Does Agribusiness Contribute to Rural Development?

I will again summarize an article from Zerkalo Nedeli, again written by Elena Borodina, but this time not dealing with small-scale producers, but the largest producers in Ukraine. The article with the title “Unequal Marriage without Government Oversight” was published on August 21 and can be found here (in Russian). The point of the article is to question the degree to which the super large agroholdings will really contribute to national and/or rural development, which is sometimes claimed by advocates of agroholdings (including even the World Bank).

Borodina first gives an account of the polarization of the agrarian sector towards either really small or really large farms, where many people in rural areas are becoming landless while land is being concentrated more and more under agroholdings. At the beginning of 2014, she states, the number of agroholdings approached 140, which controlled 6000 separate farming enterprises (40% of the total), on about 8 million ha of land (40% of the land cultivated by farming enterprises). Of all registered farming operations, these agroholdings harvest about 50% of Ukrainian winter wheat, more than half of the corn and rapeseed, a third of the sunflower seeds, and over 80% of chicken meat. Because land reform has not been completed (among other things, agricultural land sales are as yet not allowed in Ukraine), a “shadow” land market has arisen, which these companies benefit from, and it helps them attract capital.

So these companies do attract capital, which they invest in operations, but, as Borodina points out, there appears to be an inverse relationship between the growth of investment in the agrarian sector and the number of people employed in the agrarian sector. Below I have reproduced a graph using the same data as in her diagram in ZN (note: the original graph measured investment in Ukrainian Hryvnia, but I changed that into dollars using the average annual exchange rate for that year. Export sales and many inputs are often dominated in USD so this makes sense, especially considering the devaluation of the UAH in 2008).    

Borodina also points out that the agroholdings are very good at attracting capital either through IPOs and stock emissions or thanks to their access to inexpensive credit from international financial institutions such as the European Bank for Reconstruction and Development (EBRD) and the International Finance Corporation (IFC) which is part of the World Bank, and export credit agencies of different countries like Austria and Denmark. For example, the Danish Export Credit Agency, from 2003 to 2011, insured the export of livestock products valued at 154 million Euro, from Ukraine. The International Finance Corporation has since 2010 provided financing in support of Ukrainian agribusiness to the tune of 282 million dollars, while the EBRD, over the last 5 years, has presented credits totaling 55 million Euro to some of the largest agroholdings in Ukraine.

The larger point that Borodina seeks to make is that all this support to large-scale agribusiness in Ukraine will not lead to the development of the countryside, but is rather a factor contributing to the ongoing distortion and polarization of the agrarian sector in Ukraine. 

A genuine proposal for formalization of rural household farms in Ukraine or its opposite?

There was a really interesting article recently in Zerkalo Nedeli, a highbrow newspaper in Ukraine, about a proposal to formalize those small-scale household farms in Ukraine that are really operating as commercial farms. There are no numbers on how many households this is. It is certainly not a majority of rural households, but it is an important minority. The article (here in Russian) was written by Elena Borodina and Igor Prokopa, two agricultural economists who frequently write illuminating articles about Ukrainian agriculture for ZN.

This  topic is close to my research, so in this blog post, I will summarize the article. Basically, the proposed law – it is actually proposed changes to the law on fermeri (family farmers) – would allow physical persons who farm relatively small (for Ukraine) plots of land to register as subjects of entrepreneurial activities. In essence this would create a new farm category – Physical Person Entrepreneur (FLP to use the Russian acronym) and the goal is that it would encourage a rather large group of active, commercial farmers who have anywhere from a couple of thousand square meters to 10 ha (or in some cases more) to come out from the informal economy. A common vernacular name for such farmers is odnoosibniki, which means “single person” in Ukrainian and generally refers to a person who cultivates by themselves the 4 to 5 ha of land they received in the privatization of the local collective farm. Many odnoosibniki also cultivate the land of relatives who received land allotments during the privatization reforms. Even people who did not receive any land in collective farm privatization or people who lease out their land to another farm, can still have access to up to 2 ha somewhere, often close to the home, that they can cultivate very intensively.

