Ukraine - Agriculture Sector Adjustment Loan Project

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 of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS Currency unit: Hryvnia (Hrv)' Exchange rates: Hrv per U.S. dollar September 2, 1996 1.76 Hrv = US$1 August 22, 1996 177,500 Krb = US$1 November 1, 1995 181,000 Krb = US$1 Weights and Measures Metric system FIscAL YEAR January 1 to December 31 Abbreviations and Acronyms ADT Agribusiness Development Team AIS Agro-Industrial Sector AMC Anti-Monopoly Committee ASAP Agricultural Sector Assistance Program CPI Consumer Price Index EBRD European Bank for Reconstruction and Development EDAL Enterprise Development Adjustment Loan EU European Union FSU Former Soviet Union GNP Gross National Product GOU Government of Ukraine MFER Ministry of Foreign Economic Relations MOAF Ministry of Agriculture and Food MOE Ministry of Economy MOF Ministry of Finance NARD National Agency for Reconstruction and Development PGF Pre-Export Guarantee Facility PHRD Policy and Human Resources Development SCLR State Committee for Land Resources SPF State Property Fund STF Systemic Transformation Facility TACIS Technical Assistance for the Confederation of Independent States USAID United States Agency for International Development WTO 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 a IOO,OO Krb - I Hry.  UKRAINE FOR OFFICIAL USE ONLY AGRICULTURAL SECTORAL ADJUSTMENT LoAN TABLE OF CONTENTS LOAN AND PROJECT SUMMARY.1i-iii INTRODUCTION.1 I. BACKGROUND.1 The Macroeconomic Climate.1 The Agricultural Sector ................................... 3 The Agricultural Sectoral Adjustment Loan in the Bank's Assistance Strategy . . 5 II. THE GOVERNMENT'S AGRICULTURAL REFORM PROGRAM .................. 6 Agricultural Reform Goals Set By Ukraine and Measures Implemented ... ... 6 Further Reform Steps under the Agricultural Sectoral Adjustment Loan ... ... 7 Other Supporting Projects and Support From Bilateral Donors ... ....... 12 II THE PROPOSED LOAN ...... ..... ........................... 13 Rationale for Bank Involvement ............................. 13 Project Objectives and Description ........................... 13 Conditions for Appraisal, Negotiations, and Second Tranche ... ........ 14 Loan Administration and Tranching .......................... 18 Procurement ......... . 18 Disbursements ......... 18 Reporting, Accounting, and Auditing .18 Monitoring Arrangements ................................ 19 Environmental Aspects .19 Benefits and Risks .20 Recommendation .20 ANNEXES 1. Letter to James Wolfensohn from Roman Shpek .1 Attachment - Memorandum of Agricultural Reform Policies. 3 2. Matrix of Agricultural Reform Policies. 6 3. Timetable of Key Processing Events .......................... 11 4. Status of Bank Group Operations .......................... 12 5. Terms of Reference for Supporting Technical Assistance and Training ... .. 14 6. Summary of Ukraine Report: Agricultural Trade and Trade Policy ... ..... 18 7. Summary of Land Reform and Farm Restructuring in Ukraine ... ....... 24 8. Summary of Ukraine: The Agricultural Sector in Transition ............ 31 9. Ukraine at a glance .................................... 35 This report is based on the findings of pre-appraisal missions in May-September 1995 and February-April, 1996, which included Mark R. Lundell (Task-Manager), Hans Binswanger (Agricultural Policy Advisor), Csaba Csaki (Agricultural Adviser), and lain Shuker (Agricultural Economist). The proposed project was identified by a Bank mission in June 1994. Project preparation was carried out 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 their official duties. Its contents may not otherwise be disclosed wiLhout World Bank authorization.  -11- 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 input supply, output marketing, and processing firms Loan Amount: US $300.0 million equivalent Terms: Standard interest rate for LIBOR-based US dollar single currency loans, with 17 years maturity including five years of grace. Commitment Fee: 0.75 percent on undisbursed credit balances, beginning 60 days after signing, less any waiver Objectives: The objective of the Loan is to support the growth of a market-based agricultural system as described in the Government of Ukraine's Memorandum of Agricultural Reform Policies. In particular, the Loan would support instituting agricultural and trade reforms aimed at increasing market competition and encouraging private ownership and investment in land and other productive assets. It would also provide short term balance-of-payments support for financing critical imports. It is expected that the policy reform program that the Loan supports would improve agricultural terms of trade, increase input flows to farms, expand agricultural exports, and increase rural income and employment. Description: The proposed Loan would provide balance-of-payments support (US$ 300 million) for Ukraine's import needs, thereby increasing the availability of foreign exchange, interalia, for crucial imported inputs. Benefits: The Loan's major benefits would be the development of markets to replace the past administrative system and to increase rural welfare and reinvestable profits for future capital formation. By promoting land reforn and farn restructuring, a sector of viable farm management units would be developed. By reducing state procurements and restrictions on agricultural exports, more farm output would flow through commercial channels to export markets and domestic markets for higher quality products. These markets will offer higher real prices than the State has paid in the past, thereby raising farm-level income and output. By promoting privatization and demonopolization of existing agribusiness firms, the Loan would encourage market entry to take advantage of these increased opportunities.  -.1.- Risks: The primary risk associated with this Loan is the possibility of policy slippage due to political opposition to specific agricultural policy reforms. This risk has been minimized first by extensive discussion with the Government of Ukraine based on a review, analysis, and dissemination of the main benefits of policy reform for Ukrainian agriculture. This risk of policy slippage has also been partially mitigated by policy benefits in the Government's reform program which promote the interests of a wide scope of political actors: the farm sector, 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, the recovery of the agricultural sector will be too slow to maintain a policy regime of limited distortionary interventions. This risk would be 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 the agricultural sector. As free-market agricultural and trade policies are maintained in Ukraine, foreign investment will be able to provide a large share of the capital needed to fuel recovery of the agricultural sector. Environment: In accordance with the Bank's Operational Directive on Environmental Assessment (OS 4.00, Annex A), the proposed operation has been placed in Category C and would therefore not require an environmental assessment. Est. Project Cost: US $ 300.0 million Financing Plan: IBRD US$ 300.0 million Total 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, ECA Director: Basil G. Kavalsky, EC4 Division Chief: Geoffrey B. Fox, EC4NR Staff: Mark Lundell, EC4NR   REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE IBRD TO THE EXECUTIVE DIRECTORS ON A PROPOSED AGRICULTURE SECTOR ADJUSTMENT LOAN TO UKRAINE INTRODUCTION 1. I submit for your approval the following memorandum and recommendation on a proposed Agriculture Sector Adjustment Loan to Ukraine for the equivalent of US$ 300 million. The loan would be at the Bank's standard variable interest rate with a maturity of seventeen years, including five 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 agricultural policy reforms which will remove the main systemic impediments to a market-oriented agricultural sector in Ukraine. The focus is placed on policy reforms because the residual policies of the pre-reform system are the main obstacles to the recovery of Ukrainian agriculture. Once in place, the new policies would provide a framework under which capital investments, both public and private, and improved access to input 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's agricultural sector adjustment program and would complement policy reforms initiated in late 1994 and deepened 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 progressed satisfactorily toward achievement of the liberalization of prices and foreign trade, reduction of state purchases, and the acceleration of privatization. Key steps still need to be taken under the agricultural reformn 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 private farms, and to accelerate enterprise restructuring through privatization and demonopolization. The main impact of these policy changes would be to increase the growth of exportable production (for which there is 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 the Soviet Union in 1991 - GDP per capita declined from US$ 2,340 in 1991 to US$ 1,572 per annum in 1994. The cumulative decline in output of 50 percent from 1990 through 1994 was accompanied by hyperinflation during much of this period. Particularly hard hit were the energy intensive industries and those facing shrinking markets for their products such as defense-related activities. In 1991, industry accounted for 41 percent of GDP, with a large production base in metallurgy, machine building, mining and 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 the USSR.  2 5. The external trade of Ukraine, of which three quarters was with the FSU, came under serious strain as the transactions mechanisms between countries collapsed and the prices of imported goods 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 imports increased from 12 percent of FSU imports in 1991 to 50 percent in 1994. At the same time export volumes declined, with an estimated fall of 25-30 percent from 1992 to 1994. Ukraine's total external debt 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 a stabilization and structural adjustment program developed with the assistance of the IMF and the World Bank. This program focused on immediate measures to reduce the budget deficit to 3.3 percent of GDP in 1995, limit credit expansion, strengthen the external debt position, and reach a monthly inflation target of 1 percent per month. Much has been achieved since October 1994. Fiscal and monetary policies were tightened considerably and inflation sharply reduced from 20 percent per month in early 1995 to around 5 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 costs recovered, and most domestic prices decontrolled, reducing government subsidy payments. 7. In the second half of 1995, however, there were slippages in implementation of both the stabilization and structural reform programs. The GOU renewed various forms of financial support to enterprises and overruns in government budget expenditures occurred. Although the general government budget cash deficit was only 0.75 percentage points (of GDP) higher than programmed, banking .system credit 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 of the external payment arrears, tightening monetary policy, and raising communal service tariffs, public transportation fares, and household energy prices to cover 60 percent of costs. This paved the way to reaching 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, fiscal policy has been tightened to prevent the cash deficit from exceeding the 1996 target of 3.5 percent of GDP. Monetary policy is being brought under tighter control in order to reduce inflation to 1-2 percent a 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 remained low (0.1 percent in June and July) and all end-July performance criteria were met. The introduction of Ukraine'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 real economy. The pace of large and medium enterprise privatization was slower than planned in 1995, with only 13 percent of the privatization target being met. Similarly, the pace of privatization in agriculture has 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 and medium enterprise privatization has accelerated significantly in 1996. Another encouraging sign is the rapid growth of the informal private sector. While official statistics indicate that the formal private sector accounts for only 10 percent of GDP, unofficial estimates are that the private sector, including the informal sector, could be contributing as much as 45 percent of GDP.  3 9. Structural reform measures for the next few years will continue to promote private sector development by focusing on the following issues: (i) improvement of the competitive, regulatory and legal framework; (ii) reduction of state interventions that inhibit private sector development; (iii) transformation of state enterprises into commercial entities; and (iv) hardening the budget constraint on state owned enterprises. Together, the GOU's policy reforms supported by the Enterprise Development Adjustment Loan (EDAL, scheduled for Board presentation in June 1996) and those of the Agriculture Sector Adjustment Loan are aimed at achieving objectives (i)-(iii). Maintaining a stabilization program supported by the IMF will be key to hardening state enterprise budget constraints. To ensure sustained growth, there will also be a need to initiate longer term structural reforms such as: (vi) restructuring of government 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 the Public Sector Reform Adjustment Loan (FY97), the Financial Sector Adjustment Loan (FY97), and the Social Protection Adjustment Loan (FY98). The Agricultural Sector 10. The food and agricultural sector has greater economic potential in Ukraine than in any other country of the Former Soviet Union (FSU). This potential is extensively examined in the Bank's report Ukraine: Agricultural Sector Review, discussed with the GOU in summer 1994 and issued in late fall 1994. The Bank has also participated in the preparation and publication of Ukraine Land Reform and Farm Restructuring (December 1994) and a study of Ukraine's comparative advantage in agricultural product exports (in Agricultural Trade and Trade Policy - Ukraine Country Report, June 1995). These three reports formed the basis of the policy reforms agreed with the GOU under the Agriculture Sector Adjustment 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-climatic conditions, which are not only well suited to the production of grains, oilseeds, root and fiber crops, and livestock but also to the cultivation of a wide variety of temperate fruits and vegetables. Comparisons of historical data prior to reform (the late 1980's through 1991) indicate that Ukraine was the lowest cost producer in the Central Europe and the Former Soviet Union for wheat, corn, sunflower seed, and sugarbeet. Evaluating Ukrainian costs of production for these conmmodities, usillg world market prices for the material inputs, shows that Ukraine's greatest absolute advantages are in wheat and sunflower while 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 to reform, it appears not to have an absolute advantage in meat production compared to major world producers (when evaluating Ukrainian materials costs at world market prices). In addition, its meat production suffers from quality problems and its slaughter plants are not certified for most developed country markets. Nevertheless, it could continue to be a competitive supplier of lower quality cuts to the FSU market (mainly Russia). 13. Indeed, Ukraine has traditionally has been a large exporter of food and agricultural products (with net agricultural and food exports of US$ 2.5 billion in 1988-90). However, performance of the sector during the latter years of the Soviet Union was still below potential. In the late 1980's, crop yields 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 low efficiency and spoilage in food processing, owing to outdated technology. In addition to high losses of raw product in processing, energy-intensity is very high compared to world standards. Thus, Ukraine's comparative disadvantage in food processing can offset its absolute advantage in the production of raw commodities: 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%. This decline in agricultural and food processing output is partially the result of factors outside the agricultural sector: high inflation and erosion of working farm working capital, increased real costs of agricultural inputs, overall decline of real wages and domestic demand, and the breakdown of payments channels with FSU countries. 15. However, this decline also reflects the impact of unsustainable agricultural polices that are a legacy of the past. Collectivized agriculture and routine covering of enterprises losses eroded labor incentives and rewards to management for containrment of costs and resulted in low levels of factor productivity. High investment levels in field mechanization and livestock raising facilities in the 1970's and 1980's did not improve efficiency, and output growth slowed as the marginal increases in output due to 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 inefficient distribution systems for agricultural inputs and outputs. The availability of imported variable inputs such as fertilizers, agro-chemicals, and seeding and spraying equipment was severely rationed, leading to insufficient use of these high quality imported inputs. 