures that managed agriculture duringthe Soviet period are still functioning at the national level and have been preserved, almost withoutchange, at the regional level.

The Reform Process

4. The Government of Ukraine has moved the economic reform in the agricultural sectorforward on two fronts - market and price liberalization, and land reform. Progress in these areas wasslow for the first two years after independence, however there was marked progress in 1993.

5. Formal price controls have been removed for all agricultural inputs and commodities,however, the government still maintains control of the wheat market through margin controls on millsand bakeries and issuing input credits linked to forward state contracts. In addition, a vast majority ofthe country's grain storage capacity is still controlled by the state, through which the state exercises aconsiderable amount of control on prices, exports and domestic grain movements. Despite these controls,farms are increasingly dealing with private input suppliers and exporters because the poor payment recordand inefficiency of the state procurement system. One estimate by a Government source is that 25% offarms no longer work with the state procurement system.

1/Published in November 1994 as a World Bank Country Study and disserninated in translated version in Ukraine.

32

6. The privatization of land is moving slowly. Uncertainty about future legislation on landownership, the risks involved in private farming under present macroeconomic conditions and the absenceof a competitive input/output market and credit system substantially limit interest in the establishment ofindependent private farms. As of April 1994 private farmers controlled only 1.5% of Ukraine'sagricultural land, while 1 1.8 % of agricultural land was in private plots. Reform in the agricultural sectoris proceeding mainly through the reorganization of existing collective farms and state farms. Themajority of state farms have been restructured and privatized into collective farms, however some stillremain (primarily research farms) in public ownership. By the first quarter of 1994 two thirds oftraditional large scale farms had elected to formally register as private entities. However, among thefarms that decided to register, 85 % registered as collective enterprises, which is an organizational formessentially identical to the old kolkhozes. Among those farms which have undergone substantialreorganization there are 355 agricultural cooperatives (lease cooperatives) and about 100 joint stocksocieties.

An Agricultural Reform Strategy.

Market Liberalization

7. The most important contribution that the Governrment can make to improving agriculturein the short run is macroeconomic stabilization and reduction or elimination of controls on domestic andinternational market transactions. Inflation coupled with price controls has been detrimental to agriculturein the past, and will continue to plague agriculture in the future if it is not managed correctly. Greaterprice liberalization would eliminate implicit taxation of farmers arising from controls that favor urbanconsumption. The Governmnent has made major strides to correct these problems, but will need toremove remaining export restrictions and margin controls on wheat processing to complete the process.

Securing Food Supply. Protecting Vulnerable Groups.

8. Since Ukraine produces a surplus of agricultural products over and above its domesticneeds, shortages of domestic food supplies are unlikely. However, there may be groups whose incomeshave dropped to the point where their nutritional status is in jeopardy. Currently, the Governmentprovides broad based food subsidies, primarily to urban consumers, through margin controls on breadand flour processors, and export restrictions that suppress the price of domestic food products. Foodstamps programs, income transfers and subsidies linked to products with low income elasticity are allpreferable to untargeted subsidies of the kind found in Ukraine.

Restructuring and Privatizinz the Agricultural Distribution and Processing

9. The successful transformation of agriculture will depend to a large extent on thedevelopment of a competitive farm support sector - material/technical supply, agricultural services andthe marketing of agricultural commodities. Without the establishment of competitive for inputs andoutputs, private farms will remain dependent on authorities, and an efficient pricing structure cannotdevelop. Rapid demonopolization of agroprocessing input supply and marketing systems and free entryinto the market for new enterprises should be permitted to encourage market development.

33

Reform of the Agricultural Credit System

10. Subsidization and chronic non-repayment of agricultural credit is a major source ofgovernment subsidy to the agricultural sector and has undermined credit discipline in the country. Thesituation is further complicated by linking the provision of agricultural credit to State contracts. Thedevelopment of credit unions or other forms of cooperatives, small scale rural banks or informalarrangements involving private sector trade credit might be an effective means of reaching a broader arrayof rural clients.

