Ukraine - Agriculture Sector Adjustment Loan Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 19223 IMPLEMENTATION COMPLETION REPORT REPUBLIC OF UKRAINE AGRICULTURE SECTOR ADJUSTMENT LOAN (Loan 4103-0-UA) April 27, 1999 Environmentally and Socially Sustainable Development Sector Unit Europe and Central Asia Region 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 (as of April 26, 1999) Currency Unit = Hrivnya I Hrv US $0.248 US $1 = 4.025 Hrivnya AVERAGE EXCHANGE RATES February 1997 June 1997 April 1998 1.77 1.86 2.04 WEIGHTS AND MEASURES Metric System ABBREVIATIONS AND ACRONYMS Ag SECAL - Agriculture Sector Adjustment Loan AIS - Agro-Industrial Sector AMC - Anti-Monopoly Committee CAE - Collective Agricultural Enterprise CAS - Country Assistance Strategy EFF - Extended Fund Facility ESW - Economic and Sector Work EU-TACIS - European Union Programme of Technical Assistance to the Commonwealth of Independent States FSU - Former Soviet Union GDP - Gross Domestic Product GOU - Government of Ukraine IBRD - International Bank for Reconstruction and Development IFC - International Finance Corporation IMCAR - Inter-Ministerial Commission for Agrarian Reform IMF - International Monetary Fund JEXIM - Japan EXIM Bank MOJ - Ministry of Justice NARD - National Agency for Reconstruction and Development PCU - Policy Coordination Unit PGF - Pre-Export Guarantee Facility PIU - Project Implementation Unit TA - Technical Assistance USAID - United States Agency for International Development USEXIM - United States EXIM Bank WTO - World Trade Organization Vice President: Johannes Linn, ECAVP Country Director: Paul Siegelbaum, ECC11 Team Leader: Mark Lundell, ECSSD Sector Leader: Laura Tuck, ECSSD  FOR OFFICIAL USE ONLY IMPLEMENTATION COMPLETION REPORT REPUBLIC OF UKRAINE AGRICULTURE SECTOR ADJUSTMENT LOAN (Loan 4103-0-UA) Preface Contents Evaluation Summary ...................................................................... i Part I. Project Implementation Assessment .................................................................................... A. Introduction and Project Objectives B. Achievement of Objectives C. Major Factors Affecting the Project D. Project Sustainability E. Bank Perfornance F. Borrower Performance G. Assessment of Outcome H. Future Operations 1. Key Lessons Leamed Part II. Statistical Tables ...................................................................... 17 TABLE 1: SUMMARY OF ASSESSMENTS ............................................................... 17 TABLE 2: RELATED BANK LOANS/CREDITS ............................................................... 18 TABLE 3: PROJECT TIMETABLE ............................................................... 18 TABLE 4: CUMULATIVE LOAN DISBURSEMENTS .................................................................. 19 TABLE 5: KEY INDICATORS FOR PROJECT IMPLEMENTATION .............................................. 19 TABLE 6: STUDIES INCLUDED IN PROJECT ............................................................... 20 TABLE 7: PROJECT COST AND FINANCING ............................................................... 20 TABLE 8: STATUS OF LEGAL COVENANTS ............................................................... 21 TABLE 9: COMPLIANCE WITH OPERATIONAL MANUAL STATEMENTS .................................. 23 TABLE 10: BANK RESOURCES: STAFF INPUTS .......................................... 24 TABLE 11: BANK RESOURCES: MISSIONS ............................................. 24 Appendixes: A. Mission's Aide Memoire B. Borrower Contribution to the ICR C. Map 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.  IMPLEMENTATION COMPLETION REPORT REPUBLIC OF UKRAINE AGRICULTURE SECTOR ADJUSTMENT LOAN (Loan 4103-0-UA) PREFACE This is the Implementation Completion Report (ICR) for the Agriculture Sector Adjustment Loan (Ag SECAL) to Ukraine, for which Loan 4103-0-UA was approved by the Board on October 17, 1996, and made effective December 27, 1996. The closing date of the loan was December 31, 1998, compared with the original closing date of December 31, 1997. The first tranche of US$150 million was disbursed on December 27, 1996, and the Second Tranche of US$150 million was disbursed on September 10, 1998. The ICR was prepared by Mr. Mark Lundell (Agricultural Economist, ECSSD) and Mr. Elliott Hurwitz (consultant), based on an ICR mission in October 1998, led by Mr. Lundell. Preparation of the ICR also included evaluation of materials in the project file, including the President's Report, Letter of Development Policy, Second Tranche Release Waiver, reports generated by the project, and Back-to-Office reports from supervision missions (in which Messrs. Lundell, Csaki, Shuker, Hurwitz, and Kaliberda participated). The ICR was reviewed by Messrs./Mmes. Paul Siegelbaum, Lily Chu, Chadrashekar Pant, Laura Tuck, Csaba Csaki, lain Shuker, and Aleksander Kaliberda. The Borrower contributed to the ICR by providing its own evaluation of the project (Appendix A).  