If you travel even a little around Ukraine, then you
have probably noticed the changes in rural areas over the last few years.
Fields are being aggregated, they are being worked seemingly according to
schedule, the wheel tracks on them are even as seams, farm equipment is looking
newer and more powerful, and in some villages, even the social infrastructure
is being upgraded.
These are visible signs and the result of development in the
farm sector. This agricultural industry is the subject of high-level
discussions, it is referred to as the engine driving the domestic economy, and
great expectations are being placed on it. Why? Because the farm sector is
making money: hard currency for the country, revenues for the budget,
investment capital for the entrepreneurs, interest payments for the banks, and
a slice of bread and butter for those living in the countryside.
On track or
slowing down?
The question is whether
this will continue or will agribusiness turn into a bubble of the type that has
been all too common, both in Ukraine and elsewhere. To answer this question,
it’s important to understand what’s going on with prices for farm products,
financial resources for farming businesses, and the fundamentals of the
industry itself.
Let’s start with prices. World prices for food have
been sliding pretty much since 2011 (see Five-year slalom).
According to IMF data, at the end of this pastsummer,
the consumer price index for food stuffs, a basket that includes grains, vegetable oils, meat, seafood, sugar and
fruit, was 21% below its peak in April 2011. Although prices have risen 16%
since the end of 2015, as the chart shows, this dynamic is not caused by those
components of the basket on whose production and exports Ukraine specializes.
For instance, the average price of wheat in mid-September was 22% below last
year’s average and maize was down 11%. In short, world prices are exerting
downward pressure both on hard currency income that Ukraine earns from exporting
agricultural products, and on the incomes of agribusiness in hryvnias and
kopiykas.
It’s hard to say whether
a global situation that is disappointing for Ukraine’s farmers will continue
for long. But the fact that since the beginning of 2016 prices for some farm
products have been quickly recovering suggests that things have pretty much
bottomed out. Similar trends were seen in the late 1990s: over 1997-1999, the
consumer price index fell by nearly a third and prices began to recover
gradually and by discrete groups.
The first to recover were prices for oil and
other fuels—prices for farm products returned to pre-crisis levels only in
2005-2007, that is, on average 8 years after they fell. If this happens again
this time—a slowdown in developing economies tends to support this
hypothesis—farmers may have to suffer for a few more years.
Given that land is
Ukraine’s global competitive advantage, the farm sector is not really under
threat and it remains in the black, even if not by that much. But if world prices
for foodstuffs continue to fall, then some of the least efficient producers
will have to leave the market—and, together with them, some of the least
efficient grain-exporting countries.
However, Ukraine’s
growers have not been sitting on their hands. They began even earlier to switch
to more expensive and more profitable products and are now doing rather well
with them. In the last 10 years, territory sown with soya has nearly tripled:
15 years ago, it was barely even known in Ukraine.
Sunflower has expanded 150%,
among others because farmers have learned how to grow it efficiently. Today,
the yields of nearly all grains are at least 150% higher than they were then
and they continue to rise. The Agricultural Policy Ministry says that this
year, record yields since the country became independent were seen among both
grains and legumes: 43.9 centners/hectare. Although the domestic harvest was
not quite as good as the peak harvest of 2014, farmers certainly aren’t about
to leave it at that.
Logistics and market logic
The other factor that
can make the difference between success and failure when the global marketplace
is down is the right use of logistics. Although the record crop was in
2014—63.8mn t of grains—, the 2014/2015 marketing year saw only 34.8mn t exported.
In 2015, the crop was smaller, 60.1mn t, but exports in the 2015/2016 marketing
year were noticeably higher, at 39.5mn t.
In other words, Ukraine’s farm sector
has developed solid logistical infrastructure in the last few years, which has
made it possible to store grain while prices are down and sell it quickly the
minute the price is right. The industry has learned to take effective advantage
of the situation to maximize profits.
This opens the way to an understanding of the current
financial standing of domestic agribusiness. According to Derzhstat, last year,
farming, forestry and fisheries, among which farming dominates, earned record
profits and demonstrated record profitability (see Positive trend). In the last two years, net profits at profit-making
farm enterprises grew fivefold—despite the negative situation on world markets.
The first factor was that part of the crop produced two years ago at an
appropriate production cost was sold only last year.
