RUSSIAN AGRICULTURE IN 2002 - OBSERVATIONS, POTENTIALS, TENDENCIES, BARRIERS

1. Observations and Tendencies

Transition of the agriculture and food sector is in full swing in Russia. To support the transformation process policy makers tend to favour vertically integrated large holding structures. However, legal and policy framework conditions should not be biased towards a certain model of agriculture. There is room for a multitude of farm types according to their specific competitive advantage at a certain location to produce a certain good. Future and markets will give the right answer.

Russia occupies more than one tenth of the agricultural land on earth including very large areas of black soils, with very favourable climatic conditions with enormous production and efficiency potentials. The Russian population however, represents less than 2.5 % of the world population. Therefore, Russia may become a main supplier of world food markets.

Today, Russia remains a net importer of food products, in particular for products of high value. Causes for this are many, a.o. high transaction costs especially for exporters, administrative trade barriers and lack of long-term investments in the food chain and in necessary infrastructure. While cropping quickly improves, livestock products as well as the processing industry are not yet able to offer world market quality in large extent.

A significant urban bias in infrastructure development and investment accelerates migration from the land and the de-population of rural areas. Economic and social tasks are muddled in the villages because of lack of public investments in rural social institutions. Conditions need to be created that traditional small and medium enterprises and skilled crafts return to rural areas. This would particularly support the creation of employment for women.

Grain production is given the main emphasis at all administrative levels. But it is only as important as its share in the total consumption and production. Other sub-sectors seem to be under-estimated, e.g. the smallholder production of potatoes, fruit and vegetables, meat and milk. To fully exploit the Russian food export potential a further increase of grain production is a necessary pre-condition but it needs to be complemented by parallel investments in meat and dairy production including adequate milk collection systems not only for large farms but also for the mass of small private and backyard farmers and village households.

For two consecutive years, the production of cereals, maize and sunflower increased considerably. Grain harvest was exceeding domestic demand by about 10 million tons. However, export opportunities have only been used to a lesser extent. Obviously, market transaction costs including administrative trade barriers seemed to be higher than the trade margins to be realised on world markets. Export obstacles comprise local export bans or limitations, arbitrary acts of local administration as well as requested direct payments to interested parties.

2. Potentials

The increase of yield in the production of grain of about one ton per ha seems to be realistic and would flood another 50 million tons of grain on to the world markets. This would almost equal the sum of North American exports. Trade frictions on the world markets are foreseeable and need attention of Russian and European policy makers. Future WTO membership will favour Russian exports in the long run. To fully exploit the potential through improved farm practices and better farm management investments in human capital are the key issue. Education, training, further-training, adapted research and the vocational system must be re-oriented to the demands of the farms. Particular emphasis should be put on rural demonstration and training farms, farm trials and support of farm advisory services.

The dairy sector shows interesting tendencies. Near to big consumer centres large-scale milk production is recovering. This has been promoted by big investments of both Russian and foreign dairy groups in the dairy plants. The relatively low production costs of milk production supports the competitiveness of milk processing. Due to the cheap fodder base with low opportunity costs of land, a highly competitive dairy industry is emerging near to consumer centres with high export potential. Far away from consumer centres in semi-desert black soil areas, the population is keeping cattle and sheep at even lower costs in small farms, backyards and village households. Surplus milk and meat needs to be collected, processed and transferred to urban markets. This development may be supported by the establishment of farmers marketing groups or co-operatives aiming to organise milk collection points in villages.

Cattle fattening is frequently a bi-product of milk production taking place in back yards of village households. This will continue especially in areas with available pasture land. Depending on the speed of the development of meat processing and trade, we also expect "feed-lot fattening systems" at semi-desert locations comparable to those locations in Northern America. This development may be supported by the creation of farmers cattle fattening groups or co-operatives and the attraction of Western meat processing chains to inject know how and capital into the sub-sector.

Pork production has a very high potential but still suffers from a lack of care of piglet production. Smaller farms and households may have a competitive advantage in this care intensive area of production. As in cattle production the development will depend on the meat processing industry and the emergence of rural traders. Due to cheap land, labour and fodder pork has a very high potential for becoming competitive on export markets.

The food industry seems to be one of the fastest growing in the Russian economy. Due to quick turnover and being close to retail and cash operations, it provides highly interesting opportunities. This development is even accelerated by investments from non-agricultural investors, return of off-shore capital and other sources of finance including black markets. Furthermore, the food import price level, highly taxed but strongly demanded, create a high price level for competitive domestic produce as well. This leads to a positive development of farm-based small processing units and very large units but there is still a lack of medium-sized food businesses such as butchers shops, medium sized meat and sausage factories and bakeries. Vocational training and rural SME support services are needed to stimulate the development.

The sugar sector shows the importance of the food industry to stimulate farm production through vertical integration. Many sugar factories have been bought by agricultural holdings and trade companies during the last years with access to the sugar market. However, the productivity of sugar beet production remains low as long as the sugar processors prefer to further-process raw sugar from world markets instead of promoting the development of local sugar beet production.