IMPLEMENTATION COMPLETION REPORT REPUBLIC OF UKRAINE AGRICULTURE SECTOR ADJUSTMENT LOAN (Loan 4103-0-UA) EVALUATION SUMMARY Project Objectives and Evaluation of Objectives 1. The overall goal of the Ag SECAL was to support GOU policy measures to increase agricultural efficiency and promote market development. This was to be accomplished by actions to increase farm gate prices, allow more flexible response to price changes, and provide greater access to credit. Specific project outputs targeted were to: . liberalize agricultural markets by implementing more competitive government procurement methods (which would assist development of private intermediaries), and removing the remaining profit and price margins on grain and bread; * liberalize trade by removing grain export quotas and discontinuing indicative prices on trade contracts; * encourage land reform by establishing a legal basis for division and privatization of large farms, to promote development of viable farm management units; * encourage market entry in production, processing, and marketing of agricultural inputs and outputs by privatizing and demonopolizing existing entities; and * restructure state agricultural institutions to focus on the role of market facilitator, and bolster agricultural market information. 2. The targeted outputs were appropriate for Ukraine's circumstances and key to increasing the efficiency of the agricultural sector and promoting development of a market economy. Market and price liberalization would increase participation of private entities and improve incentives for efficient operation, while increasing international trade would improve farn-gate prices for Ukrainian outputs and enhance farm profitability. Achievement of Objectives 3. Overall, Ukraine's achievement of agricultural reform was partial, and major factions of the GOU seemed fundamentally unready to yield control of the sector. Significant progress was made in some areas, but in others the GOU circumvented reforms by developing new procedures and organizations. While the GOU satisfied most of the Ag SECAL conditions to the letter, it often blocked achievement of reform goals outside the framework of conditionality.  4. Moderate progress was made in market and price liberalization, with elimination of price and margin controls on grain. Considerable progress was made in foreign trade, with removal of most remaining trade restrictions and restraint in imposing additional barriers. As a result, implicit taxation of the agricultural sector has been reversed. Nevertheless, the farm sector has been unable to respond to improved prices and expand output because of lack of access to investment and working capital and corporate governance has not been sufficiently altered. Attracting investment in farming has been significantly handicapped by the GOU's unwillingness to reduce intervention in the grain sector. (It has been GOU practice to require in-kind compensation for inputs or credit supplied, as well as for tax or pension arrears.) Consequently, the GOU has effectively subordinated farm debt to the private sector, thereby reducing farms' access to capital. 5. Moderate progress was also made in land reform and farm restructuring, where--for 98 percent of agricultural land--the GOU maneuvered around Parliament's unwillingness to abolish the land sale moratorium, and also simplified procedures for withdrawal of land plots from collectives.' Over 80 percent of farm members have received land share certificates, but only about 50,000 farm members have left the large collective agricultural enterprises. The total area used by private and household farmers in 1998 had increased by about 3 percent (up 240,000 ha from 6.41 million ha in early 1996). Thus, management of farms has changed little, with rewards for efficient use of capital and higher labor productivity still weak. 6. The GOU made good progress in privatizing the agricultural distribution and processing system, with privatization of processing enterprises far exceeding Ag SECAL goals, and 85 percent of grain storage and processing facilities privatized or scheduled for privatization. However, privatization with ownership by management and workers has not so far resulted in restructured or more efficient enterprises (a deficiency not limited to the Ag SECAL project). 7. In sum, if growth of Ukrainian agriculture is to re-ignite, farm restructuring must proceed more widely, with concomitant improvements in corporate govemance. This would signal to the financial system that new managers, with a better chance of being profitable, are in place and able to use loan funds in a less risky manner. With similar changes in the ownership structures in the agro-industrial enterprises, domestic and foreign investors would have greater confidence in making the necessary capital available to improve facilities and productivity in input supply, storage and handling, and processing enterprises. Thus, a dual focus on improving corporate governance and facilitating credit and investment to farms and agro-industrial enterprises is necessary. Lastly, the investment climate is not likely to be perceived as less risky, in terms of potential state intervention in markets, unless the GOU ceases to require or even accept grain and other commodities as payment on farm debt: the state must abstain from 'A Second Tranche release condition required amending the Land Code to abolish the six-year moratorium on land sales, but Parliament declined to take this action. Instead, the government obtained an opinion from the Ministry of Justice (MOJ) which, in combination with an amendment to a joint order of the MOJ and the State Committee for Land Resources, meant that in practice the moratorium had been abolished for 98 percent of agricultural land. ii1  involvement in commodity markets if the private sector role in these markets is to expand. Factors Affecting Implementation Experience 8. Internal Factors--The constant changes in personnel in the leadership of the agricultural sector reduced understanding and ownership of the reform agenda supported by the Ag SECAL and slowed the pace for implementation of reform steps. The Parliament was also not fundamentally committed to agricultural reform and was resistant to much of the Ag SECAL program. These were the most important factors in causing the Ag SECAL to fall short of its goals. Moreover, the crucial period of project launch was hampered by the shift of project implementation and monitoring responsibilities away from the group that had handled project preparation, with a consequent loss of institutional memory. 