16. In the 1990's the state supply and purchasing system has been continually eroding. The GOU ceased in 1992 to officially set most agricultural output and input prices, but maintained considerable control over prices through state contracts and state orders. Monopolistic state trading agencies exerted substantial pressure on farms to sell at low prices by making these sales a condition for supply of otherwise-hard-to-get inputs and credit. The rise of input prices to largely world market levels in 1993-94 was not accompanied by a similar rise to border price levels for farm outputs. Since state orders and contracts have dropped substantially in 1994-95, the depressed level of farm gate prices stimulated 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 commnodities further or retail them. Still, the uncompetitive nature of state procurement enterprises and export licensing, 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 requires improved linkages to international markets, privatization and demonopolization of the agricultural input supply, 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 problems were transitory; that they could be overcome through advanced technology, better management, and the maintenance of large-scale production systems, and that subsidization of inputs could be continued during the transition. Monetary emissions by the central government to finance input supply and output marketing 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 Bank publications: Land Reform and Farrn Restructuring Study, Ukraine Agricultural Sector Review, and Agricultural Trade and Trade Policy - Ukraine Country Report.  5 involvement of state enterprises under ministerial direction in agricultural marketing. The combination of 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 and developing markets and business relations with the other FSU republics may offer the best opportunities for Ukrainian agricultural exports. Expansion into developed country markets will be hampered by perceived quality problems and, in some cases, import barriers that inhibit access and reduce prices for Ukraine's agricultural products in hard-currency markets, particularly in the European Union (EU). While Ukraine's eventual membership in the WTO will give it increased world market access, restrictions on agricultural 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 economy from a centrally planned to a market-oriented system. This reform will be, under the best of circumstances, a long process accompanied by economic, social, and political difficulties. To ensure that this transition is efficient and effective, and to minimize the transition problems, external assistance is essential. The IMF and World Bank operations of late 1994 and 1995 (Systemic Transformation Facility in November 1994, Rehabilitation Loan in December 1994, Standby Arrangement in April 1995) have provided the support needed by Ukraine to take the first major reform steps and prove to the international community that Ukraine is serious about market reforms. These operations have been oriented largely to 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 of Bank adjustment and investment loans) complements the reform strategy supported by the IMF and Bank operations mentioned above. The goal of the ASAP is to provide a policy framework and investments that promote the Government's agricultural reform program. The primary short term goal of the ASAP is to boost agricultural growth. The ASAP is expected to help Ukraine double most agricultural exports in five years.3 21. The ASAP is currently made up of mutually supporting programs supported by five agriculture-related Bank loans: the Seed Development Project, the Agriculture Sector Adjustment Loan, the Pre-Export Guarantee Facility, the Agribusiness Development Project, and the Title Registration Project. Since Ukraine is in the first phase of its stabilization program, these programs focus on key policy reforms and investment in critical areas. 1) Seed Development Project - US$ 32 million loan, which became effective in July 1996. Ensuring the stability and quality of local seed supply was identified as a necessary condition for the 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 provides investment capital for the rehabilitation of privatized seed production and processing operations. 2) Agriculture SECAL - US$ 300 million loan, with Board presentation expected in October 1996. It supports policy reform in the areas of market and trade liberalization, privatization and land 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 and the two investment loans can be effectively implemented. 3) Pre-Export Guarantee Facility (PGF) - US$ 120 million guarantee, with Board presentation expected in October 1996. The PGF is being processed in parallel with the Ag SECAL and provides support for the policy reforms made under the Ukraine Rehabilitation Loan and the Ag SECAL through the Bank's underwriting guarantees that specifically identified liberalized trade and marketing policies will not be rolled back by the GOU to the detriment of suppliers' and investors' outstanding commitments. 4) Agribusiness Development Project (Agriculture I) - $20 million loan, with Board presentation expected in March 1997. In tandem with the significant policy changes promoted by the Ag SECAL, the restructuring of agribusiness firms and collective agricultural enterprises (former collective and state farms) has been identified as the next critical constraint to the development of a market based agricultural economy. To assist the restructuring process, this project will provide management support to agribusiness managers and to the members of collective agricultural enterprises undergoing reorganization. The project would also support the development of a low cost market information system that supports traders and commodity producers. 5) Title Registration Project (Agriculture 11) - $50 million loan, with Board presentation expected in FY98. This project would support the development of land registration procedures, training and equipment. The registration system is expected to substantially reduce the cost of property transactions, thus increasing the efficiency of land and property markets. It would also provide a basis for low cost mortgage lending and to increase the security of land tenure. All of these factors 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 the agriculture sector would be required to restore this sector to profitability. In particular, greater liberalization of export markets is now understood to be critical in a country that has a comparative advantage 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 agricultural operations must be market-based also represents a key realization in redefining agricultural policy. In October 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 of tradeable private property rights in agriculture and the rest of the agro-industrial sector (AIS) a) to motivate farms and other AIS enterprises to pursue profitable activities, and b) to generate competitive  7 mechanisms which indirectly regulate these enterprises' profits and promote efficiency. The specific measures declared by the President of Ukraine as integral to agricultural reform include: i) liberalization of 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 of agricultural supply, marketing, and processing enterprises. 23. Ukraine took major steps in implementation of the reform measures emphasized by President Kuchma with the support of the IMF Systemic Transformation Facility (STF) and the World Bank's Rehabilitation Loan (negotiated and signed in November-December 1994). The GOU's Rehabilitation Program removed most food price controls4, abolished all export quotas on agricultural products (except grain5), and agreed to make at least half of state purchases of agricultural commodities through the commodity exchanges and other competitive tender mechanisms. The GOU now limits agricultural purchases financed from the state budget to levels consistent with the needs only of social sector organizations (schools, hospitals, the armed forces, etc.). This amounts to a substantial reduction of state agricultural procurements. To promote land reform, the GOU has introduced draft legislation and to eliminate the moratorium on sale of agricultural land, to mandate the delineation of land plots to those entitled 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 silos and 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 the STF and the Rehabilitation Loan need to be supplemented by a wider set of agriculture-related policy reform measures which would be supported by the Ag SECAL. The policy reform measures being implemented by the GOU and supported by the Ag SECAL focus on increasing efficiency within the agricultural sector and promoting market development. Taken as a package, these measures will increase farm gate prices, allow more elastic response to price changes, and lay the foundation for increased access to credit through the banking system. They should facilitate a growth of net agricultural output of 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 methods which impede the development of private intermediary activities and the removal of remaining profit and marketing margins in the grain and bread sub-sectors; (b) trade liberalization, including rescission of grain export quotas and discontinuation of the imposition of indicative prices on trade contracts; 4/Maximum profit and marketing margins for bread products remained in place, but implicit consumer subsidies on these products 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 dual challenge of substantially improving the herd's genetics and penetrating strong export markets.  8 (c) land reform encouraging the development of a sector of viable farm management units by 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 restructuring state agricultural institutions to focus on the role of market facilitator. 25. Market and price liberalization would be continued by the GOU by removing remaining profit and marketing margins in the grain and bread products sector, making government procurement contracts open to a wider scope of private intermediary enterprises, and actively reducing the trade policy and macroeconomic risks which input supply and marketing enterprises face. Above all, this means containing and reducing inflation by ensuring strict adherence to the Presidential decree limiting budgetary expenditures 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 the armed forces. To promote agricultural markets in which both private and state-owned enterprises can participate, all state agricultural procurements would also be executed on a competitive basis, through open tenders and purchases on commodity exchanges. Intermediaries and marketing enterprises would be encouraged to participate more widely in the agricultural commodity exchanges to increase competition for output from agricultural enterprises, which do not usually have the trading expertise to access the commodity exchanges directly themselves. 26. An anomaly exists in the tax code such that the rate of profit tax on intermediary activities is currently 45 % compared to 30% for most other sectors of the economy. By reducing this high rate of profit tax to the rates assessed on other activities, the creation of private wholesalers, a wider set of conmmodity exchanges, transport and trade companies, and service and marketing enterprises would be facilitated. 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 alternative sources of supply for inputs and alternative buyers of their output which they could access if stat-owned enterprises (both suppliers and customers) offered them unattractive prices. 27. Greater opportunity for private input suppliers and output marketers is clearly growing as state procurement of agricultural products were reduced significantly in 1994-95. State purchases in 1994 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) state purchases represent 5-7 percent of net agricultural output. Similarly, advances of working capital by the GOU to farms (traditionally through the procurement enterprises) have been curtailed. Thus, farms have become less tied to the state suppliers from whom the state used to arrange input deliveries. Since traditionally these advances have been interest free (or at least at highly preferential interest rates), credit subsidies to farms and procurement enterprises fell from over $500 million in 1994 to $250-350 million in 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 is advanced 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).  9 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 that Ukrainian agricultural markets are beginning to respond to export liberalization with higher farm gate prices and that these prices will increase further as remaining market restrictions are removed. Parity with pre-reform relative prices of outputs to inputs will not be achieved in future since total input subsidies exceeded implicit taxes on farm gate prices in the pre-reform period. Nevertheless, substantial improvements from current relative prices of agricultural outputs to inputs are clearly possible for most products (excepting some livestock products) if the market is allowed to work. For goods of which Ukraine is a low cost producer, the GOU's concern is not one of stagnant prices but rather how to secure a social safety net to support those most affected by food price increases. For agricultural products for which 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 be relied on to solve these products' currently adverse terms of trade. 29. Increasing the level of international trade is crucial to improving farm-gate prices for Ukrainian agricultural output. Without strong links of agriculture to export markets, the prices which farms receive for their output will continue to be out of balance with the world market prices they pay for inputs. Allowing real farm-gate prices to increase through greater access to foreign markets would be more successful than attempts to support agriculture through subsidized credit to state agricultural procurement enterprises and input subsidies. This is because these subsidies have not supported agricultural terms of trade since they have been offset entirely by implicit taxes imposed through repressed farm-gate prices (Para. 16). Moreover, these subsidies have fueled inflationary expectations and distorted input use. 30. Ukraine has a regional comparative advantage in agricultural production which has historically made it a net exporter of agricultural products to the Soviet Union and, prior to 1930, to much of Europe. Ukraine's future economic growth is also expected to be partially dependent on agriculture to boost exports and reduce balance-of-payments shortfalls. However, this will require the development of private trading institutions and agencies, financial and payments arrangements, and trade policies and systems that facilitate trading transactions and encourage the integration of domestic and external 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 was an important step in righting the imbalance between Ukrainian farm-gate prices for outputs and the prices of agricultural inputs (which have risen to world market levels). This will likely be the most important source of higher profits and greater working capital for farms in the short term. The positive impact of removing export quotas on agricultural products was very nearly almost offset in early 1995 as the imposition of a registry system for barter transactions was narrowly averted.8 Moreover, by maintaining export quotas on grain in 1995, the producer price of a key agricultural output was kept low, thereby reducing 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 months earlier to agricultural enterprises on credit in kind. 2/More than 30% of agricultural land in Ukraine is used for grain crops.  10 32. Registration and imposition of indicative prices by the Customs Service on barter deals has imposed excessive implicit taxation on the use of barter transactions. In February 1996, the GOU removed the remaining agricultural commodities from the export registry system and abolished the imposition of indicative prices on agricultural products. In the medium-term, barter trade will be relied on less once international payment mechanisms evolve for the execution of export contracts in an efficient and timely manner. Therefore, the restructuring of the financial sector and strengthening of commercial banks are critical to progress in this area. 33. Land reform and farm restructuring, including the privatization of land and the establishment of independent private farms, have progressed slowly to date. The Land Code of March 1992 clearly laid out farm members (both current and retired) of collective and state farms as the ultimate owners of most of the land of Ukraine's farms. The transfer into private ownership of land and other farm 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 this stipulation, the lack of defined procedures'" for withdrawing ones' shares of land and non-land assets from the farm enterprise, and the opposition of many farm directors to withdrawal of such assets, less than 1 percent 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 of subsidiary plots and gardens. Despite the approval by the Ukrainian Parliament's Agricultural Conmmittee of amendments to the Land Code to facilitate privatization of land and other farm assets, the principle of unrestricted private land ownership and private agriculture is still viewed by some political entities as a supplementary component of a farming structure based primarily on collectively-owned large-scale units. Uncertainty about future legislation on land ownership and the risks involved in private farming given the absence of a competitive input/output marketing and credit system have substantially limited the 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 organization of production and the distribution of the ownership of land and other assets; ii) explicit procedures for the distribution of land and other productive assets to the members in physically recognizable form and not as anonymous shares; iii) promotion of competitive input distribution and marketing enterprises which serve restructured farms. 