Ukraine’s parliament is supposed to pass a crucial law by the end of May that will start the process of allowing the buying and selling of land. If it is done well then the government is expected to earn an extra $1.5bn to $2bn in just the first year, and billions of dollars of investment would be unlocked, according to some estimates. But if it is done badly it could cause a “civil war”, says one of the very few foreign investors into Ukraine’s agricultural sector.
Ukraine is already a global agro-superpower, but the sector is currently un-investible for foreigners, thanks to the muddle surrounding the issue of land. Expectations of the latest reform are low. “The land reform concept that Prime Minister Volodymyr Groysman has proposed, however, is unlikely to gain support from either the agricultural sector or from parliament. Due to its limitations, it will have a very narrow effect on the economy, and a good opportunity will once again be wasted,” wrote Aivaras Abromavicius, Ukraine’s Lithuania-born former minister of economy and trade, who quit in early 2016, claiming entrenched corruption in the government made his job impossible, and Alexey Mushak, a member of the parliamentary Petro Poroshenko Bloc, in a recent blog. Abromavicius and Mushak say lawmakers are discussing alternative plans that could work better, but something needs to be done if Ukraine is going to tap its best resource.
The issue was highlighted by the drama at the agricultural sector session at Strategic Council’s Ukraine Investment Roadshow conference in London in March, which should have been a chance to showcase the country’s stand-out sector for investment.
“In the last few years the bonds issued by agricultural companies have been a spectacular failure. This is not due to the policies, but a series of misdeeds. It has bred a culture of mistrust. If a company comes to market with a new bond the first question you ask is ‘how is it different this time?’,” asked an investor into fixed income instruments from Ashmore Capital. “The sector is almost un-investable.”
Without a freehold of land or outright ownership of land (something Russia already has) it is next to impossible for foreign investors to get any exposure to Ukraine’s agricultural sector other than buying the bonds issued by the leading companies. Every single one of those – with the exception of one company – has lost investors money.
However, it is possible to lease land if the foreign investor goes into partnership with local businesses. Continental Farmers Group is a very rare example of a foreign investor that has ploughed money into Ukrainian agriculture – and made a success of the venture. The founders of CFG were also at the session and very happy with their investment. But even the group’s CFO Alistair Stewart told bne IntelliNews that it is extremely difficult to operate and the new land law is desperately needed if his company is really going to be able to capitalise on its investment.
Plundering the farm
The trouble is that there have been some outright robberies in the agricultural sector and the Ashmore bond investor says it is time for the government to take responsibility for them. The most notorious case was that of Mriya. Founded in the 90s, Mriya like its peers had slowly gathered together a large plot of land and built up a vertically integrated agro business.
In 2013, the company issued $400mn worth of Eurobonds, only to default on the bond a year later in August 2014, announcing to the shock of investors that it had built up debts of $1.3bn. The company’s bondholders were furious. “They basically lied about their business and ripped off investors,” says the Ashmore Capital investor.
The writing had been on the wall for some time. In July 2012, the Ukrainian investment house Millennium Capital published a report on Mriya entitled “Too good to be true” that presented evidence of financial mismanagement. The analysts noted that starting in 2008 the company reported unusual cost reductions, used inflated production numbers, was involved in questionable land lease acquisitions, had suspect relationships with affiliated sugar mills, as well as operating a commercial bank with capital of unknown origin.
In December 2014, the infuriated creditors launched a bankruptcy process on Mriya’s parent company, HF Assets Management, refusing a deal to take a 66% haircut on outstanding debt. “Under such circumstances, even the current price of Mriya’s Eurobond of around 11 cents per dollar may be a high price,” Roman Topolyuk of Concorde Capital said at the time.
Mriya’s then CFO Oleksandr Cherniavski then quit on December 15 that year, recommending to creditors that they “take under full control the operational management of the group and full responsibility for the restructuring process”. By January 2015, a committee of investors had installed new management in an attempt to get some of their money back. Simon Cherniavski (no relation) took charge as the company’s new CEO that February.
Meanwhile, the Ukrainian interior ministry put Mykola Guta, the chairman and founder of the board of Mriya Agro Holding Plc, on its wanted persons list on charges of “fraud committed on a large scale or in an organised group”, according to the ministry’s website. “Large scale” means in excess of $45,000, punishable by five to 12 years imprisonment, with confiscation of property.