9. External Factors--In understanding the effective degree of GOU commitment to agricultural reform, it is important to recognize that two key external factors dilute this cormmitment. First, the substantial opposition to land reform and open markets by a number of parliamentary factions lowers the probability of getting reforms through and slowly wears down the GOU's resolve. Next, the weak linkage by many international donors of their support (both credit guarantees and technical assistance) to strong GOU performance on the implementation of agricultural sector reforms further weakens commitment. In fact, sometimes the Ministry of Agriculture and Food usually places more emphasis on increasing access to agricultural inputs and machinery through credit guarantees agreements with export credit agencies than it does on getting key sectoral reforms through the government (and parliamentary) approval process. 10. Another external factor at work has been tightened budgetary constraints. The reduction of central budget expenditure has fueled the partial replacement of budgetary funding for the agricultural sector by contingent liabilities taken on by the GOU. Delivery of machinery and agricultural chemicals by foreign suppliers has been supported by large amounts of guarantees from export credit agencies (from USEXIM, Hermes, JEXIM - the outstanding value of which was about $900 million in early 1998), for which the GOU has given counter-guarantees to the export credit agencies in return. The results have been an oscillation of actual government expenditure in this area in a non- transparent way. In the area of trade policy, macroeconomic influences have had a negative impact on the pace of agricultural reforms. The continual appreciation of the real exchange rate over the period 1995-1997 has partly eroded Ukraine's historical comparative advantage in grains, oilseeds, and some meat products, and allowed the agro-industrial lobby to successfully convince the Ukrainian Parliament to increase import tariffs on food and agricultural products. 11. Sustainability--The sustainability of the Ag SECAL is uncertain. Market and price reforms were modest, and could be partially reversed. Reforms in the trade regime, however, were deeper, and GOU desire to integrate into the European trading system increases the likelihood that reforms will be sustained. Since farm members have iii  received land share certificates and are beginning to either withdraw physical land plots or lease their land rights to others, land reform seems to be on a steady but slowly progressing path. Enterprise privatization has proved popular and potentially profitable for new owners, so it is highly unlikely to be reversed. Still, the impact of this privatization on enterprise restructuring will continue to be weak in an uncertain investment climate. If Ukraine stays in compliance with IMF and Bank programs, its macroeconomic performance will probably continue to be adequate. 12. Bank Performance-- Overall Bank performance was satisfactory2. Bank staff were perceived as competent and professional, even while resistance from some parts of the GOU made progress difficult. There was a perception, however, that the Ag SECAL supervision effort should have placed greater emphasis on public relations and education, and that this might have facilitated progress. Greater attention should have been paid early on to the formation of a sustainable project implementation unit dedicated full-time to agricultural policy analysis and project monitoring. 13. Borrower Performance-- Borrower performance was unsatisfactory. While many important project goals were met, this was usually done with difficulty and delay (sometimes due to inaction by Parliament). The dominant factions of the GOU often caused reforms to be circumvented by developing new procedures and parastatal organizations. On the other hand, some parts of the GOU, particularly the Inter- Ministerial Commission on Agricultural Reform (IMCAR), were resolute in pushing for reform, and the project could not have made the progress it did without this contribution. 14. Assessment of Outcome-- Project outcome is assessed as satisfactory. While significant policy reforms were achieved in many areas, in some areas progress was limited. There has been a demonstrable improvement in farms' commodity terms of trade, as the sectoral producer subsidy equivalent has switched from very negative to positive, but farm income and output have not grown for lack of sufficient investment. Despite progress in facilitating the process of developing private land plots and the effective abolition of the land sale moratorium, farm restructuring has progressed slowly. Privatization and demonopolization of agro-industrial enterprises was successfully executed, but a poor investment climate has limited capital inflow and the effective restructuring and growth of these enterprises. Macroeconomic performance, although improved during much of the Ag SECAL project, recently worsened. 