36. To introduce these principles, additional legislation has been drafted and would be implemented to facilitate withdrawal of land and non-land assets from collective agricultural enterprises by those who have been allocated rights to this property under the Land Code. These withdrawals would not be able to be legally impeded by either farm management or the farm members' council. This will enable those working in agriculture to formally exercise claims to the land and farm assets to which they are entitled under existing law and to establish viable private farms individually or in cooperation with other private owners of agricultural assets. In addition, the importance of establishing private property rights and a proper title registration system is crucial to introducing market relations in agriculture. It would 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.  11 facilitate the use of real estate as security for investment. Procedures for mortgage of land and other real estate would also be implemented under the Ag SECAL. 37. Legislation would be adopted by the GOU enacting a title registration act. This law would contain the following features: (a) combination of record keeping for both land, buildings, and other real estate in a legally recognized report format"; (b) accessibility by all interested legal entities and physical persons to this information on owners of land and other real estate and on transactions related to the disposal of this property; and, (c) state guarantees of accuracy and reliability of this information funded partially by means of modest fees for the registration of these transactions. 38. Privatizing the agricultural distribution and processing system has been initiated in Ukraine, but restructuring in this sector needs to be expanded beyond its current scope. Of roughly 4,000 large and medium scale non-farm enterprises in the agro-industrial sector, about 10 percent had been 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 and managers. Fewer option joint-stock privatized agricultural enterprises were formed and even fewer with infusions of capital for restructuring from foreign participation. Given the slow pace of agro-industrial sector (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 a preferential right of access to the AIS enterprises' shares (purchase at book value as AIS enterprises workers and managers are allowed to purchase). This is a legitimate principle to follow, as long as it is not taken to an extreme'2 and as long as it does not generate legal conflicts between farmers and AIS enterprise workers that further delay the privatization process. 39. Like many sectors in the Ukrainian economy, the agro-industrial sector is characterized by a high decree of monopoly. These are not firms which for technological and cost reasons could be considered natural monopolies. On the contrary, they are artificial monopolies which have been administratively created from separate firms to facilitate the execution of central plans. Having been freed from a centrally planned pricing structure, they try to compensate for their low productivity in processing and marketing by offering low prices (below border prices ) for farms' commodities and charging comparatively high prices for agricultural inputs sold to farms. The GOU recognizes that price liberalization and reduced government intervention in commodity markets will not be fully successful in transmitting world price levels into Ukraine for agricultural commodities unless input supply and output marketing is substantially demonopolized. The Anti-Monopoly Committee has begun actively demonopolizing AIS enterprises deemed to be monopolists rather than simply regulating their prices. 40. Thus, the expanded agricultural policy reform program supported by the GOU would include three main components. First, the methods of privatization of AIS firms would 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 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 as collateral 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 51 percent of the assets of AIS enterprises without making any payments. This was widely perceived as disregarding the equity considerations of AIS enterprise workers and the general public, which can also use its privatization vouchers to purchases shares in AIS enterprises. The President of Ukraine vetoed this law.  12 explicit GOU targets for the number of firms to be privatized in the short and medium term. Without these measures, too many AIS enterprises would be decapitalized and go bankrupt over the next two to three years. Third, the GOU would institute rapid demonopolization of agro-processing, input supply, and product marketing systems immediately and enforce current regulations which define permissible levels of concentration in the agro-industrial sector. 41. New roles for government are being introduced to take the place of the past role of direct management of agricultural enterprises. The Ag SECAL preparation activities which focus on developing a monitoring framework for the policy reforms support the development of the GOU's ability to provide agricultural 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 making function soundly. The principal reduction of government responsibility in the agricultural sector would be the dismantling of the current "agro-industrial complex" governmental management structure. What is needed is not merely changing the names of the various ministries, but radical modification and/or merger 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 free market 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 coordinated with 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 Promotion Project and the Financial Institutions Development Loan and an EBRD loan to the financial sector. While this credit is not specifically targeted to agriculture, it will add to the general pool of credit available to the sector. iii) Technical support and capital investments for the development of an emerging system of 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 and demonopolization in the food and agriculture sector, including support for legal training and 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 as marketing or input supply cooperatives (IFC, TACIS, UK Know How Fund). vii) Technical assistance that provides agribusiness advisory services and facilitates the formation of joint ventures, thus encouraging foreign capital investment and transfer of  13 technology (EU TACIS, Government of the Netherlands, UK Know How Fund, Citizens Network, and others). viii) Technical assistance and capital investments for the development of a public market information system, thus reducing information asymmetries and high individual transactions costs associated with information gathering in an emerging market (US Department 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 face of many residual policies of a planned economy. The rationale for the Agricultural Sectoral Adjustment Loan is to establish a policy framework that would promote greater efficiency in the agricultural sector by accelerating the growth of market-based relations. The proposed policy reform package would have positive medium and long-term effects on the farm sector, agro-industrial sector, food consumers, and the national budget. However, the policy reforms to be supported under the Ag SECAL would have a number of short-term negative macro-economic impacts that create a need for balance-of-payments fin>,ncing. First, trade liberalization will transmit higher border nrices for agricultural commnodities into Ukraine: this will cause increases in consumer food prices and tlie inivestmen. saviigs gap. Second, by paying 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 public savings gaps may lead to an increase in the current account deficit in the short-term. Lastly, a substantial amount of incremental farm income will be spent on imported equipment (owing to the frequent lack of domestically 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 agricultural system. This would be achieved by instituting agricultural and trade reforms aimed at increasing market competition, encouraging private ownership and investment in land and other productive assets, and providing short term balance-of-payments support for financing critical imports. The reform program that 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. The policy conditionality would focus on the agricultural sector and address the following: i) reduction in the export restrictions allowing increased access to export markets; ii) development of a well functioning land market; and iii) enabling privatization and demonopolization of existing agribusiness firms and encouraging new entrants. The negative short-term adjustments associated with these policy changes would be cushioned by balance-of-payments financing. The funds provided under this component of the Ag SECAL would be used to finance general imports. The funds would be channeled through the National Bank of Ukraine, and allocated through the established market system for auctioning foreign  14 exchange. While balance-of-payments support is not expected to be targeted at financing imports for the agricultural 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 current practice of making grain exports subject to the receipt of an export quota and a license. This resolution has been issued. 47. The Cabinet of Ministers would issue a CM resolution to rescind the sections of Article 15 of the CM Resolution #109 (February 13, 1995) which empowers oblast governments (and the city governments of Kiev and Sevastopol) to place profit margin controls on grain procurement and storage and 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 relevant paragraphs of CM Resolution #109 concerning the trade margin controls on bread products were amended on May 13, 1996 by Cabinet of Ministers' Resolution #499. The power to impose profit and 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 the Ministry of Agriculture and Food (MOAF) will issue recommendations, respectively specifying procedures 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 of Ministers and were registered by the Ministry of Justice. For property shares, MOAF has worked out and published its recommendations. 49. The office of the First Deputy Prime Minister for the Agro-Industrial Complex would draft an Action Plan to undertake a publicity exercise in each oblast to inform the stated beneficiaries under the Land Code of the procedures available to them for exchanging their land and property shares for 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 activities in 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) which assesses taxes on the increase in the nominal value of grain stocks would be rescinded, leaving the value  15 of these stocks to be taxed under the normal provisions for profit taxes. On profits taxes - the Tax Inspectorate under the Ministry of Finance (MOF) has issued an internal memo (circulated to the MOAF) which clarifies the tax status of sellers of agricultural produce. This memo states that sellers 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 draft amendment to the Law on Taxation of Enterprise Profits (1995) was submitted by the Cabinet of Ministers to the Ukrainian Parliament. This amendment would reduce the profit tax rate on commission sales on commodity exchanges to 50 percent. On commodity stocks - it has been clarified 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 setting of obligatory indicative prices for export contracts for products whose export is not subject to contingent intergovernmental 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") abolished the imposition of indicative prices on the above mentioned contracts. Land Reform 52. The State Committee for Land Resources (SCLR) would execute land share registration and issue land share certificates to all entitled beneficiaries in 100 restructured collective agricultural enterprises. Roughly 500 farms had completed the land share calculation process for their members by February 1996. By May 1, the SCLR had assisted more than 100 farms to distribute land share certificates 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 the subscription process for agro-industrial enterprises would be reduced to a period comparable to that for other medium and large enterprises in other sectors; (ii) that there would be no reversal of privatization transactions previously completed in the agro-industrial sector; and, (iii) that shares of agro-processing enterprises that are to be offered to primary producers (suppliers) of raw product would be transferred to 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 of instructions by the State Propeity Fund to speed up agro-industrial privatization; and c) the issuance of a Presidential Order (May 28, 1996) to the Cabinet of Ministers to prepare normative documents to further streamline the agro-industrial privatization process. The Presidential Order instructed the Cabinet of Ministers to ensure the implementation of points (i), (ii), and (iii) above by 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 total agricultural credit subsidies to less than an equivalent of US$ 130 million in 1996; and, b) to phase out these subsidies according to a reduction schedule developed for 1997-1998. The subsidy levels implicit in the draft 1996 Budget are within the US$ 130 million limit. At Negotiations, the GOU agreed to establish the current karbovantsi equivalent of US$ 130 million (23 trillion karbovantsi) as the annual ceiling for these implicit credit subsidies for 1997-98.  16 55. The MOAF would submit a plan to the MOF to limit total state purchases of agricultural products financed in the 1996 State Budget to an equivalent of US$ 550 million. The purchasing levels implicit 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 Order dated August 9, 1996 (the SPF Order) regulating the process of agro-industrial privatization on the basis of the Law "On Peculiarities of Privatization in the Agro-Industrial Complex" (July 10, 1996) and a copy of the legal opinion from the Ministry of Justice of Ukraine regarding retroactivity of the Article 21 of the Law. After reviewing the documents, the Bank concluded that the SPF Order still leaves a possibility for collective agricultural enterprises as legal entities to acquire shares of privatized agro-industrial enterprises for free and at the nominal share value for cash. In order to resolve these issues, the Bank delegation proposed and the Ukrainian delegation agreed , that as a condition of Board presentation, the following measures be taken: a) SPF Order be amended to provide that free shares be transferred to individual farm members in proportion to the shares which they have purchased with privatization certificates, cash, and compensation certificates so that the full 51 percent allocation of shares is fully distributed; b) SPF Order be amended to eliminate the right of collective agricultural enterprises to purchase shares of agro-industrial enterprises at the nominal share value; c) Provision of further clarification that the process of transformation into open joint stock companies described in Article 21 of the Law "On Peculiarities of Privatization in the Agro-Industrial Complex" (which provides for the sale of 51 % of shares of closed joint stock agro-industrial enterprises to collective agricultural enterprises) confers preferential share purchase rights to individual farm members and not to collective agricultural enterprises. d) receipt of legal opinion from counsel acceptable to the Bank that the SPF Order including 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 the closing 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 on the livestock sector in May 1996) would be eliminated.  