3. Barriers and peculiarities

Since the new presidency understood the need for changing the tax system, liberalisation started but still without well functioning public control. Citizens are accustomed to avoid control and tax evasion is widespread. To date, special tax exemptions for investments or savings are still unknown in Russia. At the same time the system is so incomprehensible that further reforms are needed to develop transparency and trust.

Value added tax for food products is at 10 %. Most of the Russian population is buying its food, in particular fresh produce, at street markets without VAT. Small traders pay a flat rate for small turnovers. Legal entities are not permitted to offer services free of VAT. This hinders the creation of farmers marketing groups and the foundation of co-operatives for machinery service and input-output trade. It favours large holdings in agriculture.

The creation of employment through investment is highly taxed. Investment costs are burdened with VAT at a rate of 20 % to be paid in advance. For imported goods such as agricultural machinery or equipment a further burden is high customs duties. However, imported goods are often essential to improve farm practices and to create a stimulating and innovative environment for Russian producers. This is particularly visible in grain harvesting with still too high harvest losses of domestic combines. Customs duties and VAT have to be paid in advance for imported goods. Frequently, investors are advancing large amounts of cash unable to use it as working capital to improve their operations.

Public administration is usually reluctant to serve private operators in a transparent way. Statistics only partly reflect reality. Investors have to go to numerous places to get their necessary permissions and stamps. There is an urgent need to improve the data base and information systems for farmers, traders and particularly exporters. Trade promotion programmes including advice on participation at foreign food trade fairs are urgently needed. One-stop service agencies should be established for investors at federal and regional level to increase foreign direct investment in agriculture and food. Administrative reforms are also urgently needed to favour the promotion of transparent procedures and in particular the career perspectives of young civil servants in rural areas.

The Russian banking sector made an important development in urban areas during the last years but rural financial markets are still poorly developed. Savings are very little. Most of the banks re-finance their lending operations by loans from the national bank. Due to the limited product range of banks, high banking fees and widespread lack of trust and confidentiality there is still a reluctance to deal with banks. Usually banks offer short-term loans at prohibitively high interest rates for farmers. Venture capital is rare. Usually public administration is subsidizing sector loans leading to preferred conditions for preferential groups. Credit co-operatives are developing but savings are limited. Most of them are sourced by public credit lines. This situation favours again large holdings with access to non-agricultural financial sources.

4. Competitveness of different farm types

In principle, there are four types of farm businesses in all possible legal forms in Russia:

1. Large farms, formally privatised collective farms with a contribution of about 30 % to the Gross Agricultural Output. Many farms have high debts, are unprofitable and technically bankrupt. On the most profitable farms a "hidden management buy-out" takes place.
2. Holdings, often owned by large food processing companies or non-agricultural companies. Major advantages: access to markets, vertical integration of the food chain and financial strength. Major bottlenecks: farm management and control of the production process. Contribution to the Gross Agricultural Output about 15 % with a tendency to grow.
3. Private farms, from small family based to large farms with a very small number of owners and very efficient farm management. Potential seems to be underestimated by the administration. Contribution to the Gross Agricultural Output about 10 %.
4. Backyard farms, including subsistence households selling their surplus to the markets. Practically ignored by the administration. Contribution to the Gross Agricultural Output about 40 %.
5. Other farms, amongst them state farms and farms of non-agricultural companies with special purposes, e.g. seed production, research, food production for company staff etc. Contribution to the Gross Agricultural Output about 5%.

Studies and improvement of statistical services are needed to better understand the competitive advantages of each farm type. If the above estimates are right, it had important consequences for future development strategies and policy making. An agricultural farm accountancy data network and a coherent statistical system - comparable to the EU - is needed to monitor income, productivity and employment in the different production systems.

The agricultural strategy of the Russian Government puts main emphasis on food security. This is a justified policy objective. However, the Russian norms and statistics need improvement. The given standards overestimate necessary needed quantities per capita by about 50 % compared with FAO and WHO standards. Priority should instead be given to food quality and consumer protection through adequate food standards. If food security issues are used to justify emergency and humanitarian aid as in the past it even creates negative impacts on the development of the sector. It is distorting markets, slows down necessary structural change and leads frequently to corruption.

5. Aid to Russia

Aid to Russia and in particularly to the agriculture and food sector is needed, useful and may contribute to speed up necessary developments and reforms. However, it is not free of diverse interests and disputes. Some key issues and recommendations:

• Aid should be balanced to support market institutions and foreign direct investments instead of strengthening the still existing bureaucracy.

• Aid is biased towards urban areas. The share of agricultural projects in aid programmes should reflect the importance of the sector contributing with about 25 % to the Gross National Income and to rural employment.

• Beneficiaries of projects are frequently public institutions. The private sector and rural initiatives of self-help should receive more attention.

• Donor coordination needs strengthening. It needs courage to share lessons learned of projects to avoid duplication of failed efforts.