The incentive for such people to register as subjects of entrepreneurial activity is that they would be able to participate in state support programs intended for family farmers and also there is a promise of a special social insurance program. The costs however – as Borodina and Prokopa detail – appears to be very high, perhaps too high. The proposed changes to the law envisage a rather cumbersome registration process, requiring that these farmers, many of whom would not have a car, travel 10 to 40 km to the local district center. It would further entail paying pension fund taxes, registration with the tax authorities, and the obligation to regularly answer statistical surveys from district statistical departments.

Borodina and Prokopa estimate that a household with 2 ha and 3 cows, which would have an estimated annual income of 30,000 UAH (about 1826 Euro in today’s crashing exchange rates), would go from paying 40-50 UAH in land tax today to somewhere between 300 and 900 UAH in annual tax, plus around 400 UAH a month in social taxes, plus still VAT. Then there is the amount of time one would have to spend. Private households wishing to register as FLP would have to travel, not just once, but regularly to the district center to pay taxes and submit reports on their activities.

At the same time as this possibility is now being proposed, there is another proposed law change that would forbid households from selling surplus produce on markets in an attempt to push every household that is to some extent commercial to be in the formal economy.

Borodina and Prokopa argue that it is important to try to formalize the activities of the active rural households engaged in commercial agriculture, but that these proposals will do the opposite – push active farming households deeper into the shadows.

Instead they argue that farms in the informal sphere should be formalized as family farmers without having to register as a legal person (or a FLP). One should recognize, they argue, that farming is a special activity and should not face the same demands placed on other economic actors. Second, the registration procedures and accounting obligations for family farmers should be greatly simplified and the tax obligation lightened. Finally, reforming family farming should only take place within the context of a comprehensive reformation of agrarian policy with respect to all categories of farms, a reformation that would define and accept family farming as an essential element in ensuring the functioning of the agro-food sector.   

This was a good article and I recommend those who can read Russian to read Borodina’s and Prokopa’s other material on ZN.  

Interim Results from current agricultural season of the Swedish Agroholdings in Russia and Ukraine

Originally, I wanted to blog about how the current crisis in Ukraine is affecting or not affecting the "Swedish" investments in Ukrainian and Russian agriculture -- such as Black Earth Farming, etc... However their recently posted half year results (see below) do not give an indication of much of anything, and that points to a completely different problematique, i.e. the special problems agricultural firms face in reporting results, which itself can be said to be part of a larger problem concerning the degree to which corporations can optimally conduct farming compared to family (or peasant) owned and operated farms.

The diagram below shows the relationship between net profit/loss as published in the half year results of  four "Swedish" firms between 2006 and 2013 and the final annual result for net profit (Note that data for the entire period 2006 to 2013 was not available for all the firms, for example for Grain Alliance (GA), there was only data for 2013). The x-axis is net half year profit/loss in kr, and the y-axis is net annual profit/loss. BEF posts their results in dollars, while Trigon posts their results in Euro, so I have used the average annual exchange rate from dollar or euro to Swedish kronor, which are published by the Swedish Central Bank. Arrayed on the x-axis in blue are the half-year net profit/loss results for 2014 in kr (annual results for the year have not yet of course been published). Note that Agrokultura has posted an interim net profit of 47.7 million kr, for 2014, which however becomes a net loss of 48 million kr when taking into account the sharp decline in value of the Ukrainian Hryvnia. I have chosen to use the latter figure in this diagram. In any case, as shown in the diagram there is only a loose correlation between half year net profit/loss results and annual profit/loss results (r2 = 0.0305).   