17 Land Reform 59. Amendments to the Land Code would be enacted to: (a) abolish the 6-year moratorium on sale of land; and (b) limit to three months the time within which co-owners can exercise their preferential 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 more members of a collective agricultural enterprise to withdraw adjacent plots; (b) limit to three months the time period within which the farm members' council of the collective agricultural enterprise has to consent 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 of the 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 would finalize an Action Plan (with measures, budget, and ministerial competence) to undertake a publicity exercise in each oblast to inform the stated beneficiaries under the Land Code of the procedures available to them for exchanging their land and property shares for land plots and other farm assets. It would then execute 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 of rural and urban land and other real estate. 63. The SCLR would complete the registration process for land share certificates in 2,000 collective agricultural enterprises and issue land share certificates to at least 75 % of entitled beneficiaries in these enterprises. The SCLR would also complete the process of exchanging land shares for physically identified 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 state agencies, starting in November 1996, are carried out on a competitive basis through open tenders and/or agricultural commodity exchanges in a manner facilitating private sector participation. 65. The SPF would implement streamlined agro-industrial privatization procedures as set down in its amended Order (receipt of which was a condition of Board Presentation) in order to accomplish 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 Food Industries) would devise and execute demonopolization plans for 100 agro-industrial regional or national monopoly enterprises or enterprise associations, including at least five state-owned national monopoly enterprises or associations engaged in the processing of agricultural products and in input supply.  18 Macroeconomic Stabilization 68. The Government of Ukraine will continue to maintain a macroeconomic framework consistent with the objectives of the Ag SECAL as determined on the basis of performance criteria acceptable 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 would become available. The balance of the Loan (US$ 150 million) would be released upon fulfillment of the Second Tranche conditions. The loan will be a single currency loan in US dollars at a variable interest rate (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 of Disbursement Rules under Structural Adjustment and Sectoral Adjustment Loans, the proposed Ag SECAL proceeds will be disbursed against satisfactory implementation of the adjustment program, including compliance with stipulated tranche release conditions and achievement of a satisfactory macroeconomic framework. Disbursements will not be linked to any specific purchases: hence, evidence will 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 upon World Bank notification of the release of each tranche. Proceeds of the Loan will be deposited by the World Bank in this account at the request of the GOU by the submission of a simplified withdrawal application. 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 the standard negative list), the Bank will require the GOU either (a) to return that amount to the account for use for eligible purposes, or b) to refund the amount directly to the Bank, in which case the Bank will cancel 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 appoint a Project Manager who would maintain all project accounts. Although the Bank will not routinely require an audit of the Deposit Account, it reserves the right to require an audit by independent auditors acceptable to the Bank. In addition, audit reports would be submitted to the World Bank not later than six months after the close of each fiscal year, or the date of final disbursement.  19 Monitoring Arrangements 73. The Ministry of Finance will be responsible for monitoring the implementation of the program. The appointed Project Manager would prepare quarterly progress reports detailing the implementation of the reforms outlined in the policy matrix and in the letter of development policy. The Bank will also monitor the implementation of the reform program through semi-annual reviews, as well as in the context of the preparation and supervision of other projects. The National Agency for Reconstruction and Development (NARD) will evaluate the progress reports prepared by the Ministry of Finance's Project Manager. 74. In addition to monitoring the fulfillment of the various policy conditionalities, the NARD would examine the performance of a number of economic indicators designed to gauge the impact of the implemented policy conditionalities. The base values of these indicators, taken from the work that the Bank has executed with the GOU through the Institute of Agrarian Economy and the Ministry of Agriculture and Food, would include the following (in addition to other variables to be worked out prior to Board presentation): ratios of domestic commodity prices to border prices; comparisons of processing margins 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 and retailing margins in the food sector (expected to rise as full deregulation is implemented); measures of the growth of private and individual farming and the growth of privatized agro-processing; measures of agricultural and food exports (both volumes and values); evaluation of the issuance of land titles and the degree 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 of Agriculture and Food) a semi-annual report presenting and discussing the measures and their link to the implemented policy conditionalities. Environmental Aspects 75. In accordance with the Bank's Operational Directive on Environmental Assessment (OS 4.00, Annex A), the proposed operation has been placed in Category C because of its focus on sectoral policy reform and would therefore not require an environmental assessment. Environmental issues related to the agricultural sector were described in a 1993 Bank study prepared in cooperation with the Ukraine Ministry for Environmental Protection: Ukraine.- Suggested Priorities for Environmental Protection and Natural Resource Management. The results of that study, including those concerned with the agricultural sector, were discussed at a workshop for local authorities and interested external experts in Ukraine in November, 1993. A major area of concern identified by the study was agricultural runoff affecting surface and ground water, caused by sometimes inappropriate soil management measures, poor fertilizer/pesticide application and management, poor waste management on livestock farms, and lack of suitable equipment. The structural reforms supported under this operation would help to set the stage for 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 investment operations in the future. Meanwhile, the Bank is cooperating with bilateral donors which are supporting demonstration activities concerned with on-farm resource management.  20 Benefits and Risks 76. The Project's major ben, fits would be the development of markets to replace the past administrative 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 be developed. By reducing state procurements and restrictions on agricultural exports, more farm output would flow through commercial channels to export markets and domestic markets for higher quality products. These markets will offer higher real prices than the State has paid in the past, thereby raising farm-level income and output. By promoting privatization and demonopolization of existing agribusiness firns, 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 increased availability of foreign inputs which are critical for a quick supply response in the sector. This is a key goal in the Government's overall program to halt the decline in output in agricultural output, with the ultimate goal of increasing agricultural incomes and exports. 78. The primary risk associated with this Loan is the possibility of policy slippage due to political opposition to specific agricultural policy reforms. This risk has been minimized first by extensive economic and sector work with the Government of Ukraine and subsequent discussion and dissemination of the ESW's main conclusions about the benefits of policy reform for Ukrainian agriculture. The policy slippage risk has also been partially mitigated by building policy benefits into the Loan's reform program which promote the interests of a wide scope of political actors: the farm sector, 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, the recovery of the agricultural sector will be too slow to maintain a policy regime of limited distortionary interventions. 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 the agricultural sector. As free-market agricultural and trade policies are maintained in Ukraine, foreign investment will be able to provide a large share of the capital needed to fuel recovery of the agricultural sector. Recommendation 79. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank, and I recommend that the Executive Directors approve it. James D. Wolfensohn President 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 Wolfensohn President International Bank For Reconstruction and Development 1818 H Street N.W. Washington D.C. 20433 Dear Mr. Wolfensohn, Please find attached the Memorandum of Agricultural Reform Policies, which determines the program of structural reform being implemented in the agricultural sector. The agricultural reform directions announced by Ukrainian President L. 1>;uchma in a comprehensive program of economic reforms in October 1994 support the creation of private property rights in agriculture and the rest of the agro-industrial sector (AIS). Their main purpose is to motivate farms and other AIS enterprises to pursue profitable activities and to generate competitive mechanisms which indirectly regulate these enterprises' profits and promote efficiency. The specific measures declared as integral to agricultural reform include liberalization of food prices, agricultural export liberalization, development of agricultural commodity exchanges, distribution of land plots to farm workers and other eligible beneficiaries, and privatization of agricultural marketing and processing enterprises. Implementation of the reform measures has been supported under the Rehabilitation Loan concluded 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 agricultural commodities through the commodity exchanges and other competitive tender mechanisms. The GOU now limits agricultural purchases financed from the state budget to levels consistent with the needs only of budgetary organizations (schools, hospitals, etc.). To promote land reform, the GOU has introduced draft legislation to eliminate the moratorium on sale of agricultural land, to mandate the delineation of land plots to those entitled to land under the Land Code, and to institute a national registration system for land and other real estate. The privatization of agricultural infrastructure through mass privatization procedures was initiated in 1995. Over the next two years, the Government of Ukraine will continue to implement these reforms by: maintaining the implementation of agricultural reform steps described above which have already been initiated; removing remaining price restrictions in the agricultural sector; removing remaining impediments to agricultural exports; establishing the institutional basis for division and privatization of large farms to promote land reform and encourage the development of a sector of viable farm management units; privatizing, demonopolizing, and encouraging market entry in production, processing, and marketing of agricultural inputs and outputs; and establishing a framework of information services 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 the negotiations (and respective documents) between the delegations of Ukraine and the World Bank regarding 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 Sectoral Adjustment Loan in the amount equivalent to US$ 300 million. Sincerely, Roman Shpek Chairman of the National Agency for Reconstruction and Development  3 UKRAINE AGRICULTURE SECTOR ADJUSTMENT LOAN Memorandum of Agricultural Reform Policies The decline of Ukrainian agricultural output in 1992-1995 was largely the result of unsustainable agricultural polices that were a legacy of the past. Collectivized agriculture and routine covering of enterprises losses eroded labor incentives and rewards to management for containment of costs and resulted in low levels of factor productivity. (High investment levels in field mechanization and livestock raising facilities in the 1970's and 1980's did not improve efficiency, and output growth slowed as the marginal increases in output due to increased use of fuel, fertilizer, feed, and other variable inputs declined to very low levels.) The cumbersome mechanisms of central planning and control resulted in monopolistic and inefficient distribution systems for agricultural inputs and outputs. Though the GOU ceased in 1992 to officially set most agricultural output and input prices, it still maintained considerable control over prices through state contracts and state orders. Monopolistic state trading agencies exerted substantial pressure on farms to sell at low prices by making these sales a condition for supply of otherwise-hard-to-get inputs and credit. These practices and export barriers caused poor transmission of international prices to the domestic market. The end result was been a large erosion of agriculture's terms of trade. Addressing these problems will require land reform and farm restructuring, privatization and demonopolization of the agricultural input supply, marketing, and processing enterprises, and the improved 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 in domestic and foreign trade and actively reducing the trade policy and macroeconomic risks which input supply and marketing enterprises face. Above all, this means containing and reducing inflation by ensuring strict adherence to the Presidential decree limiting budgetary expenditures 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 the armed forces. To promote agricultural markets in which both private and state-owned enterprises can participate, all state agricultural purchases will 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 agricultural commodity exchanges to increase competition for output from agricultural enterprises, which do not always have the trading expertise to access the commodity exchanges directly themselves. The creation of private wholesalers, commnodity exchanges, transport and trade companies, and service and marketing enterprises, will be encouraged by reducing currently high levels of taxation on intermediary activities. This will give agricultural producers alternative sources of supply for 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 regional comparative advantage in agricultural production which has historically made it a net exporter of agricultural products to the Soviet Union and, prior to 1930, to much of Europe. Ukraine's future economic growth is also expected to be partially dependent on agriculture to boost exports and reduce balance-of-payments shortfalls. To ensure the growth of agricultural exports, the GOU will promote the development 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 and external markets. The removal of all export quotas on agricultural products is viewed as an important step in righting the imbalance between Ukrainian farm-gate prices for outputs and the prices of agricultural inputs which have now risen to world market levels. Increasing the level of international trade is crucial to improving farm-gate prices for Ukrainian agricultural output, to alleviating the sector's dependence on implicit credit subsidies, and to increasing farm incomes. By early 1996, the GOU had removed the remaining agricultural commodities from the export registry system and abolished the imposition of indicative prices on agricultural export contracts. Land reform and farm restructuring is viewed as an essential step in establishing a competitive private sector agricultural system in Ukraine. Restructuring of collective agricultural enterprises will focus on three major principles: (a) distribution of land and other productive assets to the members in physically recognizable form and not as anonymous shares; (b) freedom of decision to members about future organization of production after the distribution of the ownership of land and other assets; and (c) promotion of competitive input distribution and marketing enterprises which serve restructured farms. To introduce these principles, legislation has been drafted and will be implemented to facilitate withdrawal of land and non-land assets from collective farm enterprises by those who have been allocated rights to this property under Ukrainian legislation. Measures will be taken to ensure that these withdrawals will not be impeded by either farm management or the farm members' council. This will enable those working in agriculture to formally exercise claims to the land and farm assets to which they are entitled under existing law and to establish viable private farms individually or in cooperation with other private owners of agricultural assets. In addition, the importance of establishing private property rights and a proper title registration