Some 80% of Mriya was owned by Mriya Agro Holding Plc, registered in Cyprus, which is in turn owned by HF Assets Management Limited of which Guta and the members of his family are the beneficial owners. Guta is accused of defrauding the company for of about $100mn.
The whole Mriya story is intensely embarrassing for Ukraine as it undermines the one investment story that should be a no brainer for investors. There were other similar stories, such as the listing of LandKom in the mid-noughties that were slightly less egregious, but still lost investors money. And since then all Ukraine’s bonds have been hit by the country’s virtual economic collapse in 2015 and 2016. Debt has been restructured across the board even by Ukraine’s best-run companies, so almost no bond investor has been able to make money from fixed income recently.
“Don’t get me wrong: I love the Ukrainian agricultural sector story,” said the Ashmore Capital investor, “but if there is a new bond and I go to my investment committee, they just say no.”
At this point, Daniel Bilak, the director of UkraineInvest, the state investment promotion agency, jumped in to smooth ruffled feathers and confessed to some uncomfortable truths in the process.
“Between 2007 and 2010 were the casino days,” Bilak told the room in his sonorous voice. “The prospectuses of some [Ukrainian] companies listing on the Warsaw Stock Exchange were just fantasies. It has severely damaged the reputation of Ukraine… But we hope to draw a line under this. We need to talk to investors. The story is not on a balance sheet. This is a frontier market. This is the Wild East.”
And Bilak is right. The opportunity is there and investors should be interested precisely because of the problems – they mean the rewards for investors that get it right can be huge.
In the same session, Continental Farmers Group CFO Stewart got up to highlight his company’s successful investment and its desire to continue to expand. CFG began life as private equity investors specialising in agriculture in the former Warsaw Pact counties. It cut its teeth in Poland since 1994 but moved on to Ukraine in 2006.
After the Ukraine business was got off the ground, the company listed in 2011 on London’s Alternative Investment Market (AIM) that specialises in smaller more exotic businesses . It was sold again in June 2013, this time to a consortium of Saudi investors and the country’s sovereign wealth fund. The company manages 44,000ha near Lviv in the west of the country and produces a mix of crops including cereal and sugar.
“There have been various scandals like Myira and LandKom, but they are becoming less common now. Now we have a quality company doing quality things,” says Stewart. “But it is still the Wild East.”
CFG would love to invest more money, and with its rich Arab owners behind it, raising more funds is not the problem. “To allow Ukraine’s agriculture sector to take off two things have to happen: the moratorium on land sales needs to be lifted and the capital markets have to be reformed,” Stewart told the room.
Part of the company’s problem is that it has to lease the land from individuals, local councils and other private people, rather than buying land outright. Typically, the terms of the lease provide for rents to be reassessed every year and lease payments may be indexed in accordance with the official inflation rate on the day of payment. Lease payments can be paid in cash or by payment in kind upon the agreement of the parties to the lease and are often paid in kind with crops, the company says on its website.
“The main issue is that if you don’t own the land then there is little incentive to invest into it,” says Stewart. “You can use things like fertilisers to improve the yields, but its not worth doing things like drainage or building irrigation – making investments that will add to the long-term value of the land.”
This is why the upcoming reform is so important. In March, Prime Minister Volodymyr Groysman reported that in its latest memorandum the IMF had made it clear that pension reforms and laws to launch an agricultural land market on the Rada’s docket were the key demands, but the plan on the table falls short of the mark, say critics.
“Earlier this month, Groysman presented the government’s plan that allows only individuals to buy land, and only up to 200 hectares per person. Parliament will likely reject this concept, since it ignores the fact that Ukraine’s agricultural sector cannot be globally competitive with land holdings limited to 200 hectares per person that cannot be used as bank collateral,” Abromavicius and Mushak said in their blog. “While Groysman’s initiative is an important and much-awaited step in the right direction, it must be bolder in order to succeed.”
The IMF is watching closely. It released another $1bn tranche from the $17.5bn standby programme in early April, but attached a scathing comment to the disbursement, singling out the need to liberalise the land market, which “remains underdeveloped due to a moratorium on the sale of land, limiting the expansion of this key sector and leaving the rural population poor”. The fund also said state-owned enterprises (SOEs) were stifling growth; pension reforms are pressing; and the judiciary needs an overhaul.
