1. Ukraine’s Sunflower Sector: The Main Conclusions of the EBRD/FAO/LMC Study Presentation by James Fry LMC International, Oxford, UK June 2004

2. Outline of the Presentation Background to sunflower production and crushing in Ukraine Key issues Export tax Credit VAT reimbursement for exporters Recommendations

3. The Agricultural Sector Ukraine is the world’s third largest sunflower producer in the world, with production of 4.3 million tonnes in 2003/04. The Ukrainian farm sector has undergone considerable changes since independence and the restructuring process is still underway. Most sunflowerseed is grown by large agricultural enterprises (average size 1,700-2,000 hectares). Since the introduction of a market economy, yields have fallen because cutbacks in the application of inputs, such as fertiliser, and low reinvestment in agriculture.

4. The Agricultural Sector The experience of some farms suggests that yields (currently around 1.1 tonnes per hectare) can improve significantly with the application of:  Up to date farm practices  Modern machinery  Improved seeds (particularly high yielding hybrids) Yields have also suffered because of the reduction in the rotational period between sunflower crops, which harms soil fertility and increases the risk of disease.

5. The Crushing Sector 17 major crushers (capacity of 250-1,100 tonnes per day) produce 85% of Ukraine’s sunoil output. However, output of 4.3 million tonnes of seed could support a maximum of nine domestic crushers, each with an economically efficient daily crushing capacity of 1,500 tonnes. This average capacity is at the lower end of the average in W Europe and is the minimum that would enable the sector to remain competitive. Therefore more consolidation in the crushing sector is expected over the coming years.

6. Ukraine Sunflower Crushing Costs (per tonne of seed), 2002 Capital & Fuel & Labour TOTAL of which Sundries Chemicals variable Ukraine Base Case (Actual Costs) 27.8 5.4 3.1 36.4 12.1 90% Capacity Utilisation 21.7 5.4 2.4 29.5 10.6 Average Daily Capacity of 1,500 tonnes 12.4 5.2 2.2 19.8 8.3

7. Key Issues Three main issues affect the economic well-being of Ukraine’s sunflower sector:  Export tax  Severe lack of credit  Failure to pay promptly the VAT refunds to which oilseed product exporters are entitled.

8. Export Tax Ukraine currently imposes a 17% tax on sunflower seed exports. This has the effect of  Reducing seed exports and increasing oil exports  Reducing the domestic price of seed The extent to which local prices fall below export prices depends upon whether crushers can process the entire crop. The export tax will be discussed in detail in my next presentation.

9. Availability of Credit Lack of credit is a major constraint for farmers. To generate cash, they often sell just after harvest, when prices are low. Without bankable documents for land ownership, farmers cannot use their land as collateral to secure loans. Lack of legislation to permit the use of warehouse receipts prevents farmers from borrowing using stored seed as collateral. The limited amount of subsidised credit is widely alleged to be allocated in a biased way.

10. Value Added Tax (VAT) VAT at a rate of 20% is assessed on all sales of sunflowerseed. However, the government does not receive these revenues, which are allowed to be used by farmers for the purchase of inputs. 20% VAT is charged on domestic sunflower oil and meal sales, but no VAT is levied on product exports.

11. VAT: Problems for Crushers When crushers export products they are entitled to have their VAT element of the seed purchase price reimbursed. By law, crushers/exporters should be reimbursed within three months. However, the government is significantly in arrears with VAT payments, and some exporters may not be reimbursed at all. Late or no refunds of VAT imposes a financial burden on crushers, who sometimes try to pass the cost back to farmers.

12. VAT: The Impact on Crushing Margins (1) The average sunflowerseed price in 2000/01 was $169/tonne. This implies a total VAT export refund of $8.5 million for a crusher buying 300,000 tonnes of seed and exporting the products made from these sunflower seeds. The following diagram reveals the impact on export crushing margins when VAT is refunded and when it is not.

13. Crushing Margins for Exporters of Oil and Meal, with and without VAT reimbursements -40 0 40 80 Oct-00Jan-01Apr-01Jul-01Oct-01Jan-02Apr-02 With VAT Refund Without VAT Refund Margin at Export Parity Prices and Without VAT on Seed

14. VAT: The Impact on Crushing Margins (2) The diagram reveals that the issue of export VAT is critical for crushers; without refunds export margins may be negative for several months of the year. While crushing margins without VAT refunds are in line with those in the EU, this takes no account of higher exchange rate risks and financing costs. If there were no export tax or VAT, the diagram shows that margins would be lower than they actually were if full VAT refunds were received on time, but higher than they would be if VAT refunds are not made.

15. VAT: Other Implications The uncertainty created by the current system causes the following problems:  It reduces the price received by farmers.  It acts as a minor deterrent to oil and meal exports. The VAT refund on exports is a net cost to government (because the original VAT on seeds is received by farmers, not the government), yet the refunds are paid by the government. Also, since tax authorities operate regionally and their budgets are related to their net revenues, the regional tax offices have a clear incentive not to refund the VAT on exports.

16. Study’s Recommendations Reduce or end the 17% seed export tax Make prompt refunds of VAT on export sales a priority Reform the VAT system, eliminating or lowering the VAT rate that is applied to sunflowerseed sales Introduce an enforceable system of ownership rights to land, to allow it to be used as collateral for credit Establish a legally accepted system of warehouse receipts to enable inventories, too, to be used as collateral for borrowings

17. Thank You! Thank You!