system is crucial to introducing market relations in agriculture. It will allow buyers, sellers, lenders and others to establish with certainty their rights to real estate and facilitate the use of real estate as security for investment. Procedures for mortgage of land and other real estate will also be implemented. The Government of Ukraine will introduce necessary measures in order to adopt and implement a law on unified national registry of land and other real estate. Introduction of the above system will focus on the following: (a) combination of record keeping for both land, buildings, and other real estate in a legally recognized report format; (b) accessibility by all interested legal entities and physical persons to this information on owners of land and other real estate and on transactions related to the disposal of this property; and, (c) state guarantees of accuracy and reliability of this information funded partially by means of modest fees for the registration of these transactions. Privatizing the agricultural distribution and processing system has been initiated in Ukraine, but restructuring in this sector needs to be expanded beyond its current scope. The expanded reform program would include three main components. First, the methods of privatization of AIS firms would 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 AIS enterprises via explicit GOU targets for the number of firms to be privatized in the short and medium term. Without these measures, too many AIS enterprises would be decapitalized and go bankrupt over the 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 define permissible levels of concentration in the agro-industrial sector. New roles for government will be introduced to take the place of the past role of direct management of agricultural enterprises. The primary role will be the provision of agricultural market information, policy making and sub-sectoral analysis. The principal reduction of government responsibility in the agricultural sector will be the further dismantling of the current "agro-industrial complex" governmental administrative structure, typified by production departments and associations of state enterprises. While this restructuring is expected to take a number of years, the Government will initiate this process by strengthening its institutional capacity in the area of policy analysis and the provision of agricultural market information. Privatizing the agro-industrial complex will substantially reduce 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 actions referred 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 would consist of the Agricultural Reform Conditionalities agreed to under the Agriculture Sector Adjustment Loan Agreement as well those described below which the Government of Ukraine will undertake to further 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 of interventions acceptable under the WTO or voluntary export restraints under other multi-lateral agreements. (b) The MOAF and MOF would continue to refrain from introducing subsidies associated with input prices or direct producer price subsidies. (c) The MOAF and MOF would establish the current karbovantsi equivalent of US$ 130 million (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 Market Information 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 AIS enterprise 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 (a second tranche condition), the Cabinet of Ministers will issue a resolution to develop the implementation procedures 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 of commodities. State agricultural purchases reduced in by state agencies, starting in November agricultural markets. Distortion-free Agriculture 1994 to roughly 40% of 1989-92 average levels of 1996, are carried out on a competitive and competitive agricultural markets (MOAF) and shares of state purchases in total marketed production. basis through open tenders and/or Ministry of In 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 sector agricultural products financed by the State Budget participation - 2nd Tranche. Continue to starting in 1996 limited to an equivalent of US$ 675 refrain from introducing subsidies million. 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 its early 1995. Clarified by Tax Inspectorate that non- Taxes to be sought. accessible by all agricultural Tax commission sales of agricultural commodities are to be enterprises either directly or through Inspectorate taxed at 30%. Amendment to the Law on Profits Taxes intermediaries. Avoid discouraging submitted to the Parliament of Ukraine that would storage activities. reduce profits taxes on commission sales on agricultural commodity exchanges to 30%. Clarified that the Cabinet of Ministers resolution (#682, August 27, 1995) which assesses taxes on the increase in the nominal value of grain stocks is no longer in force.  PROGRESS TO DATE FURTHiER MEASURES ULTIMATE OBJECTIVE RESPONSIBLE AGENCY 11. Agricultural Foreign Trade Policy Agricultural commodities removed from the export * Eliminate export duties and indicative * Market transparency * Ministry of registry system in March 1995. In February 1996, the prices on agricultural sector goods (i.e., Foreign setting of obligatory indicative prices for export those which were imposed on the livestock Economic contracts ceased for products whose export is not sector in May 1996) - 2nd Tranche. Relations and subject 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 of import and export markets (e.g. advantage Ministers imposition of import and export quotas, export taxes, or export registration) with the exception of interventions acceptable under the WTO or voluntary export restraints under other multi-lateral agreements. HI. Rural Financial System Budgetary allocations and credit emissions for * Establish the annual ceiling for implicit * Eliminate distortionary credit * MOF in agricultural procurements were reduced significantly in credit subsidies in 1997-98 at 23 trillion policies. cooperation 1995-96 under the reform programs supported by the karbovantsi (the current karbovantsi with MOAF IMF STF and Stand-By operations. Agricultural credit equivalent of US$ 130 million). subsidies were capped at US$ 130 million equivalent in karbovantsi 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 * MOAF increased 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 to place trade margin controls on bread, flour, and bread products were rescinded by a Cabinet of Ministers resolution May 1996. Basic anti-monopoly regulations developed during * Devise and execute demonopolization 0 Facilitation of the emergence of new 0 Anti-Monopoly 1993-1994. plans for 100 agro-industrial regional or and restructured firms, and the Committee, national monopoly enterprises or growth of efficiency in both input State Property enterprise associations, including at least and output markets and in Fund, and co five state-owned national monopoly agro-processing. MOAF enterprises or associations engaged in the processing of agricultural products and in input supply - 2nd Tranche. By early 1996, about 10 percent of roughly 4,000 large * Implementation of these streamlined * Accelerate AIS privatization and 0 SPF and medium scale non-farm AIS enterprises had been procedures for privatization of AIS stimulate the inflow of investment privatized. 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 (which procedures for streamlining Privatization of agro- does not include state farms) - 2nd industrial enterprises so (i) that the subscription process Tranche. for agro-industrial enterprises would be reduced to a period comparable to that for other medium and large enterprises in other sectors; (ii) that there would be no reversal of privatization transactions previously completed in the agro-industrial sector; and, (iii) that shares of agro-processing enterprises that are to be offered to primary producers (suppliers) of raw product would be transferred to the individual members of these suppliers.  PROGRESS TO DATE FURTHER MEASURES ULTIMATE OBJECTIVES RESPONSIBLE AGENCY 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 Committee restriction which limits lease payments to no more than (a) abolish the 6-year moratorium on sale conducive to promoting long term for Land the landholder's tax obligations on the land parcel. An of land; and (b) limit to three months the investment, access to financial Resources amendment 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 of Parliament of Ukraine by the Cabinet of Ministers and land being sold by a co-owner - 2nd passed 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 and work for land share registration and some have share certificates in 2,000 collective agricultural land and restructuring of MOAF registered 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% of in 100 collective agricultural enterprises was executed entitled beneficiaries in these enterprises - by May 1996 2nd Tranche. Complete the process of exchanging land shares for physically identified land plots at least 75 collective agricultural enterprises - 2nd Tranche.  PROGRESS TO DATE FURTHER MEASURES ULTIMATE OBJECTIVES RESPONSIBLE AGENCY A Presidential Decree specifying the agencies in charge 0 Enact legislation to establish a unified * Establish documented property rights 0 Cabinet of of land registration has been drafted (indicates SCLR national registry of rural and urban land to facilitate lease, sale, and the use Ministers and 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 of exchange of land shares and property shares for land members of a collective agricultural agricultural productivity by Ministers plots 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 corporate within which the farm members' council agricultural enterprises. of the collective agricultural enterprise has to consent 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 of the plot to be withdrawn within 12 months after 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 the exercise to inform the agricultural population in each specific measures, budget, and ministerial Land Code as to the practical Deputy Prime oblast of the procedures available to them for competence - 2nd Tranche. implementation of farn Minister for the liquidating their property and land shares and obtaining restructuring. Agro-Industrial access to the assets to which they are entitled under Complex Ukrainian legislation.   11 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 Ukraine IBRD Loans and IDA Credits in the Operations Portfolio Original amount in USS millions Project 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 17.00 UA-PA-35814 L40570 1996 UKRAINE ENTER. DEV. ADJUST. 310.00 210.00 UA-PA-38820 L38650 1995 GOVT. OF UKRAINE HYDROPOWER REHAB. 114.00 114.00 UA-PA-44110 L40160 1996 GOVERNMENT OF UKRAINE COAL PILOT 15.81 15.81 UA-PA-9106 L36140 1993 MINISTRY OF FINANCE, UKRA INSTITUTION BUILDING 27.00 22.92 UA-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 Investments As 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 16.50 Ukraine 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.  14 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 economy to 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 has begun to achieve many of its policy objectives it needs to begin providing assistance at the farm and business level if privatization is to achieve its full potential. The aim of the Agribusiness Development Team program will be to create 10 regionally based centers capable of designing and implement strategies to provide private farmers, aspirant private farmers, kolhozes, and agribusiness firms with information and training on privatization, private sector business management, and agricultural marketing. These will be set up over the course of 1996 and financed for a total of three years using funds available from bilateral 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 the Deputy Prime Minister for the Agro-industrial Complex and his Policy Coordination Unit (PCU) which will coordinate the technical assistance and training to be undertaken through the ADTs. To meet the goal of providing training in privatization, business management, and agricultural marketing, each ADT would undertake three major activities. First the ADT will conduct a complete assessment of the existing resources available to farmers and businesses in the Ukraine, as well as possible participants of a training program. 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 operate an agribusiness information center. 3. Activity 1 In order to maximize the resources already available the first task of the ADT will be to meet with appropriate organizations already working on privatization and business training issues in the region which the ADT would work. The Managing Director can then identify areas of unmet need on which to focus the training and locate resources. Special focus will be placed on using existing organizations to help identify potential trainees who will be invited to participate in the first ADT training workshop. 4. Activity 2 The ADT will hold training workshops, with the focus of the each workshop dependent on the information gained during Activity 1. Topics will include issues concerning privatization, the preparation of business and financing plans, and the development and implementation of marketing plans. The workshops will target providing private farmers, business owners, and aspirant farmers 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 model curricula that will be available for use in the agribusiness training centers set up as more bilateral donors implement their technical assistance plans in this area. i/These technical assitance and training activities are not financed under the Ag SECAL. They are being financed through bilateral donor grants and would be further financed under a separate Ukraine Agribusiness Development Project currently under preparation by the Govermnent of Ukriane and the World Bank. The terms of reference are included here to further explain the activities included under point (g) of the Memorandum of Agricultural Reform Policies.  15 5. As new workshops are held throughout the Ukraine the curriculum will be adapted based on input provided from the oblast regional workshops. Once the regional agribusiness centers are operational a model curricula, based on inputs from various oblasts in Ukraine, will have been developed and available to all centers. In each ADT, a Technical Advisor and Training Associates will conduct the workshops. The Managing Director will also participate in the planning and implementation of the workshops, especially the contracting of expatriate experts on finance, privatization, business development, and marketing who will train the Technical Advisor and Training Associates and elevate the 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 business development associates to assist in the development and delivery of all of the ADT services. Special emphasis will be on the design and operation of an agribusiness information center. A preliminary set of objectives for the center will be to provide counseling on privatization issues, financing sources, the development of business plans, and the identification and targeting of selected markets. If the ADT is successful the agribusiness information center will continue to be operated by the two local associates and the administrative assistant. The managing director and the technical advisor will then be free to widen the 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 months 1 Technical Advisor 34 months 2 Training Associates 32 months (each) 2 Business Development Associates 28 months (each) I Administrative Assistant 36 months 3-4 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 Ukraine formulate 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 interventionist policies based on inaccurate projections of supply and demand on domestic and foreign commodity markets. Technical assistance provided under this component in a two year period will focus on strengthening the capacity of government institutions to collect, analyze, and disseminate information to enhance private and public decision making. The technical assistance will be implemented by twinning a group of experts from Ukrainian agricultural information and research institutions with experts from similar foreign institutions. The program for this component has three major objectives: (a) to build a commodity economic information system and initiate the publication of regular reports providing an assessment 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 reports describing supply, demand, and price developments and recent or forthcoming policy decisions. The reports 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 officials and private sector users in agriculture and agribusiness. The information base generated by the reports will be made available to Ministry policy-makers and will serve as the analytical underpinning for policy analysis. The in-country training will be hands-on in nature. Sessions will be divided between lectures on basic macroeconomic theory and workshops in the application of the theory to analysis of Ukraine's commodity markets. Expatriate experts will lead their counterparts through all the steps in preparation of commodity reports: development of data sources, identification of private sector and public sector information contacts, basic commodity analysis, preparation of supply, use and price tables, preparation of short-term commodity forecasts, and packaging information in concise, easy-to-read formats. 