The second factor was
the devaluation of the hryvnia. Indeed, this time around, farm businesses took
advantage of the logistics infrastructure to wait out, not so much the fall in
world grain prices—even if a priori this was part of the original calculus, prices have
not yet recovered while surplus inventory has been sold—, as the instability of
the hryvnia at home, until such time as there was a more-or-less clear exchange
rate in the context of a new macroeconomic equilibrium.
With prices for farm
goods tightly tied to the dollar while part of the production cost remains
hryvnia-based—wages, a small portion of the seed funds, depreciation of
equipment purchased in the past, and so on—, profits were sky-high last year.
Thus, the financial state of the industry is the best it has been for many
years. And it’s quite possible that it will continue to be so for many more
years, as costs will climb while the devaluation of the hryvnia on such a scale
might be the last such devaluation, so there won’t be much purpose to holding
back product.
Good news, bad news
These super-profits in
the farm sector have had a number of consequences, both good and not so good.
Firstly, growers have begun investing actively. Last year, capital investment
in agriculture rose 26.1%, to UAH 27.1bn, despite the fact that the country was
still in crisis. By contrast, total capital investment in the entire domestic
economy shrank 1.7%.
In the first six months of 2016, capital investment in the
sector skyrocketed 74.0%, compared to only 9.6% in the entire economy. That
huge flow of cash to farming had to be spent on something, and so Ukraine is at
a crossroads: if it is spent unproductively—on price wars for market share,
yachts and expensive buildings for farmers, uneconomic purchases of components
of the production cost—, this could all turn into a bubble, which will greatly
cost the AIC in terms of development. Otherwise, the sector is set to continue
growing apace.
Secondly, the
super-profits being enjoyed by farmers have provided a solid basis to cancel
the sector’s tax breaks. Such a decision is timely, but it’s not quite ripe,
because the livestock industry will suffer a lot as a result. Furthermore, the
proportion of large holdings among those enjoying these super profits is high,
so the benefit for small and medium farmers could be limited. This means that
the strong support for farmers initiated by the Ag Ministry should make it
possible to eliminate this distortion.
Thirdly, international financial institutions are
starting to more confidently provide credits to the sector. Despite a
generally difficult situation in the bank sector, the NBU says that the
agribusiness credit portfolio slipped 0.9% over January-July 2016, while the
entire portfolio contracted by 4.6%. Needless to say, fundamentals such as the
lack of a land market and the low quality of collateral, which make
agribusiness less than attractive for banks to lend to, have not disappeared.
But over the last year or two, a number of IFIs have begun to look for
opportunities to finance agricultural enterprises and have been noticeably
expanding credit portfolios focused on the industry.
It’s clear that
Ukraine’s agricultural producers have spare cash today and will likely continue
to have it for at least a few more years. The question is how much of a horizon
they have to expand into, that this cash is placed to assist with. What about
structural prospects? Much here will depend on the regulator, i.e., the state.
The latter, through the Ag Ministry, has been initiating large-scale reforms,
the main one being setting up a market for leasing land in order to resolve the
country’s land woes.
Conceptually, this is the right decision. But the fact
that the farm sector has a lot of spare cash right now means that the cost of
leasing land could quickly become too high. This risk is something the state
needs to anticipate.
At the same time, a market for leasing land should untie
the hands of the banks, which will then have access to a class of valuable,
quality assets that can be used for collateral. Could this lead to an
exaggerated boom of lending in the AIC—and eventually to problems for many
companies who borrowed to expand and then discovered that the potential for
growth was far less than the money they had borrowed?
The second reform is
targeted support for SMEs in the farm sector. Judging from the concept that has
been presented so far, this assistance is meant to help farmers fill those
niches that are not being supplied today. This offers considerable potential
for growth for at least a few years.
In any case, today agribusiness has money and the
state seems to have good ideas for quality reforms and is ready to carry them
out. This combination should foster sharp growth in the sector over the next
few years. And the state, as the regulator, needs to control the situation so
that this phase of acceleration is dominated by efforts to be efficient, not a
dash for cash that threatens to cause a bubble and the inevitable crash.
Some skeptics say that
this is all just to turn Ukraine into Europe’s farming arm with room for only
10-20 million Ukrainians to live comfortably. The hope is that the AIC will
become the driver to pick up related sectors: heavy machinery, chemicals, fuels
and so on. But regardless of this, Ukrainians need, above all, to take
advantage of the God-given potential of their soil. Today, they have everything
they need, to do so.
Translated by Lidia
Wolanskyj
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