Economic And Distributional Impact From Lifting The Farmland Sales Moratorium In Ukraine

The authors estimate different scenarios of land market opening and find that the most growth-enhancing scenario is the one with minimum list of restrictions and financial support of small farmers to access the capital and increase their productivity. Under this scenario, additional annual GDP growth over the next five years can be as high as 1.9%.

Moratorium on farmland sales in Ukraine has been in place since 2001. The scale of moratorium is impressive (see articles 1, 2). It affects close to 70% of the territory and 16% of the Ukraine’s population that cannot freely dispose of their farmland plots. Most of these owners live in rural areas and are of old age. Discussions about lifting the moratorium and its future design are still ongoing and there is a growing political support to remove the moratorium. Indeed the new President of Ukraine ordered the Government and the Parliament to approve land reform this year by the 1st of December and the Prime Minister of Ukraine Oleksiy Honcharuk announced that the land market will be opened as of October 1st, 2020. 

In the more detailed technical note we provide the ex-ante estimates of the moratorium impact using a classical partial equilibrium analysis and existing farm-level performance data. Specifically, we look at various scenarios of the future farmland market design and estimate how the incomes of various stakeholders and agricultural value added  would change. The list of the modelled scenarios includes various combinations of the following options: phasing versus one-go opening of the land market (ie. allowing transfer of state land first, to be followed by private land later), access of foreigners (yes/no), access of small farms to credits (yes/no), availability of targeted support program for small farmers to allow their productivity improvements (yes/no), multiple land ownership restrictions for physical persons and legal entities,  including implicit control against excessive land concentrations. Depending on the scenario setup, the modelled impact ranges from nearly 0% of additional annual GDP growth over the next 5 years time horizon (most restrictive scenario whereby legal entities have no access to the farmland sales market) to 1.86% of the most liberal market design with access of foreigners, no land ownership ceilings caps and financial support of small farmers to access the capital and increase their productivity. 

Based on the results of the modelling scenarios and taking into account global experience we therefore summarize below key recommendations with respect to the desired farmland market design for Ukraine. 

Open markets in one go: Starting to allow transfer of state land first, to be followed by private land later is not recommended for several reasons. Total state land supply at the moment is limited at only about 2 mn ha of the estimated 9 mn ha of registered state land suitable for agriculture, most of which is leased and thus cannot be sold. Markets relying on state land only would thus be very thin, resulting in high prices and outcomes biased towards wealthy individuals/agricultural companies. As state land is expected to be transferred to amalgamated communities (OTGs) who may want to decide for themselves whether to lease or sell, using state land as the motor for land market opening would also conflict with the decentralization agenda. Given state land market low liquidity, banks would not be interested in getting involved so that small farmers already owning land will not be able to access credit for working capital or investment, diversification and job creation. Finally, lifting the moratorium on state land will not allow Ukraine’s 7 mn landowners to exercise their constitutional rights while tarnishing the country’s reputation as it fails to act on the ruling of the European Court of Human Rights that found the moratorium on agricultural land sales indeed violating human rights and required changes to eliminate this. Most importantly, the growth benefits one could expect from lifting the moratorium on state agricultural land are very limited. 

Strictly enforce anti-monopoly legislation: Regulation to ensure competition in the land market is essential to avoid exercise of market power. 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*. Lower size limits can be defined in local land use plans and enforced at OTG level. Higher level thresholds currently discussed (i.e. 8% of agricultural area  of an oblast, and 0.5% for the nation) are essentially a political decision. Speculative land holding should also be discouraged by increasing land tax rates to realistic levels that can be varied within certain bands at local level and by improving enforcement via electronic link between the Land Cadastre and the State Fiscal Service. 

Beyond these, nationally uniform limits on land holding size (e.g. 200 ha for individuals and 1000 ha for legal entities) that neglect the country’s regional diversity and the potential of variation and changes in optimum farm size over space and time and that are difficult to enforce and easy to circumvent are not recommended. International experience shows that such restrictions hardly ever worked as intended anywhere but instead created distortions, corruption, and a shadow economy. Moreover, simulations suggest that the costs in terms of foregone growth would be high. 