10. Expanded Information Collection System. Expatriate experts will work with the Ukrainian team to assess the information being collected domestically and what is available from international sources. The goals would be to identify information gaps, evaluate potential remedies, and examine 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 and dissemination. The team of expatriate experts will make international agricultural data bases available to the Ukrainian team and provide initial training on the computer software necessary to use the data. As information gaps are uncovered, the teams will explore possibilities of collaboration with foreign statistics agencies to help improve actual data collection. 11. Policy Analysis. The ultimate goal in this area is to develop a corp of analysts trained to 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 analysis capability is most successful after an comrnodity situation and outlook program is fully in place. In the second year of the project limited training in policy analysis will be provided, primarily focusing on the economics 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 build a commodity reporting program which Ukraine can sustain after the technical assistance has been completed, every effort will be made to minimize publication costs and to disseminate the information as widely as possible in order to generate demand for it. Reports will be brief and in a format that could easily be reprinted in agricultural newspapers. The expatriate team will work with the Ministry of Agriculture and the Agricultural Academy to seek out institutes, local ministry offices, or producers groups who can help disseminate the commodity information at the local level. Cooperation with international donor organizations working with local advisory services will also be pursued. Specialists from these other donor groups would work with local staffs to "translate" this information into a format that will be useful for farmers and agribusiness in the region. The contacts that will be developed with local offices will provide the Ukrainian comnmodity analysts with in-depth insights into local market conditions that will assist them in better meeting the information needs of the public and private sectors.  17 13. Tranin Personnel A two-year program covering four commodities will require approximately 50 person-months of training implemented both in Ukraine and including visits of the Ukrainian team to the headquarters of foreign agricultural information institutions. This would cover a Ukrainian team of 8-10 analysts. The Ukrainian analysts would be drawn primarily from the Institute of Agrarian Economy. However, implementation will involve close cooperation with the Ministry of Agriculture, 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 particular component of the training.  18 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 for Ukraine, Belarus, and Moldova that has been prepared by a team supported by the World Bank. This report 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 expanded agricultural trade. Ukraine is a nation with a significant endowment of agricultural resources, and under the FSU exported agricultural commodities to the other republics. Ukraine has traditionally produced an exportable 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 reforms in Ukraine evolve. The objective was accomplished by analysis of production, unit costs and output prices 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 the period 1991-1994). 3. The assessment of agricultural trade potential is made using two methods. The first method 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 an indication of the price at which Ukraine could "profitably" sell commodities in the Russian or international market, given the prevailing domestic prices. The domestic prices, of course, reflect the continual heavy intervention of the government. 4. The second approach is to convert the prices to a 1991 basis. In 1991, Ukraine was on the ruble standard. Thus, by adjusting for inflation and using 1991 prices, there is an opportunity to compare real prices of major agricultural commodities between Ukraine and Russia without any reference to 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 are generally. 5. The comparisons of relative prices calculated in US dollars or 1991 rubles must be carefully interpreted. Government is heavily involved in Ukraine agriculture and in the agriculture of neighboring 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 costs and prices. Thus, the study presents a variety of production cost simulations reflecting potential changes in agricultural input and output prices during transition period that may affect the direction and volume of future trade flows. Even with these adjustments, however, the comparisons represent only guidelines to indicate where the agriculture in Ukraine might be competitive in international markets, if Ukraine continues on its current course of agricultural reform. 1/Published in October 1995 as a World Bank Technical Report.  19 6. Finally, the comparisons do not deal with the problem of actually exporting agricultural commodities. Systems for export require sophisticated trading institutions, quality control, payments clearance, and other support activities. These are generally not present in Ukraine. Ukraine is more able to 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 be carefully 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 production chain for the selected agricultural comrnodities. Previous studies have primarily relied on final product prices and variety of commodity to conimodity price ratios for assessing existing distortions, inefficiencies and 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 methods of deflating all prices and cost data to a pre-reform level. Third, the study uses the same data base and methodology for estimation of basic deflators: nominal and real annual average exchange rates, and nominal and real annual average CPI for four transition economies: Belarus, Moldova, Russia and Ukraine. Use of the same methodology to deflate all prices and unit production costs to 1991 level, when all the above countries operated under the same currency regime, allowed for direct between country comparisons of the cost trends, of the different strategies that each country uses to reform its agriculture and other features relevant to the assessment of agricultural trade potential. Fourth, the same methodology for FSU countries has been used to make adjustments to potential changes in input and output prices that could 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 in agricultural 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 of production, unit cost and output price trends for each commodity that has been chosen for analysis. The major emphasis is given to the unit costs trends and to the changes in its components. This chapter also provides a variety of cost simulations and discussion of potential competitiveness of each commodity in the FSU and international market. Chapter 4 provides a summary of production, unit cost and prices trends. It is also includes a summary table of conclusion on the potential international competitiveness of each commodity analyzed in the study. For those who are more interested in the "how" rather than in 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 to many of the other European nations of the Former Soviet Union (FSU). Policymakers have found it difficult to privatize the Ukrainian economy and develop policies that are consistent with a market economy. Public ownership on means of production have continued to dominate the economic environment and have engendered significant government intervention at every level of production and distribution. 10. The Government feared unemployment and social unrest, which it believed would jeopardize the existence of an independent Ukraine much more than high budget deficit, inflation or weak domestic currency. Inflation rates, partly due to agricultural and consumer subsidies on food, have been  20 above 1,000% for several years since 1991. To address inflation, budget deficits, and hard currency availability, Ukraine has tended to retain old inefficient methods, including government state orders, procurement of major agricultural commodities, government-controlled exchange rates, hard currency taxes, nontransparent restrictions on trade, and subsidized interest rates. Combined with the consumer subsidies, these measures have driven Ukraine into even deeper economic and social crisis. In 1994 the real 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 smooth economic transition to a market economic system and has continued to be a hope of economic recovery in mid-90's. The agricultural sector has continued through 1994 to be one of the strongest sectors of the Ukrainian economy. While industrial production, construction, transport, and trade has dropped by approximately 50% from 1990 to 1994, agricultural production decreased by only 35 %. Moreover, from 1992 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 most regulated sectors of Ukrainian economy. State procurement of agricultural conunodities and the levels of procurement prices has continued to be dominant factors in determining farm production from 1991 to 1994. The Government of Ukraine has continued to control the procurement and distribution of most agricultural outputs, and was the major player in the domestic food market. Price and margin controls persist, 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 distribution of power between the government and the farms in negotiating the quantities to be procured and procurement prices has changed over the last four years. Currently, it is not so obvious whether the government or the state and collective farms are more interested in state procurement and procurement prices. Due to significant political and economic pressure, there has been a tendency in agricultural policy 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 substantially above the reported costs of production. For sunflower seeds, winter wheat and corn the difference between production costs and procurement prices was the largest among all other crops and livestock products. A huge difference between price/cost ratios for crop and livestock products is also one of the features of recent developments in Ukrainian agriculture. It appears that farms2 are trying to compensate their losses in livestock production by relying on relatively stronger procurement prices for crop products. 14. The situation for livestock production is weaker for several reasons. The government has taken important steps toward liberalizing this subsector and has made livestock production more responsive to input and output prices. The government has substantially reduced direct price subsidies to pork and poultry producers and, at the same time, substantially reduced government procurement of these commodities, allowing the farms to deal directly with the meat processing plants. Due to the significant reduction in meat consumption, retail prices for pork, poultry, and other meats have increased more slowly than the procurement prices for crops. This has been one of the major reasons for the reduction in meat production. 2/Predominant share of the Ukrainian farms specialize in both crop and livestock production.  21 15. Within the overall system of incentives that guide the agricultural enterprises in their production 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 system almost every year since independence. At the same time, the debate on agricultural loans and procurement prices, which can be seen as implicit taxation, has been intense and ongoing among all involved in agricultural production. 16. In 1993-1994, subsidization of agriculture shifted from explicit budgetary transfers to implicit credit subsidies. The low interest loans to agriculture became a core of government support of agriculture. However, coupled with a soft policy on returning these loans the new system of supporting agricultural enterprises was not much different from the system of direct subsidization of agriculture during the Soviet era. 17. The slow pace of economic reform was coupled with unfavorable external economic environment: the collapse of traditional channels of inter-republican trade; decline in overall volume of exchange 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 international conimunity. The first priority has been given to developing independent trade relations with the western countries at the expense of maintaining and reforming trade relations with the FSU countries. Especially for Ukraine, which is poorly endowed with fuel resources and has to rely on imports, solid trade relations with Russia and other suppliers of fuel from the FSU region has been a key to a much smoother economic transition. Unfortunately, political tensions between the neighboring FSU countries in the early 90'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/dollar exchange rates, delays in payment clearance have made trade between companies extremely risky and unattractive. 18. Deep govermnent involvement in international trade has become another complication of the transition period and has had several negative consequences on almost all aspects of recent economic development. It has added up substantially to inflation and government budget deficit; prevented Ukraine from developing standard mechanisms of international trade; separated Ukrainian producers and trading companies from international trading community and from knowledge this community could bring to the country. 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 agricultural commodities included in this analysis. 19. The current administration in Ukraine is committed to a more rapid pace for the market reforms, including complete price liberalization, significant subsidy reductions, and the privatization of land and other production capacities in agriculture. It looks like that the new Ukrainian government is making serious steps in developing a sound monetary, exchange rate and trade policy. There are clear signs of a more positive attitude towards the strengthening of commercial relations between Ukraine and other FSU republics (especially with Russia).  22 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, sunflower seed, and pork production, it has been decreasing in real terms. However, calculated in US dollars, the cost of all selected commodities showed a significant increase: nine fold in sugar beet; about fivefold in winter wheat, sunflower seed and poultry and fourfold in pork production. The opposite dynamics of the cost of production calculated in constant rubles and US dollars reflects the fact of continuous appreciation of local currency calculated in real terms. Less variable dynamics of the cost of production give the impression that farms in fact, have been adjusting to relatively higher input prices by reducing the use of inputs such as fuel, mineral fertilizers and herbicides and substituting them with relatively inexpensive inputs such as labor. This is due to the reduction in subsidies for inputs, and domestic input prices that are more reflective of international prices. The largest real cost of production increases have occurred 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 agricultural commodities are tending toward world market levels. 21. When evaluated simply in terms of prices converted at the present exchange rates or into the 1991 ruble, all prices of the commodities selected for analysis (sugar beet and sugar, sunflower seed and 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 reflect significant input subsidies for most commodities supplied by government in the form of outright grants and artificially low input prices or credits provided for purchase of inputs at interest rates that are far below the market interest rate. 22. Comparisons of the costs of production adjusted for input subsidies ("calculated cost' for short) with the prices prevailing in the border international markets cast a significant doubt whether Ukraine has a comparative advantage in some of the commodities chosen for this study. Winter wheat and flour, corn and formula feed, and sunflower seed and oil have survived the test of adjustments of input prices to international level and again have shown a considerable export potential. Reduction of consumer subsidies on food have decreased overall consumption of food and increased potential for the export of additional quantities of grains, sunflower seed and oil, and sugar for export. Ukraine also appears to be a comparatively cheap producer of sugar beet, but this advantage in raw commodity is offset by very inefficient refining operations: the calculated Ukrainian production cost of sugar is above the international level. In our estimate, Ukraine would have to significantly modernize it sugar processing and 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 that with existing technology and productivity levels, pork production is the least competitive commodity among those selected for the study. In 1992-1994, the calculated unit cost of pork meat production was 40%, 60%, and 44% higher the international market price, respectively. Relative stability and current cost advantages of small scale private hogs operations is temporary, and will probably vanish as soon as grain prices fully adjust3. 