Ukraine’s agricultural sector has been one of the country’s top performers in recent years, picking up the slack created by a conflict-driven economic slump and powering the current economic recovery. This agribusiness boom has attracted considerable domestic and international investment to the sector, with many major projects focusing on upgrades of Ukraine’s agricultural infrastructure. However, at the small and medium-sized enterprise level, Ukrainian farmers require additional access to medium-term finance in order to improve productivity.
Many Ukrainian farmers currently operate with old equipment that requires upgrading. The country’s agricultural machinery replacement needs for tractors and combine harvesters are estimated at anywhere between USD 2 and 8 billion per year. This represents a considerable investment that would also lead to increased yields and decreasing costs, but it is largely dependent on increased access to medium-term financing.
Search for Stability
Due to a combination of economic recession and political instability, Ukrainian banks have limited access to medium-term deposits. Meanwhile, the level of foreign direct investments in the country has also experienced a sharp decline since 2014. These conditions serve to generate currency volatility, creating a low-confidence economic environment where medium-term financing is in limited supply and often prohibitively expensive. Greater financial sector stability and predictability are crucial if the agriculture sector is to benefit from the levels of medium-term financing capable of meeting potential demand.
The Ukrainian banking industry appears to be moving towards this stability via a period of tumultuous reform that is succeeding in improving corporate governance throughout the sector. Increased stability in the Ukrainian financial sector now depends on the ability to maintain banking sector regulation while overseeing crisis management. As the main regulator of Ukraine’s banking sector, the National Bank of Ukraine (NBU) is introducing systemic reforms that are making the sector stronger. These measures include the removal of non-transparent and money-laundering banks from the market. Financial monitoring of banks is becoming stronger, with capital requirements enforced and the ultimate beneficiary owners of banks disclosed. We are also moving closer towards the reality of a cashless economy, removing the corruption issues created by widespread reliance on cash. These factors are all contributing to growing confidence in the banking sector, which should translate into larger volumes of medium-term deposits in the national currency. This in turn can fuel medium-term lending to the agriculture sector.
In the developed world, private pension funds and life insurance companies represent a major source of local currency medium-term financing. It is quite normal for the financial contribution of these groups to be greater than that of individual savings accounts. In order to secure access to this stream of funding, Ukraine much complete the ongoing process of pension reform. The current pension reform agenda has set a number of targets for 2020, including the creation of well-regulated and stable private pension funds. This has the potential to create a critical mass of medium-term hryvnia deposits, paving the way for greater access to medium-term capital for farmers.
Another factor capable to easing access to medium-term financing is agricultural land sales reform. Discussions on lifting the moratorium on agriculture land sales have currently stalled but will likely restart in 2018. This presents opportunities for banks looking to expand their financing to the agricultural sector. In many countries, the use of agriculture land as collateral or in mortgage financing to purchase land is a reliable and low-cost way to obtain financing. Lifting Ukraine’s moratorium on agricultural land sales could significantly contribute to agricultural sector development, provided there is medium-term financing available.
Any agricultural land reform could help solve bottlenecks for medium-term finance created by a lack of collateral among many smaller-scale Ukrainian farmers. The broader issue of creditor rights also requires consideration if farmers are to receive better financing terms. In light of perceived weak creditor rights in Ukraine, banks often currently require 150-200% collateral coverage. Banks use this excessive collateral to cover potential losses in Ukrainian courts. The enhancement of creditor rights, together with adoption of a quick and efficient collateral enforcement process, would allow banks to decrease the collateral coverage ratios they expect. By enhancing the rule of law, banks can reduce collateral and risk premiums, creating more affordable lending options for farmers.
Boosting the Breadbasket
In order to increase medium-term financing for farmers, Ukraine should seek to adopt a broad range of policies. These measures include ensuring greater financial sector stability, securing medium-term hryvnia deposits from private pension funds and life insurance companies, and strengthening creditor rights (including efficient collateral enforcement and foreclosure). The creation of a national state registry of all loans for legal entities would also help, together with the establishment of an open agricultural land market to provide farmers with powerful collateral. These steps will help to foster confidence and create the conditions for the expansion of medium-term financing to the benefit of Ukraine’s farmers.
About the authors: Leah Soroka is Program Manager of ECA Agricultural Financial Services at IFC. Petro Bogachevych is Agri-Banking Expert of ECA Agri-Finance Project at IFC