Allow legal entities to buy land: Restricting land market participants to individuals only will limit demand for land, keep prices low, and limit benefits to landowners as well as economic impact. Commercial banks will not be interested in extending/developing land financing instruments for individuals only, so credit and financial market benefits are unlikely to materialize and the scope for reallocation of land to better producers will be scant. To allow effective implementation of anti-monopoly and anti-money laundering legislation, only Ukrainian legal entities beneficially owned by individuals who are registered in Ukraine should be allowed.  

Provide financial support to small producers: As tradable land is an ideal collateral, functioning land markets can unlock large amounts of mortgage lending. This would benefit small producers who mainly operate own land and who could access credit to invest in intensification and high value-added crops if the moratorium were lifted. Lack of familiarity with and perceived high risk of the SME sector may, however, prevent banks from providing credit in the initial period after market opening, potentially undermining SMEs’ competitiveness, market participation, and growth. A partial credit guarantee (PCG) can reduce this risk and allow SME access to finance. The mechanism is establishment and initial capitalization of a commercial agency that, for a fee, assumes part of the risk of default by targeted groups on the credits they get. Preliminary calculations suggest that to capitalize an agency that would cater to initial demand for investment and land purchase about USD 60 would be needed. If a commercially run private entity with majority private participation were set up, donor, IFI, and private sector support could cover all or part of this, potentially supplemented by part of the agricultural subsidy budget. 

Support SME investments through redirecting agricultural subsidies: Most Ukrainian farmers currently produce low margin field crops rather than orchards or horticulture because they lack market links and access to capital for investments, e.g. in irrigation, that could easily double their output per hectare. With developed financial markets and agricultural value chains, credit for such investments would be available. Yet, even after moratorium lifting, these developments will take time. Bridging this gap by providing investment grants to SMEs, possibly administered by banks together with PCG resources, would be a more appropriate use of state subsidies of USD 250 mn per annum which currently mostly go to waste. A more realistic tax regime for the agricultural sector, which will be needed in any case, could then recoup some of this investment in the future. Calculations suggest that such a measure which could be operationalized quickly and could significantly add to GDP growth. A comprehensive farmer registry to verify farmers’ land data to establish eligibility and also reduce banks’ lending cost would need to be established, and this process has started. 

Do not completely forbid foreign ownership: Land purchases by foreigners imply a host of risks, most importantly money laundering, use of land acquisition for political motives and the fact that foreigners may cause irreversible damage and then just leave the country. Yet few of the key agricultural exporters ban foreign land ownership. Instead, they opt to carefully regulate and scrutinize such investment. 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. The fact that problems caused by foreigners are due to gaps in regulations or enforcement that are also exploited by country nationals further reinforces this. 

Instead of banning foreign land ownership altogether, it could thus be prudent to set clear standards in terms of transparency (e.g. no shell companies) or national co-ownership and make foreign land acquisition contingent on criteria, e.g. minimum levels of investment, job creation, or exports of what it produces, to be achieved. As long as these are centrally monitored and enforced, communities could decide if (or under what conditions) foreign land acquisition is allowed in their local development plans. 

Take active measures to minimize risks: Measures to ensure regulations are enforced and the risk of abuse is minimized are greatly facilitated by institutional reforms and technological links. They include:

• To enforce anti-monopoly laws, registration software should automatically block transactions if restrictions are violated; transaction records and cadastral data should be publicly available; and free messages could be sent to all parties (including local Government) potentially affected by a registered transaction to protect against fraud and allowing to raise objections. 
• Recording and publication, subject to privacy restrictions, of sales price data; using rules to check for transaction prices in force for other real estate and exploring additional seller protections (e.g. a mandatory sign-off on any transactions apparently below-market value) to protect against fraud. 
• Reliance on the free legal aid system already established by the Ministry of Justice with monitoring of outcomes throughout the system to preclude coercion or involuntary dispossession of ill-educated land owners.
• The scope for negative environmental impacts should be reduced by routinely monitoring land use and compliance with local land use plans using remote sensing data rather than ad hoc mechanisms. 
• To provide funding for SME support, current subsidy programs should be restructured and targeted more effectively and linked to farmers’ registry & local land use plans, land tax/fee collection be streamlined and the agricultural tax regime be reviewed to ensure the sector pays its fair share to the state budget. An independently commercially run partial credit guarantee agency involving private & IFI seed capital should be established.