3/An estimated 30% of bread production is fed to hogs and cattle by private farmers.  23 24. Although, Ukraine does not appear to be competitive internationally in pork production Ukraine remains the lowest-cost pork producer in the FSU region. However, the fact that the calculated cost of pork production is above the international market price makes it unclear whether Ukraine will supplant European and US exporters of pork to Russia. It is more likely that in the short run, Ukraine will become a net importer of pork. However, in the long run, with successful adjustments in the crop sector 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 least ambiguous if not low. In the short run, before the significant adjustments made in grain production and the 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 FSU region, there is a possibility of exporting poultry meat to Russia, Belarus and other FSU countries. The situation is somewhat different for egg production. Adjusted for input prices and subsidies, the unit cost of 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 of the agricultural commodities selected; that livestock and poultry which now evince little competitive potential will become more competitive. This will require adjustment in the livestock sector and in the procurement and distribution system for feed. In general, the profile for Ukraine agriculture suggested by the analysis of trade potential is that of a nation that is a producer of food grains for export, coarse grains and oilseeds for export and feed use, and livestock for export. The sequence of the reforms to date indicate that the first opportunities for export will come for sugar and food grains, followed by oilseeds and coarse grain, and then by livestock products. 27. The export potential can be realized if the reforms in agriculture are accelerated and sustained. Assuming that Ukraine will succeed in privatizing its agriculture, and that the law of supply and demand will be the primary guideline for economic decision making in agriculture, it is reasonable to discuss some steps that will lead to a "normalization" of trade policy. Current taxes, restrictions on foreign currency, licensing, and quotas should be converted to tariffs. These tariffs can be reduced over time as the sectors adjust to international markets and prices. However these type of recommendations will be too general and generic if we do not mention a variety of nontransparent restrictions to trade that have 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 and the introduction of so called "recommended minimum export prices" for more than fifty different commodities including grains, sugar, sunflower seeds and oil, meats and milk products4. Unless the trade policy is rationally formulated, there will continue to be difficulties in export. In fact, inconsistent and complicated trade policy represents one of the major reasons why Ukraine is at present not exporting more wheat, sugar and sunflower oil. In a country that lacks a reserve of foreign currencies, these trade policies represent a major obstacle to economic development. Many of these trade policies have emerged to help protect the domestic market and the consumer and producer subsidy system. With the further withdrawal of consumer subsidies and the phasing-out and decoupling of producer subsidies, there is little justification for continuing the current trade policy. Accordingly, a change to a transparent and more open 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 and uncertainty to trade than any other trade restrictions.  24 ANNEX 7 SUMMARY OF LAND REFORM AND FARM RESTRUCTURING IN UKRAINE' 1. Under legislation adopted in 1992, Ukrainian law recognizes private ownership of agricultural land, as well as collective and state ownership. Also in 1992, a program to transfer land from state ownership to collective and individual ownership was initiated on a large scale, along with procedures to restructure collective and state farms. The transfer of land ownership and restructuring of traditional farrns create opportunities for private farming to develop in Ukraine after decades of collective management of agriculture. The impact of these developments at the farm level is examined in the present study by evaluating responses of 2500 participants in the process. 2. In July 1994, Ukraine had approximately 30, 000 private farmers cultivating 2 % of agricultural land in 20-ha farms, with another 12 % of farmland cultivated individually by farnilies of employees 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 the remaining two-thirds still in the traditional forns of lifetime possession and usership. Functioning land markets have not begun to develop in Ukraine due to slow documentation of individual ownership and a 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 farms and by state farms that are subject to privatization in the future. Three-quarters of large farm enterprises in Ukraine reorganized, but the preferred new form is that of limited liability partnership or collective enterprise, 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. The main obstacles reported by the respondents are insufficient capital, difficulty obtaining machinery and farm inputs, and legal and political uncertainty. Loss of social benefits is not an overriding concern, as private farmers do not experience particular difficulties in access to social services. Distribution of farm products is still dominated by state procurement, which is the main outlet for both large-scale farms and private farmers. Alternative trade channels are not well developed. Input supply is similarly dominated by the state, although private suppliers are beginning to emerge. 5. Further progress toward improved efficiency in Ukrainian agriculture requires continued restructuring of farrn enterprises into smaller autonomous units based on private ownership of land and assets, clear formulation of procedures that allow exit of individuals and small groups with shares of land and assets, development of land markets, and establishment of functioning market infrastructure for competitive input supply, marketing services, and financial services. 'Published in December 1994 as a World Bank Discussion Paper  25 Why monitor land reform and restructuring of farms in Ukraine? 6. Transfer of agricultural land and assets to private ownership and the creation of more productive 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 toward the subsistence needs of producers and local markets, rather than specializing to take advantage of export opportunities. The Government of Ukraine is responsible for designing and implementing a program through which producers will receive ownership of land and assets and create new kinds of farms. The task of privatizing land and restructuring farmns is intrinsically complex. The pace at which it proceeds depends on a number of factors, each of which will likely require remedial intervention from the government. Identification of the constraints and concrete opportunities for Government action and international 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 winter of 1993-1994 by the Ukrainian Agricultural Academy of Sciences and the World Bank. The objective of the study has been to conduct a rigorous empirical and analytical assessment of changes in land ownership andfarm structure from independence through Spring 1994. Does the process of reform in Ukraine reflect a clear commitment to private ownership of land and assets? 8. The overall objective of the agricultural reforn is to create an internationally competitive sector with high returns to the rich endowment of land and skilled agricultural labor. The legal framework and implementation of reforms in Ukraine are still ambiguous as to whether agriculture in the fiuture will be based predominantly on private ownership of land and assets, or on collective ownership under new and different management. This ambiguity is reflected in the laws and procedures that give equal legal status to private ownership and collective ownership, but constrain the activities and transactions necessary to make private ownership fully functional. A stronger articulation of commitment to privatize ownership of land and assets, rather than reform collective ownership, is needed. Collective enterprise in a variety of forms will continue because many new owners will choose it, but the new collective enterprises should be based on clear private ownership. The new Government's strong endorsement of the general reform program, as evidenced by the Fall 1994 agreements with the International Monetary Fund, provides an opportunity 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 explicitly leaves restructuring to the new owners. Except for the case of parastatal monopolies that must be reconfigured prior to privatization, enterprise level restructuring is not in general a feature of industrial reforms. Privatization in agriculture follows a different path. The collective and state farms, like the parastatal monopolies, must be reconfigured as part of the privatization process, because they have no analogue in agriculture in market economies. While it is sometimes argued that a collective or state farms could be privatized directly as a corporate farrn, there is no ready counterpart in market economies for a 3,000 ha farm with 400 owner-employees. A simple transfer of ownership to members and employees of state and collective farms would not directly create viable and competitive production units. For this reason programs of land reform and farm restructuring include additional mechanisms through which  26 owners can create new farming units, either within the former farm, or through exit. Privatization thus proceeds immediately into restructuring. What is the current status of the reform? 10. The process of fundamental restructuring to improve the performance of Ukrainian agriculture has begun. Over 70% of all farm enterprises in Ukraine formally reorganized. The share of state owned land in farms in the survey dropped from 100 % before 1990 to 35 % in 1992, but 62 % of the land on surveyed large farms is in collective, not individual ownership. The average size of subsidiary household plots almost doubled from less than 0.3 ha to 0.5 ha, and approximately 30,000 private farms were registered. Over 13% of farmland in Ukraine is now cultivated by users of household plots and private farmers. A state reserve of land intended for distribution to future private farmers was initially created by transfer of 10% of the land of collective and state farms. Most of this land (nearly 2.5 million ha at its peak) is still cultivated by the large farms under loosely defined lease arrangements. The process of restructuring; that is, changing the internal form and organization of farms, is still in a preliminary phase, and has not moved beyond the creation of shareholding farrns. The shareholding farn is similar to the traditional collective and state farms, and can be adopted with relative ease simply by registering the 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 of restructuring. There is no clear mechanism for creation of new production units other than the shareholding large farrn or the individual family farn. According to the survey, not many employees desire to leave the collectives and create new business units. A minimally reorganized new collective agriculture is unlikely to be internationally competitive. It continues to suffer from the inherent economic weaknesses of production cooperatives and labor-managed firms, which include a tendency toward overemployment, poor labor discipline, and failure to meet financial obligations. The incentive structure in new collectives remains incompatible with market signals. 12. Private Farming: Private farming is growing, but remains a distant third player in contribution to aggregate production, after the new collective sector and traditional household subsidiary farm ing. Private farmers are engaged in commercial production for markets, and are not subsistence farmers. In response to changing market conditions, private farmers have chosen a production mix that emphasizes crop production to a greater extent than on farms that remain collective. Private farmers are better educated than employees on collectives. Private farmers report that owIn savings is the most important source of start up capital, and that availability of financing for working capital and investment is a major problem. 13. The Ukrainian private farmers provide evidence that when the legal framework created opportunities for producers to function outside collectives, individuals welcomed the opportunity, and acted upon it. Private farmers at present are functioning between systems, and are using any possibilities that arise to keep their operations functioning. That they exist at present and that their numbers are increasing is testament to the firrnly held belief that land will in the future have value, and that private production has a future. Private farning can survive and prosper in Ukraine in an appropriate institutional environment. It is unlikely that private farming will be substantially strengthened as long as private farmers are forced to operate in the narrow and inhospitable gap between the command and market systems.  27 14. Market services. Private suppliers of market services are emerging in Ukraine, but a functioning market infrastructure still has not developed. Collective farms and private farmers continue to rely largely on state channels for input supply. Farm managers and private farmers report that inputs are available, but that prices are high. Purchased inputs, particularly fuel and chemicals, are more expensive relative to output than prior to the reforms, and farms have greatly reduced input use. Barter transactions to secure inputs have increased. Employees who intend to remain in collectives fear that as private farmers they would not be able to secure inputs, would face high risks, and would have difficulty securing sufficient capital. These concerns are much more prominent in the decision to remain in collectives than the fear of losing access to social services. State channels are also still dominant in marketing of output, particularly for the important cash crops, such as grains and oilseeds. Private farners and managers of large farms are dissatisfied with the prices and services they receive from state marketing firms. Financial services are reported to be the most severe problems for private farmers and for those considering private farming. 15. Social Services and Benefits: There has been little change in the way in which social services are provided in rural areas. The new collective farms continue to be major providers for services other than health and education, for which they play a secondary role after the state. By law enterprises can elect to transfer responsibility for provision of social services to the local council, along with ownership of assets in the social sphere. Farm managers report that very little transfer to local councils has taken place, and that they continue to provide a wide range of social benefits. The majority of employees, however, report that they do not receive many among the sixteen enumerated benefits provided by their enterprises, suggesting that except for health and education provision of social services even under the traditional system may have been less than universal. For example, less than one half of the employees reported that they enjoyed the use of subsidized vacation facilities, while 90% of farm managers stated that they provided this benefit. While 85% of managers indicated providing heating fuel to 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 has distracted from the sectoral agenda, and frequent changes of legislation have created a sense of uncertainty about the future course of reform. Lack of a supportive environment. Functioning markets for farm inputs and products have not yet emerged, impeding successful operation of new privatized agriculture. The financial sector is in disarray, few banks are able to give mortgages, and few land owners are willing to offer land as collateral. Mortgage finance is an important instrument of agricultural lending for private investment, but its development requires security of tenure, legal title to land that can be used as collateral, and existence of land markets to give objective valuation of land. Land markets do not function 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. Fully functioning land markets, including unconstrained purchase, lease, and mortgage will be necessary if Ukraine is to develop the high yielding, high value agriculture consistent with its endowment and needed to support rural incomes.  