Agriculture accounts for about 8% of Ukraine’s GDP – much more than Europe’s other agricultural producers. Ukraine is second only to Russia in the amount of acreage of farmland in Europe, with a total of 41.5mn hectares of agricultural land – about 70% of the total area of the country – of which two thirds (32mn ha) is arable land.
The free land market draft law proposal drawn up by some 25 lawmakers, “would have a strong, positive impact on the country with potentially staggering results. In the first year after the market opens, $1.5bn-$2bn is expected to be added to the state budget due to the sale of one million hectares of state land that are currently being used inefficiently,” said Abromavicius and Mushak. “Two to three years after the market opens, investments in the agricultural sector are anticipated to rise to $10bn. And over time, an additional highly liquid mortgage market worth $45bn should arise, stabilising Ukraine’s banking system.”
There have already been some reforms of land, similar to the privatisation voucher system that were used to transform Soviet enterprises to private ownership, but they have not gone nearly far enough. About 7mn are employed in agriculture or 40% of the rural population. When the collective farms were broken up these workers were given “pai” or a land share certificate on average worth about 4ha. In addition about 7mn people were given outright ownership of small plots of about 0.4ha from a “land reserve fund”. This was to be used for small scale farming that made up a total of about 2.6mn ha. There are a total of 24mn ha under cultivation in the country.
Stewart says there are several options when it comes to privatisation of land and it will take several years to complete the process. One of them is to follow Poland’s example of introducing freeholding as a half-way house. Another is to follow Russia’s more radical decision to simple liberalise land ownership so that even foreigners can buy land outright.
“Ukraine has the best soil in the world,” says Stewart. “But they have to get the reform right. The people need to get something from the value of the land, but the big companies need to survive too. And this has to be done without letting the oligarchic groups dominate, otherwise you will end with a civil war.”
As an alternative to Groysman’s offical plan some twenty-five MPs plan to propose a liberal market model alternative in May 2017, titled “On Turnover of Agricultural Land”, that is based on the following points, say Abromavicius and Mushak:
“It’s important to keep one principle in mind: the more limitations, the lower the initial price, which contradicts the idea of maximising the value of land for those who have been deprived of their lawful right to sell their land for sixteen years. In a system with excessive limitations, dodgy operators will flourish, and they have always brilliantly circumvented restrictions in a legally weak environment,” say Abromavicius and Mushak. “But the draft law would open the market to both private individuals and legal entities registered in Ukraine, starting on January 1, 2018 ... All of this would help avoid chaos during the land liberalisation process and would open the sector to its full potential.”
The significance of agriculture to Ukraine’s economy stems mainly from crop production, which accounted for nearly 67% of all domestic agricultural production in 2012, Poland's OSW institute said in a recent report. And the bulk of this land is the chernozem, or famous “black earth” soil. Ukraine is probably the most fertile country in the world.
In addition to being a leading grain producers, it is also the continent’s largest producer and exporter of corn, the second largest producer of sunflower seeds and sunflower oil (and the world’s largest exporter), as well as being a leading producer and exporter of wheat and barley
The US Department of Agriculture revised its grain exports forecast for Ukraine in the current agricultural year (July 2016-June 2017), bumping up the total by 1.5mn tons from January. According to the USDA website, the wheat exports forecast was revised up by 800 US tons and corn exports by 700 tons. The all time record 2016 grain harvest totalled 66mn tons – up 9.8% from the year before and double the level of five years ago – of which nearly 42% was exported. Record harvest yields were reported for wheat at 4.2 tons per hectare and corn at 6.6 tons per hectare. Ukraine harvested 26mn tons of wheat, 28mn tons of corn, 13.9mn tons of sugar beet, and 13.6mn tons of sunflower seed.
The pai land certificate system that gave some land to those already working in agriculture was flawed from the beginning as the pais were not demarcated at specific locations and the farmers were not issued with title deeds to individual plots.
In the late 1990s a process was begun to allocate land to the certificates but it didn’t get very far. However, parliament in May 2003 passed a special bill regulating the question of land titles and by the end of 2012, title deeds had been issued to 6.4mn people or about 93% of the eligible population. As a result, in late 2012 as much as 30.7mn hectares of agricultural land, or three quarters (74%) of all agricultural land in Ukraine was – nominally at least – in private ownership, estimates OSW.