Generally speaking, interim results are a good indicator for annual results, at least according to an article published in 1972 by Reilly, Morgensen and West in the Journal of Accounting. OK, that's a rather old article, but this is just a blog. (It would be interesting to see how agricultural firms compare to non-agricultural firms in terms of the relationship between interim and annual results, and how vertically integrated food processors compare with “pure play” companies such as the Swedish agricultural companies in the former Soviet Union) Obviously firms in sectors that experience a lot of seasonality will see more fluctuation in interim results in relation to annual results, and agriculture is definitely a sector with a lot of seasonality. The problem here however is not the seasonality per se, but the way in which international accounting principles stipulate that crops growing in the field should be valued for the purposes of financial reporting.  IAS 41 Agriculture, which are the international accounting principles that all the Swedish listed firms use, state that, after enough “biological transformation,” the crops should be valued according to “fair value,” less cost of sales, and, importantly, that the fair value of the crops should appear in the income statement as revenue. That is how we can talk about these firms being profitable before they have sold any of the harvest. The problem is that fair value depends on yield and prices, both of which are constantly moving targets. The basis for “fair value” for the first half of the year is generally taken to be the yield estimate and prices on 30 June, but even this close to the harvest of winter wheat, when one should have a good idea of what the harvest will be and what price it will fetch, small adjustments in either can have a big impact on the bottom line. A second factor affecting quarterly results is how slow or fast companies sell their harvest. Generally the largest part of the harvest is sold in Q4 of the year of that harvest, the second largest part of the harvest is sold already in Q3 of the same year and then the third largest part is sold in Q1 of the next year. But depending on storage capacity and what they think future prices will be, companies can keep crops in storage hoping that the prices will be better in the future or they can sell them relatively fast, believing that prices will only go down in the future. The first scenario will make a farming company’s bottom line look worse for the calendar year in which the harvest was gathered, but better during the next calendar year. At times, companies can still be selling crops into the second quarter of the following year. Finally, it has to be mentioned that late summer crops (corn, sunflower, soy) have an increasingly large impact on the annual result -- something that would not be visible in the 1H / 2Q reports because not enough biological transformation has happened to make a fair value assessment. 

To go back out to the big picture, firms listed on the stock exchange are obligated to publish interim and annual results (though auditing requirements are stricter for annual results). For agricultural firms, this in turn requires that the firms account for the value of crops growing in the field. Internationally accepted accounting principles state that crops growing in the field should first be valued at cost, but then, after enough biological transformation has occurred, they should be valued at fair value, and posted in the income statement as revenue, despite it being unrealized. This can be and often is the  largest item on the revenue side in interim results. (For more on IAS 41 Agriculture and how fair value is arrived at, see Fischer and Marsh 2013) The firms have not come up with this by themselves, and if anything, we – coauthors and I – have heard a fair amount of criticism about the fair value exercise coming from representatives of these firms in ongoing research we are conducting. Black Earth Farming's 2Q 2014 results are interesting in this regard. In what can only be described as a good faith effort to really arrive at a fair value, they explain in some detail how they are changing their fair value accounting. One of the main points to make about this is this is not something that a family farmer would have to go through. 

Is there another way to tell half way through the year, if it will be a good year? The answer is not really -- because it is too early to  make an assessment of the late summer crops. One can say at this point that, however, just as the spring was favorable in terms of weather in Ukraine and Russia, the fall is shaping up to be hot and dry, so the yield of summer crops will be negatively affected, even as prices, at least according to this article, continue to fall. 

Third quarter results are a better indicator of the final annual result, since as assessment of the summer crop outcome is possible. The diagram below is the same as above, but for 9 month results as reported in the 3Q reports. Note that Agrokultura does not publish 3Q reports, and Trigon did not publish 3Q figures in 2007, so there are a few missing data points. Even here though there is a lot of variation where 9M net result is -60 million kr or more (i.e. from -60 million kr towards 0): at this level of net loss 9 months into the calendar year, annual results have varied from -150 million kr to +50 million kr. So, there are some question marks here as well (and not enough data points).

So we'll have to wait until November, when companies post 3Q results, before we can get a somewhat better sense of how 2014 will be for these companies. This year, probably the biggest impact will be how currency exchange rates affect the bottom line. If I read Agrokultura’s 2Q report correctly, they would have been profitable if the Ukrainian Hryvnia had not lost 50% of value. For the next crop year however, these firms will face tighter credit and more expensive input prices (since many inputs are imported).