Ukraine land market reforms watered down but on track to be introduced in 2020

Ukraine land market reforms watered down but on track to be introduced in 2020
Ukraine is on track to create a watered down version of a land market in 2020
By Ben Aris in Berlin January 5, 2020

Ukraine is grappling with creating a market for farmland that could boost economic growth by as much as 3% and increase the value of the economy by $85bn if introduced. But land sales are a highly sensitive political question and just suggesting the creation of a land market has already cost Ukrainian President Volodymyr Zelenskiy some of his political popularity.

A draft bill to create the market was passed in its first reading in December and the remaining two readings are due at the start of this year. However, while the idea has been accepted in principle, many of the details remain to be worked out. As the government has decided to exclude foreign participation in the land market the effect of the reform has already been significantly watered down.

A moratorium on farmland sales in Ukraine has been in place since 2001 and affects close to 70% of the territory and 16% of the Ukraine’s population, which cannot freely dispose of their farmland plots.

Zelenskiy ordered the government and the parliament to approve land reform by December 1 and the Prime Minister of Ukraine Oleksiy Honcharuk announced that the land market will be operational as of October 1, 2020.

The end of the moratorium is expected to have a major impact and could dramatically boost economic growth, according to a study jointly authored by the World Bank and the Kyiv School of Economics, published by Vox Ukraine at the end of 2019.

Another report by UIF released in 2017 entitled, "Moratorium on land: the extent of losses for the Ukrainian economy” forecasts average annual nominal GDP growth of 6-7% after the moratorium is lifted, depending on the conditions that are applied. The UIF study evaluates two scenarios. In both scenarios land ownership per beneficiary is limited to 500 hectares (ha), with foreigners excluded from the market in the first scenario and foreigners are allowed to participate in the second.

Another report from Easybusiness released in 2019, “Life After: Key aspects of land market opening”, predicts that lifting the moratorium on land sales in Ukraine will generate an additional $14bn to $85bn of GDP over the next 10 years under different scenarios compared to the status quo or continued moratorium scenario. Again the study looks at different scenarios, which materially impact the development of the market, particularly the thorny question of if foreigners will be allowed to participate.

Zelenskiy eventually rejected the idea of foreign participation until there is a nationwide referendum on the question in several years time in a bill that was passed in its first reading in mid-December.

The International Monetary Fund (IMF) and foreign investors have criticised the ban on foreigners participating in the land market , as they believe it will lower the value of the land on sale by limiting the pool of investors.

Under the most liberal scenario without regulations and with the access of foreigners, the average farmland sales price is expected at $5,640/ha and the effect on GDP will be an additional $85bn over the following 10 years. That is equivalent to an expansion of GDP by 70% from the $124bn the economy was worth at the end of 2018.

“This in turn implies additional annual GDP growth of 5.4pp – a result very similar to the UIF (2017) report,” says Klaus Deininger, the lead economist at the World Bank, and Oleg Nivievskyi of the Kyiv School of Economics, who authored the study published by Vox Ukraine.

Pros and cons

The introduction of pricing for farms means the market should trigger structural changes and sort the farms by productivity and profit that will lead to an overall increase in the value of land and farms.

The private ownership of land should also trigger investment into land to improve productivity and yields. Under the current leaseholding system there is little incentive for farmers to invest heavily into developing land the leaseholder doesn't own.

Private ownership of land will also open up credit lines as land can be offered as collateral, allowing farms to raise the capital they need to invest into their land.

There is a debate over whether the land market should be opened in two phases, with the state offering circa 2mn ha from a total of 9mn ha of state registered land suitable for agriculture in the first phase before throwing open the gates to private sales, or if the whole market should be opened in a single stoke of the pen.

In the second case the state could offer about 0.3mn ha of land in addition to the estimated 2.3mn ha of privately owned land, according to estimates made by the US Department of Agriculture (USDA) in 2015. Experts estimate that about 8% of landowners could be persuaded to sell their land in the first five years after the moratorium is lifted and another 3% would sell over a longer period.

One of the big worries about the reform is that it will be skewed in favour of oligarchs. Deininger writes that typically smallholders have a difficult time accessing land even if there is a functioning market as Ukraine’s credit markets are so underdeveloped they simply cannot raise enough money to grow their farms by buying more land.

