Advisor of the UCAB president on financing in the agro-industrial sector Nataliya Zinych has analysed the current state of financing and investment in Ukrainian agriculture in collaboration with the colleagues from the Humboldt University Berlin and the National Agricultural University of Ukraine. In their study the relationship between investments and capital access is investigated, when using an example of large farms from three regions of Ukraine (Zhytomyr, Cherkasy and Mykolayiv oblasts). Empirical results confirm the presence of the two contradictory phenomena, soft budget constraints and credit rationing.
The soft budget constraints, henceforth SBC, stem from the state and non-state bailouts for unprofitable enterprises (across other farms) with subsidies, credits, tax privileges, and other policy instruments. The SBC phenomenon is caused by government paternalistic objectives in order to provide economic and social stability in the agricultural sector during the transition process. However, only about ten percent of the analysed farm observations face soft budget constraints.
Credit rationing is caused by the presence of information asymmetries in the lender-borrower relationship. As a result, farms’ demand for external funds of capital is confronted with a small supply. In fact, about 61% of analysed farms are not able to borrow the desired amount of capital despite their willingness to pay the current interest rate. Being credit rationed, farms face an underinvestment problem during economic transition.
The dual existence of soft budget constraints and credit rationing in the large farm sector endangers the tendency of the wrong capital allocation and slow structural change in Ukrainian agriculture. Nevertheless, it is a rather speculative question if unprofitable farms should be liquidated as long as the large farm sector absorbs a considerable share of rural labour. An alternative way in this context is the step-by-step acquisition of the SBC farms by more successful agricultural enterprises.
Moreover, the establishment of a sound banking system may help to increase supply of external capital to the profitable farms. However, these farms should learn how to signal their financial wealth in order to receive credit. In the credit rationing equilibrium, the banks sorting among potential borrowers do not implicitly choose those loans with the highest total returns. When credit is restricted, not necessarily the projects with the lowest return are terminated. Thus, banks need to develop an appropriate credit rating system to choose appropriate borrowers.
Another source of external finance is direct (foreign) investment, which may support farms with financial constraints, but may also facilitate ‘soft’ takeovers of SBC farms. In the last time, the capital access in Ukraine has been complicated because of the negative developments on the world capital markets. However, several foreign investors have entered the Ukrainian land rent market. For all that, direct investment is still hindered in the agricultural sector of Ukraine because of complicated bureaucratic procedures, slow land market reform, and substantial price fluctuations on agricultural output markets. Advisor of the UCAB president on financing in the agro-industrial sector Nataliya Zinych emphasises that financial and sectoral developments in Ukrainian agriculture are directly influenced by the level of macroeconomic stability and institutional development in Ukraine.
Association “Ukrainian Agribusiness Club” is the youngest business-association in agriculture and food sector of Ukraine. It was organised in September 2007 by a group of forward-thinking owners and top-managers of largest Ukrainian vertical-integrated agro-industrial companies interested in creating a strong, unified voice for the national agriculture and food industry.
Press-centre of UCAB