15. Future Operation--The Bank has arranged with the GOU to maintain active participation in agricultural reforms with: participation in IMCAR, of which it is a member; a strong ESW and TA program; and 3 follow-on agricultural projects. 16. Key Lessons Learned--The following were the key lessons learned: Build a stable base for reform and anticipate potential changes in leadership. -- With the brief tenure of many officials in the agricultural sector, one must carry on a 2 According to new ICR preparation formats to be introduced after July 1,1999, it could be more accurately rated as "marginally satisfactory". iv  wi'0e dialogue with agricultural policy makers if the degree of support for an agricultural reform program is to be well gauged and maintained over a multi-year period. Thus, a core group of articulate, agricultural policy analysts and working group leaders is key to generating and sustaining momentum in an agricultural reform program and maintaining the Government's level of attention to troublesome and politically charged agricultural reform issues. *Recognize the limits of the policy instruments included under the conditionalities. Though it is always the intention to craft a program of sectoral conditionalities which targets all the main obstacles to agricultural sector restructuring and growth, these conditions are bound to be necessary but not sufficient reform steps. There will always be unforeseen obstacles that arise, and influences beyond the program of reform steps specifically set. The failure of the GOU to win Parliamentary approval over 1997-98 for the Ukraine Pre-Export Guarantee Facility (PGF), which has as its aim the reduction of political risks for investors in the agricultural sector, has reduced advances of working capital to the agricultural sector and greatly limited the impact of the Ag SECAL reform steps. The approval of the PGF should have been a Board presentation condition for the Ag SECAL. *Pay closer attention to the time frame and lags of policies' having intended effects and favor ambitiously set numerical targets over legal steps with quantifiably umnmonitorable results. It was unrealistic to believe that the implementation of the sets of conditionalities aimed at farm restructuring and agro-industrial privatization and demonopolization would be able in a year and a half s time to substantially reorient land tenure, alter corporate governance, and cause newly formed enterprises to exhibit independence of their former national and regional supervising monopolies. In addition, the impact of some of the conditionalities would have been better targeted by defining the final results deemed to indicate real progress (e.g. dissolution of 1 000 collective agricultural enterprises) and leaving the amendment of laws and government regulations necessary to achieve such goals entirely to the discretion of the GOU. *Considerable Attention Should be Accorded to the "Political Economy of Change"--For a project as ambitious as the Ag SECAL, in a political environMent as difficult as Ukraine, considerable attention should be given to the "political economy of change." An explicit analysis should be made of: (1) the receptivity of major political groups to change; (2) public education and outreach programs required to reach interested stakeholders; and (3) elements of the project design that could appeal to stakeholders.' With reformn steps formulated as tranche conditions dependent on Parliamentary action, the Bank should have made an independent effort to assess potential Parliamentary support. v  IMPLEMENTATION COMPLETION REPORT REPUBLIC OF UKRAINE AGRICULTURE SECTOR ADJUSTMENT LOAN (Loan 4103-0-UA) Part I: PROJECT IMPLEMENTATION ASSESSMENT A. INTRODUCTION AND PROJECT OBJECTIVES Introduction 1. Economic conditions in Ukraine worsened dramatically after independence in 1991, with GDP per capita declining from US $2,340 in 1991 to US $1,572 in 1994, accompanied by hyperinflation. Ukraine's external trade came under serious strain as transaction mechanisms with its main trade partners collapsed and the prices of many imports-particularly energy-rose dramatically. Export volumes declined and Ukraine's external debt reached US $7.2 billion by the end of 1994, from zero in 1991. In October, 1994, the Government of Ukraine (GOU), under a new President, adopted a stabilization and structural adjustment program with the assistance of the IMF and World Bank. This program concentrated on immediate measures to reduce the fiscal deficit to 3.3 percent of GDP, limit credit expansion, strengthen the external debt position, and reduce inflation. As a result, inflation declined, foreign exchange restrictions were removed, and most domestic prices were decontrolled. 2. While slippages in implementing both the stabilization and structural reform programs occurred in the second half of 1995, by early 1996 the GOU had renewed its commitment to stabilization by tightening monetary policy and implementing various structural reforms. These measures paved the way for a re-phasing of the IMF Stand-by Arrangement in May, 1996, with an attendant commitment to tight fiscal and monetary policy and continued progress in structural areas. Agricultural Sector 3. Ukraine's food and agricultural sector has greater economic potential than that of any other country of the former Soviet Union (FSU). This potential is due primarily to the country's favorable agro-climatic conditions, which are well-suited to production of grains, oilseeds, root and fiber crops, and livestock, as well as cultivation of a wide variety of temperate fruits and vegetables. Ukraine has a very low cost of production for a wide variety of agricultural products, even when evaluating inputs at world market levels. The country has traditionally been a large exporter of food and agricultural products, with net exports of US $2.5 billion per year in 1988-1990. Prior to 1930, it exported agricultural products to much of Europe.  