Land Reform and Farm Restructuring

11. The objective of agricultural restructuring should be the creation of a sector ofindependent, privately-owned and largely owner operated farms that are free to change their farrningmethods and output mix in response to evolving product and production technology and changes in inputand output prices. They should also have the freedom to select the most efficient organizational form,whether it be as individuals, small groups or collectives. The land reform and farm restructuringprogram in Ukraine should focus on three areas.

i) Restructuring and privatization of collective and state farms. This would include:

* separation of production activities from social and municipal functions

e distribution of land and other productive assets to members in physically recognizableform and not as anonymous shares

e freedom of decision to members about future organization of production after thedistribution of ownership of land and other assets; and

* promotion of competitive input and marketing enterprises which serve the restructuredfarm sector.

ii) Promoting Private Farming and Farmers Cooperatives. International evidence is clear thatindividually owned private farms are more efficient than collective or state farms. The evidenceis also clear that agricultural systems that have a critical mass of private farmers, they create aneffective demand for new competitive sources of supply for inputs and channels for marketing,storage processing and distribution.

iii) Strengthening Land Legislation. Several new laws are being prepared on land ownership andland use in the framework of a new land code. The new legislation envisages the fullprivatization of agricultural land. If this law is passed in the parliament, Ukraine will have oneof the most progressive approaches to land reform in the FSU. According to the draft, everycollective farm member will receive, without payment, an average land share with full ownershipand title. Further work in the area of revisions to the land law are:

* giving the immediate right to sell and buy agricultural land and shares receive bycooperative farm members

34

* allowing rental levels for agricultural land to be freely negotiated between parties

* permitting mortgaging of land to finance purchase and/or improvement;

* ensuring timely processing and approval of applications for land; and

* consolidating land records in each district center and computerizing record keeping.

Improving Agricultural Productivity.

12. Land reform, state and collective farm enterprise restructuring, and privatization areimportant preconditions for the improvement of the efficiency in agricultural production. However, ifefficiency is to be improved on a sustainable basis, there will need to be a substantial recapitalizing ofthe agricultural sector. This will include

* the development of physical facilities (wholesale centers, farmers markets etc.) to supportthe market for agricultural products and inputs for agriculture;

X reconstruction and major modernization of support services along decentralized privateand/or cooperative lines;

* reconstruction and modernization of agroprocessing;

e introduction of environmentally friendly technologies.

Restoring International Trade

13. Export of agricultural crops can make a significant contribution to sectoral growth. Thereis a marked difference between the problems to be addressed in exporting products to the FSU and non-FSU countries. To expand exports to FSU countries, substantial investments are required in reducingtransaction costs through the establishment of secure payment systems. For expanding export to non FSUcountries, Ukraine will need to make substantial investments, both public and private, in improving thequality of exports, for example, grading and cleaning equipment.

New Roles for Government

14. The Government's role should be to establish the general rules and facilitate the conditionsfor smooth operation of markets and independent business organizations, and remove itself from the dailyoperations of agribusiness companies. In order to achieve this goal there must be a completerestructuring of agriculture sector ministries and committees.

35

Ukraine at a glanceEurope & Lower-

POVERTY and SOCIAL Central middle-Ukraine Asia income Development diamond-

Population mid-1995 (millions) 51.6 488 1,154GNP per capita 1995 (US$) 1,630 2,240 1,700 Life expectancyGNP 1995 (billions USS) 84,1 1,093 1,962

Average annual growth, 1990-95

Population (I%) -0.1 0 4 1 4 GNP GrossLabor force (%) -0.1 0 6 1.8 per primary

Most recent estimate (latest year available since 1989) capita enrollment

Poverty: headcount index (% of population) 32Urban population (% of total population) 70 66 56Life expectancy at birth (years) 69 68 67Infant mortality (per 1,000 live births) 15 23 36 Access to safe waterChild malnutrition (% of chi/dren under 5)Access to safe water (% of population) 97 78Illiteracy (% of population age 15+) 2 - UkraineGross primary enrollment (% of school-age population) 87 97 104

Male 87 97 105 --- Lower-middle-income groupFemale 87 97 101

KEY ECONOMIC RATIOS and LONG-TERM TRENDS

1975 1985 1994 1995 -IEconomic ratlos*

GDP (billions US$) 99.6 86 2Gross domestic investment/GDP .. 27.3 8.8Openness of economyExports of goods and non-factor services/GDP .. . 64 5 45.6Gross domestic savings/GDP .. 28.4 3.0 5.6Gross national savingslGDP .. .. 2 7 4 7

Current account balance/GDP -1 4 -1.8Interest payments/GDP 0.1 0.6 Savings -t InvestmentTotal debtGDP 5.5 98Total debt service/exports .. .. 2.1 6.1Present value of debt/GDP .. .. 5.0Present value of debtexports .. .. 34.8 Indebtedness