At the same time the opposite is true for oligarchs that have plenty of access to credit and cash, which would mean the agriculture business will be rapidly monopolised by a few large groups.

Allowing foreigners to participate in the process would introduce some competition, but with their equally deep pockets, and the relative attractiveness of Ukraine’s extremely fertile land, the result is the same: the rapid monopolisation of land, except some of the owners would be large international agricultural groups that would export profits.

“Even if land can be used as collateral, a large part of the transaction costs of providing credit is fixed. Thus, even if they have credit-worthy projects, small farmers may have difficulty accessing credit. And hence support to level the playing field for them may have positive impact on productivity,” say Deininger and Nivievskyi.

One of the recommendations the World Bank makes is for the government to set up some sort of guarantee fund, especially for smallholders, to access credit easily, which would level the playing field somewhat and could double the productivity of small farms. The government also needs to end the subsidies it has offered large farms as part of its effort to promote the sector.

“Over the last two decades, agricultural support in the form of substantial tax benefits and direct budget outlays in Ukraine has always been favouring large producers thus creating unequal conditions for developing the small ones. This partially distorted the farm structures towards the large and mega-large agriholdings in Ukraine and left less space for improving productivity and diversification of the small ones,” say Deininger and Nivievskyi.

Outcomes

There are a lot of moving parts, but Deininger and Nivievskyi estimate in the most liberal scenario – foreign participation, no caps on land ownership, financial support for small farms – the reform could create some $10.6bn of additional value in the economy, or add 8% to GDP and $2bn-$3bn per year over three to five years. This extra activity would boost GDP growth by 1.8%-3.1% each year – a significant acceleration of growth.

“Scenarios with more stringent restrictions in general produce lower GDP growth rates. The lowest growth occurs in the scenarios were legal entities have no access to the farmland sales market. The scenarios whereby only state land is sold on the market produce some growth but it fades pale compared to growth opportunities contained in the one-go land market opening scenarios,” Deininger and Nivievskyi write. “Expected farmland in this case is relatively high, though, i.e. more than $6,000 per ha, which is because of the high demand and very limited supply available.”

The government's choices will make a big difference to the impact of the reforms and the price of land which could range from $1,000/ha to $6,500/ha depending on the conditions.

In order to maximise the effectiveness of the reforms the academics made several recommendations.

The first was to open the market all in one go. The state can only offer about 2mn of its 9mn ha of agricultural land as most of this land is already leased and so cannot be offered for sale. Because of the limited supply prices would soar, which favours the oligarchs and excludes the smallholdings. And finally the two step approach to opening the market would have only a minimal impact on growth, lifting GDP by 0.74% at most, compared to 3.1% in the scenario where private agricultural land markets are opened as well. 

The second recommendation is to set up and strictly enforce anti-monopoly rules covering land ownership. The basic idea is to limit the amount of land any one person or company can own to prevent the oligarchs or big firms from dominating the business.

“Strict enforcement of anti-monopoly regulation that limits the share of land owned by one entity to 35% of agricultural area of an amalgamated community (OTG) is necessary to avoid undesirable outcomes,” Deininger and Nivievskyi write.

The amount that anyone entity can own is still being debated but amongst the suggestions are 200 ha for individuals, 1,000 ha for legal entities and a total cap of 0.5% of the whole country. Zelenskiy believes that in the framework of opening the land market in Ukraine, it is necessary to establish the possibility of owning land by one individual or private entity of not more than 10,000 ha. The experts also recommend raising the tax on land to prevent speculative land holding.

While Ukraine has already decided to exclude the politically sensitive issue of allowing foreigners to buy land until the question has been put to a nationwide referendum, the authors list the many benefits to allowing the foreign investors in.

“The reason is that foreign land ownership provides important benefits that, in the case of Ukraine, would include (i) the ability to tap capital, technological know-how, and access to value chains especially in horticulture and fruits, that are not available locally; (ii) the scope for such investment from the EU to help improve EU market access in return; (iii) the improved transparency associated with FDI from developed countries which are often subject to strict transparency rules; and (iv) higher benefits to landowners in the form of higher land value,” say Deininger and Nivievskyi.

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