Privately owned farms appeared on this land, but it was still not possible to buy and sell land, so a system of land-lease emerged, where owners of big farms could lease the land they used. According to data from late 2012, half of all domestic agricultural land in Ukraine (49.8%) is under the management of about 50,000 businesses, operating mainly on leased land.
“Until 2010, the average annual cost of leasing 1 hectare of agricultural land did not exceed the equivalent of $40. More recently, however, lease fees have increased to around $70 following a government decision to raise the arbitrarily determined normative value of 1 hectare of farmland, and to increase the minimum land lease fee (to 3% of the land’s normative value),” OSW said.
The boom years of 2000-2008 saw the emergence of large agri-businesses. Fast economic growth and a relatively stable economy led to the consolidation of large amounts of land in the hands of a few dominant companies that have become household names.
The state did its part by introducing some laws that supported the development of the sector. The most significant changes included: the introduction by parliament of the so-called “fixed agricultural tax” in December 1998, VAT rebates, and state subsidies for agricultural production, which mainly benefited the largest players.
“The development of large-scale farms, however, was most directly facilitated by the increasingly appealing export opportunities. Since 2005, global markets have seen a systematic increase in the price of food and agricultural products, which translated into higher prices for the main grains produced in Ukraine: wheat, barley and corn,” says OSW. Over this period the prices for things like grain have effectively doubled, while the price of corn has trebled, due to growing global demand.
As business boomed, the managers of the most successful farms have expanded to an average of 100ha by leasing more land or buying smaller farms, and reinvested their profits in production and developing their own exports. Today, some 16.2% of the farms account for 80% of Ukraine’s agricultural production.
The largest of these firms to emerge is UkrLandFarming, which operates across an area of 670,000 hectares, making it the world’s eighth biggest agricultural holding by land size, according to OSW. UkrLandFarming remains unmatched even by the largest agricultural companies in Russia – despite Russia’s unrestricted land market. UkrLandFarming is owned by Oleg Bakhmatyuk, who began his career in the late 1990s as a manager in Itera, a Russian gas trader with links to the former Gazprom management.
However, more recently Ukraine’s biggest oligarchs, most of whom made their money in metals and finance, have become more active in agriculture.
Oligarchs who already own large agricultural holdings are: Ihor Kolomoisky (120,000 hectares), former acting prime minister Yuhym Zviahilsky, who has close links to President Petro Poroshenko (62,000 hectares), and Poroshenko himself (96,000 hectares). Interpipe’s Viktor Pinchuk has also expressed an interest in investing in agriculture, while Dmytro Firtash established the holding DF Agro in 2001, and has so far invested his money in the production of vegetables. In 2011, Rinat Akhmetov, Ukraine’s wealthiest businessman and one of the sponsors of the former ruling Party of Regions, together with his business partner Vadim Novinsky, created HarvEast Holding, based on the agricultural assets of the Ilyich Iron and Steel Works (200,000ha), but most of this land was in the disputed Donbas and Crimea regions.
The 10 largest Ukrainian agricultural holdings currently control more than 3.1mn hectares of land, or more than 15% of Ukraine’s total farmland.
And ironically the very fertility of the lands has lead to some major distortions in the sector, the most notable of which is Ukraine produces very little beef, but huge amounts of poultry and lots of pork.
“No farmer in his right mind would grow pasture for beef. The land is far too productive to grow grass for cows. If you want to produce protein then you grow grain and feed it to chickens and pigs,” says Leonid Kozachenko, president of the All-Ukrainian public organisation Ukrainian Agrarian Confederation. “Ukraine is the biggest and more efficient chicken producer in all Europe.”
Most of Ukraine’s meat is imported and subsidised by the government. And changes to the market are also impeding the production of beef. Milk prices have fallen dramatically in the last few years.
“Agriculture is not a potential. It is already an opportunity. Ukraine has world-beating agricultural production and our leading companies have done it on their own as unlike Europe, we have no agricultural subsidies,” says UkraineInvest director Bilak. “The companies have to innovate and compete and agricultural products already accounted for 38% of our exports in 2016.”