1975-84 1985-95 1994 1995 1996-04(average annual growth) - UkraineGDP 3.5 -6.6 -23.5 -11.8 5.1GNP per capita 3.1 -6 8 -21.6 -13.7 -0 3 Lower-middle-income groupExports of goods and nfs . -11.0 6 7 8 1

STRUCTURE of the ECONOMY1975 1985 1994 1995

(% of GOP) Growth rates of output and Investment (%)Agriculture . 193 17.4 17.8 60Industry . 45 6 45.4 42.3 3D -

Manufacturing .. 38 0 40 5 38.7 -

Services 352 37 2 399

Private consumption 53.7 77 2 77 2 -60General government consumption . 179 19.8 17.2 - GDI ---- GDPImports of goods and non-factor services . 70 3 48 9

1975-84 1985-95 1994 1995(average annual growth) Growth rates of exports and Imports I%)Agriculture -3.6 -22 0 -9.0 10,Industry .. -8.9 -29.9 -17.0

Manufacturing .. 2.2 -23.9 -15.0Services -6.0 -33.8 .9.7

-5 90 D1 92 93

Private consumption .. -2.7 -231 -17.8General government consumption .. -9.7 -23.1 -28 6 |'iGross domestic investment .. -18.6 -15.5 45.0 -15 Imports of goods and non-factor services .. .. -7.2 -2.3 Exports ImportsGross national product 3.5 -6.6 -23.5 -12.7

Note: 1995 data are preliminary estimates.

The diamonds show four key indicators in the country (in bold) compared with its income-group average. If data are missing, the diamond willbe incomplete.

36

Ukraine

PRICES and GOVERNMENT FINANCE1975 1985 1994 1995 Inflation

Domestic prices(% change) 5000

Consumer prices 891.1 376.0Implicdt GDP deflator -0.5 -1.3 903.1 427.4 2,5T0

Govemment finance(% of GOP) o 90 91 92 93 94 05

Current revenue 45.3 38 6Current budget balance -4.6 -0.7 -GDP def -- CPtOverall surplus/deficit -8 2 -4.7

TRADE

(millions US) 1975 1985 1994 1995 rExport and Import levels (mill. USS)(millions USS)Total exports (fob) 12,111 13,647 20.000

Commodity 1 3,980 4,542Commodity 2 496 567 15.000Manufactures 2,800 3,000

Total imports (cit) 14,471 15,945 '°°t 0Food67 70Fuel and energy . .. 6.305 6.753 .0

Capital goods 2,978 3,815 _I 99 90 91 92 93 94 95Export price index (1994=100) 100 112

Import price index (1994=100) 100 115 [ Expofts nImportsTerms of trade (1994=100) .. .. 100 97

BALANCE of PAYMENTS1975 1985 1994 1995

(millions US$) I Current account balance to GDP ratio (%)Exports of goods and non-factor services 14,713 16,408 | _ , , , ,__Imports of goods and non-factor services 16.044 17,615 69 90 91 92 !93 i 94 95

Resource balance -1,331 -1,207

Net factor income -74 -507 iiNet current transfers 9 200

Current account balance, Ibefore official transfers -1,396 -1,514 _

Financing items (net) 1,301 467 jChanges in net reserves 95 1,027 -21

Memo:Reserves including gold (miii USS) .. .. 646 1,129Conversion rate (local/US$) .. .. 1.OE+05 1.7E+05

EXTERNAL DEBT and RESOURCE FLOWS1975 1985 1994 1995

(millions US$) Composition of total debt, 1995 (mill. USS)Total debt outstanding and disbursed 5,438 8,465 G A

IBRD 102 491 255 491

IDA 0 0 cF

Total debt service 300 918 2347 1542

IBRO 0 8IDA ~ ~ ~ ~ ~~~~~~0 0 f 0IDA° °D

128Composition of net resource flows

Ofricial grants 216 240Official creditors 98 400Private creditors 208 -20Foreign direct investment 250 300 E

Portfolio equity 0 0 3702

World Bank programCommitments 500 146 , A - IBRD E - BilateralDisbursements 102 401 8 - IDA D - Other multilateral F - PrivatePrincipal repayments 0 0 C - IMF G - Short-termNet flows 102 401 _

Interest payments 0 8Net transfers 102 393

Intemational Economics Department 8/20J96

Note: Estimates for economies of the former Soviet Union are subject to more than the usual range of uncertainty.

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