4. Despite its potential richness, from 1990 to 1995 agricultural output fell by more than 30 percent. While part of this decline was a result of external forces, it also reflected inefficiencies due to the legacy of collectivized agriculture, reduction of subsidies to the livestock sector, and continued implicit taxation of the crops sector by the state supply and purchasing system. Implicit taxation resulted from state trading agencies that pressured farms to sell at low prices by making these sales a condition of obtaining scarce inputs and credit. 5. In 1996, Ukraine agreed with the Bank to embark on an ambitious effort to transform its economy to a market-oriented system. In agriculture, this consisted of measures to liberalize exports, remove price restrictions, reduce state purchases, and accelerate privatization of medium and large enterprises. These measures were supported by an agricultural sector assistance program, consisting of 5 Bank adjustment and investment loans, of which the Ag SECAL was the centerpiece: Project Loan Amount Status Seed Development Project US$32 million Effective July, 1996 Ag SECAL US$300 million Effective December, 1996 Pre-Export Guarantee Facility US$120 million Parliamentary approval pending Title Registration Project US$50 million Expected 1999 Agribusiness Development Project US$20 million Postponed indefinitely Project Objectives and Evaluation Of Objectives 6. The overall goal of the Ag SECAL was to support GOU policy measures that would increase efficiency within the agricultural sector and promote market development. This was intended to be accomplished by actions to increase farm gate prices, allow more flexible response to price changes, and provide greater access to credit. Specific objectives were to: . liberalize agricultural markets by implementing more competitive government procurement methods (which would assist development of private intermediaries), and removing the remaining profit and price margins on grain and bread; * liberalize trade by removing grain export quotas and discontinuing indicative prices on trade contracts; * encourage land reform by establishing a legal basis for division and privatization of large farms, which would promote development of viable farm management units; * encourage market entry in production, processing, and marketing of agricultural inputs and outputs by privatizing and demonopolizing existing entities; and * restructure state agricultural institutions to focus on the role of market facilitator, and bolster agricultural market information. 7. These objectives were appropriate and were key to increasing the efficiency of the agricultural sector and promoting development of a market economy. Market and price 2  liberalization aimed at increasing participation of private entities, improving incentives for efficient operation, and stimulating growth of agricultural production. Liberalizing international trade focused on improving farm-gate prices for Ukrainian outputs and enhancing farm profitability. Increased private ownership of land was key to promoting restructuring of large farms and developing new viable farm entities. And efforts to reduce barriers to entry and operation of private firms in production, processing, and marketing were critical to providing actors with appropriate incentives and stimulating structural change as well. The Ag SECAL was foreseen in the CAS as a critical vehicle for carrying out the Bank's strategy in the sector. B. ACHIEVEMENT OF OBJECTIVES Summary of Actions Taken 8. Overall, GOU progress in implementing agricultural reform has been partial, and the GOU seems unready to yield control of many segments of the agricultural sector. Less progress was made than anticipated, and that headway took longer than expected. While significant progress was made in a number of areas -- most notably in foreign trade and removal of profit and margin controls -- in other areas the GOU circumvented reforms by developing new procedures and parastatal organizations which hinder development of private intermediaries. While the GOU satisfied many Ag SECAL conditions, it often blocked achievement of reform goals outside the framework of SECAL conditionality. For example, even though the GOU has technically removed state orders, it has often required in 1997-98 that debtors repay debts to the state in grain, effectively reintroducing the old system under a different guise. 9. As noted, although significant progress was made in some areas, the GOU did not meet all the conditions for the release of the Ag SECAL Second Tranche. However, the GOU did take several additional actions that -- together with the progress in areas where conditionality was fulfilled -- led Bank management to decide that a waiver to permit the tranche release was warranted, and the Second Tranche was released on September 10, 1998. 10. Moderate progress was made in Market and Price Liberalization, with some positive and some negative aspects to the GOU's performance.