28 Inadequate mechanismsfor restructuringand exit. Procedures for further restructuring at the farm level are inadequately developed, and individuals and farm managers lack basic information about the options open to them. According to respondents in the study, the mechanism of exiting collectives with land and assets is not yet operational. Mechanisms will have to be developed through which a group of shareholders can present a proposal of separation, including specification of the land and assets they would like to take with them. Procedures for adjudication of disputes that arise when the remaining shareholders do not approve a separation proposal will have to be devised. High risk and lack of instruments for risk management. Political uncertainty, lack of clarity in design 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 high inflation increases risk for agricultural producers, and exacerbates the retreat from markets into internal distribution and accumulation of inventory. Participants in land reform and farm restructuring are likely to choose to remain within larger units, where non-cash distributions provide 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 a complete framework within which implementation can proceed. Nor is the environment created by the macroeconomic reform program yet supportive of strong agricultural reform. A number of changes in law and procedures should be considered. 18. Improvements in the market environment are of highest priority. Although creation of fully functioning market institutions will take time, the regulatory environment can be improved quickly by removing remaining export barriers and remnants of the state order system. Agreements in the fall of 1994 with the International Monetary Fund and the World Bank lay the foundation for the creation of a better market environment. Privatization of input supply, agricultural processing, and marketing should be 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 farm restructuring, 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 be imposed on all farms, as well as all other enterprises, so that accumulating arrears do not undermine the reforms and distort incentives to which managers respond. 19. Distribution of ownership shares should continue. Clear individual ownership should be established for land and productive assets. Distribution of share certificates is the first stage of this process, and it should be completed expeditiously. Land in the state reserve should be transferred to private 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 ownership and transactions. The moratorium on sale of land should be removed. The current prohibitions are an obstacle to creation of market-oriented farming through regrouping of land and assets. Prohibitions on transactions in land also inhibit financing and investment. Leasing arrangements should be formalized and lessees should pay for land. At present, many lessees use land and pay for it indirectly or not at all.  29 Much of the land leased comes from the state reserve fund, and the lease is in practice simply permission to 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 such as taxation should be used to prevent large-scale accumulation of land by absentee owners for speculative purposes. 22. Land tenure should be documented and made secure. Where land currently in private use can legally pass into private ownership, this process should be accelerated and the land titled. Land in private use that cannot legally pass into private ownership should be leased to the user for the period during which its tenure status can reasonably be expected to be clarified. Operators who lease land should pay for it. 23. Procedures for exiting collectives with land and asset shares should be claimed and made operational Procedures for individual exit exist in theory, but virtually no respondents in the study reported exit with land or assets. Procedures for exchanging and grouping shares among individuals prior to exit have not yet been developed, and are needed. The experiences in Russia under the Nizhnii Novgorod restructuring pilot and in Hungary under the Cooperative Transition Act should be examined for relevant lessons. 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 former collectives 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. Mechanisms must be developed to enable pensioners to sell their asset shares and lease their land to active producers in return for payment. 25. Restructuring of rural services currentlyprovided by the collective sector should be treated as an independent process, rather than an adjunct off restructuring. Public services that will remain in the public sector should be transferred to local governments in a mandatory process, after enhancement of the administrative and financial capacity of the local governments. Farms should be required to divest a portion of the assets used in provision of services that belong in the private sector. The rights and interests of farmn shareholders should be protected in the divestiture process, and the ultimate objective of divestiture 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 guide the rural population through the transformation. Much of the rural population at present is poorly informed 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 advance to the second stage of the overall land reforn and farm restructuring program, which involves creation of market-oriented, profit-motivated structures based on clear individual ownership of land and assets and an incentive system encouraging individual responsibility and rewarding effort. The new farm structures may take a variety of forms. Some persons will exit individually with shares of land and assets and establish private farns. Others will pool their shares and create small partnerships or cooperatives for farmning. 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 formner collectives will thus gradually break up into individual farms or small fanning groups, where production will be based on privately owned land and assets. These new producers will be supported by market services, 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 as service firrns or cooperatives. 28. Full implementation of the program already initiated (with changes indicated above) will thus result not in complete fragmentation of existing farms, nor enforced corporatization of the large traditional units. Instead farms of a range of sizes reflecting the judgment and decisions of new owners of land and assets will emerge over time. Because this will be a dynamic process with internal mechanisms for adjustment in farm size, it is especially important that leasing, purchase, sale, and mortgage 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 established production and trading practices, Ukraine has been forced to confront the demands of a market based economy. In the food and agriculture sector, this redirection of production facilities needed is considerable 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 farm system. Agricultural Performance and Structure 2. The food and agriculture sector has greater economic potential in Ukraine than in any other region of the Former Soviet Union (FSU). This is due primarily to its favorable agro-climatic conditions. Ukraine is currently a major producer of grains, oilseeds, root crops and livestock, and has the potential to become a major producer of fruit and vegetables, however, performance in the sector has been far below potential. Crop yields are 50% to 55% of those in Western Europe, fertility yields of livestock 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 major hallmarks and inefficiencies of the Soviet system. Most of the production is organized in large-scale state farms and collectives. The large bureaucratic administrative structures that managed agriculture during the Soviet period are still functioning at the national level and have been preserved, almost without change, at the regional level. The Reform Process 4. The Government of Ukraine has moved the economic reform in the agricultural sector forward on two fronts - market and price liberalization, and land reform. Progress in these areas was slow 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 mills and bakeries and issuing input credits linked to forward state contracts. In addition, a vast majority of the country's grain storage capacity is still controlled by the state, through which the state exercises a considerable 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 record and inefficiency of the state procurement system. One estimate by a Government source is that 25% of farms 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 land ownership, the risks involved in private farming under present macroeconomic conditions and the absence of a competitive input/output market and credit system substantially limit interest in the establishment of independent private farms. As of April 1994 private farmers controlled only 1.5% of Ukraine's agricultural land, while 1 1.8 % of agricultural land was in private plots. Reform in the agricultural sector is proceeding mainly through the reorganization of existing collective farms and state farms. The majority of state farms have been restructured and privatized into collective farms, however some still remain (primarily research farms) in public ownership. By the first quarter of 1994 two thirds of traditional large scale farms had elected to formally register as private entities. However, among the farms that decided to register, 85 % registered as collective enterprises, which is an organizational form essentially identical to the old kolkhozes. Among those farms which have undergone substantial reorganization there are 355 agricultural cooperatives (lease cooperatives) and about 100 joint stock societies. An Agricultural Reform Strategy. Market Liberalization 7. The most important contribution that the Governrment can make to improving agriculture in the short run is macroeconomic stabilization and reduction or elimination of controls on domestic and international market transactions. Inflation coupled with price controls has been detrimental to agriculture in the past, and will continue to plague agriculture in the future if it is not managed correctly. Greater price liberalization would eliminate implicit taxation of farmers arising from controls that favor urban consumption. The Governmnent has made major strides to correct these problems, but will need to remove 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 domestic needs, shortages of domestic food supplies are unlikely. However, there may be groups whose incomes have dropped to the point where their nutritional status is in jeopardy. Currently, the Government provides broad based food subsidies, primarily to urban consumers, through margin controls on bread and flour processors, and export restrictions that suppress the price of domestic food products. Food stamps programs, income transfers and subsidies linked to products with low income elasticity are all preferable 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 the development of a competitive farm support sector - material/technical supply, agricultural services and the marketing of agricultural commodities. Without the establishment of competitive for inputs and outputs, private farms will remain dependent on authorities, and an efficient pricing structure cannot develop. Rapid demonopolization of agroprocessing input supply and marketing systems and free entry into 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 of government subsidy to the agricultural sector and has undermined credit discipline in the country. The situation is further complicated by linking the provision of agricultural credit to State contracts. The development of credit unions or other forms of cooperatives, small scale rural banks or informal arrangements involving private sector trade credit might be an effective means of reaching a broader array of rural clients. Land Reform and Farm Restructuring 11. The objective of agricultural restructuring should be the creation of a sector of independent, privately-owned and largely owner operated farms that are free to change their farrning methods and output mix in response to evolving product and production technology and changes in input and 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 restructuring program 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 recognizable form and not as anonymous shares e freedom of decision to members about future organization of production after the distribution of ownership of land and other assets; and * promotion of competitive input and marketing enterprises which serve the restructured farm sector. ii) Promoting Private Farming and Farmers Cooperatives. International evidence is clear that individually owned private farms are more efficient than collective or state farms. The evidence is also clear that agricultural systems that have a critical mass of private farmers, they create an effective 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 and land use in the framework of a new land code. The new legislation envisages the full privatization of agricultural land. If this law is passed in the parliament, Ukraine will have one of the most progressive approaches to land reform in the FSU. According to the draft, every collective farm member will receive, without payment, an average land share with full ownership and 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 by cooperative 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 are important preconditions for the improvement of the efficiency in agricultural production. However, if efficiency is to be improved on a sustainable basis, there will need to be a substantial recapitalizing of the agricultural sector. This will include * the development of physical facilities (wholesale centers, farmers markets etc.) to support the market for agricultural products and inputs for agriculture; X reconstruction and major modernization of support services along decentralized private and/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. There is 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 reducing transaction costs through the establishment of secure payment systems. For expanding export to non FSU countries, Ukraine will need to make substantial investments, both public and private, in improving the quality 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 conditions for smooth operation of markets and independent business organizations, and remove itself from the daily operations of agribusiness companies. In order to achieve this goal there must be a complete restructuring of agriculture sector ministries and committees.  35 Ukraine at a glance Europe & Lower- POVERTY and SOCIAL Central middle- Ukraine Asia income Development diamond- Population mid-1995 (millions) 51.6 488 1,154 GNP per capita 1995 (US$) 1,630 2,240 1,700 Life expectancy GNP 1995 (billions USS) 84,1 1,093 1,962 Average annual growth, 1990-95 Population (I%) -0.1 0 4 1 4 GNP Gross Labor force (%) -0.1 0 6 1.8 per primary Most recent estimate (latest year available since 1989) capita enrollment Poverty: headcount index (% of population) 32 Urban population (% of total population) 70 66 56 Life expectancy at birth (years) 69 68 67 Infant mortality (per 1,000 live births) 15 23 36 Access to safe water Child malnutrition (% of chi/dren under 5) Access to safe water (% of population) 97 78 Illiteracy (% of population age 15+) 2 - Ukraine Gross primary enrollment (% of school-age population) 87 97 104 Male 87 97 105 --- Lower-middle-income group Female 87 97 101 KEY ECONOMIC RATIOS and LONG-TERM TRENDS 1975 1985 1994 1995 - IEconomic ratlos* GDP (billions US$) 99.6 86 2 Gross domestic investment/GDP .. 27.3 8.8Openness of economy Exports of goods and non-factor services/GDP .. . 64 5 45.6 Gross domestic savings/GDP .. 28.4 3.0 5.6 Gross national savingslGDP .. .. 2 7 4 7 Current account balance/GDP -1 4 -1.8 Interest payments/GDP 0.1 0.6 Savings -t Investment Total debtGDP 5.5 98 Total debt service/exports .. .. 2.1 6.1 Present value of debt/GDP .. .. 5.0 Present value of debtexports .. .. 34.8 Indebtedness 1975-84 1985-95 1994 1995 1996-04 (average annual growth) - Ukraine GDP 3.5 -6.6 -23.5 -11.8 5.1 GNP per capita 3.1 -6 8 -21.6 -13.7 -0 3 Lower-middle-income group Exports of goods and nfs . -11.0 6 7 8 1 STRUCTURE of the ECONOMY 1975 1985 1994 1995 (% of GOP) Growth rates of output and Investment (%) Agriculture . 193 17.4 17.8 60 Industry . 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 -60 General government consumption . 179 19.8 17.2 - GDI ----GDP Imports 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 -15.0 Services -6.0 -33.8 .9.7 -5 90 D1 92 93 Private consumption .. -2.7 -231 -17.8 General government consumption .. -9.7 -23.1 -28 6 |'i Gross domestic investment .. -18.6 -15.5 45.0 -15 Imports of goods and non-factor services .. .. -7.2 -2.3 Exports Imports Gross 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 will be incomplete.  36 Ukraine PRICES and GOVERNMENT FINANCE 1975 1985 1994 1995 Inflation Domestic prices (% change) 5000 Consumer prices 891.1 376.0 Implicdt 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 6 Current budget balance -4.6 -0.7 -GDP def -- CPt Overall 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 4,542 Commodity 2 496 567 15.000 Manufactures 2,800 3,000 Total imports (cit) 14,471 15,945 '