Developing Market Infrastructure for Farming Entities

Transcription

1 Center for Economic Research Developing Market Infrastructure for Farming Entities Report has been prepared under assistance of USAID/Bearing Point Economic Reforms Project Team Leader: А. Khaitov National Experts: Research Coordinator: К. Mullabaev, К. Akhmedov, А. Tuychiev Т. Shadybaev Tashkent 2004

2 Introduction Developing Market Infrastructure for Farming Entities Chapter 1. Major preconditions for establishing market infrastructure elements in the rural area 1.1. Reform of agrarian sector of the economy and development of agricultural infrastructure 1.2. Evaluation of financial possibilities of farms to use infrastructure services 1.3. Legal Basis for Establishment and Development of Agricultural Infrastructure. Chapter 2. Factors Increasing Efficiency of Market Infrastructure Elements 2.1. General Principles of Agricultural Market Infrastructure Elements Efficiency Analysis 2.2. Improving market mechanisms of selling resources for agricultural production (mineral fertilizers, fuel and lubricants) Increasing quality of mechanized services rendered to farmers 2.4. Developing market mechanisms of agricultural produce procurement outside the state order 2.5. Increasing Mini-banks Efficiency 2.6 Developing Water Using Infrastructure 2.7. Training and Re-training System and Consulting Services 2.8. Developing Insurance Market in Agricultural Sector Conclusion

3 3 Glossary Present paper applies the terms below in the following meanings 1 : MTP machine and tractor parks non-state enterprises with fleet of agricultural equipment established on the base of former machine and tractor fleets of collective farms. They render mechanized services to shirkats mainly and also to farms in the process of agricultural production (on ploughing fields, cultivation, harvesting etc.); Alternative MTP enterprises with collective property of farmers established in the process of reorganizing shirkats into farms through giving them agricultural equipment belonging to shirkats. They provide mechanized services to farms when making agricultural production (on ploughing fields, cultivation, harvesting etc.); Market infrastructure on serving farms a network of objects on rendering different production, trade, purchasing, banking, insurance, consulting services to agricultural enterprises; Production agricultural infrastructure a network of objects on rendering production services to agricultural enterprises: MTP and alternative MTP, repair enterprises, rendering veterinary services, organization of irrigated water supply etc.; Mini-banks opened by commercial banks points of banking services to agricultural center. They are created without establishing a legal entity; Association of water consumers association (union) of newly established farms and other legal entities and individuals conducting business and other activity related with selection, use and discharge of certain amount of water; Network on sale of mineral fertilizers a point providing agricultural enterprises with mineral fertilizers. At present mineral fertilizers are supplied to agricultural producers by points (warehouses) of Joint Stock Company «Qishloqkhujalikkimyo» being a part of state joint stock company «Uzkimyosanoat». These objects have no status of a legal entity, chartered fund and complete balance sheet. Network on selling mineral fertilizers functions from permanently established outlets with appropriate buildings, warehouse facilities and mechanisms for storing and delivering mineral fertilizers to customers. Network on sale of fuel structural unit of unitary enterprises of Joint Stock Company «UZneftemakhsulot» being a part of holding company «Uzbekneftegaz» with no status of a legal entity, chartered fund and complete balance sheet. It sells fuel to farmers against cashless settlement. Network on sale of pedigree cattle and zoo-veterinary services established at local level by state veterinary services and also by private sector point on rendering zoo-veterinary services to agricultural enterprises and to population as well. 1 Terms similar to those that used in current standard legal acts are applied with considering their interpretation (legal or semantic) in current laws. 3

4 4 Introduction The present paper is a logical continuation of earlier conducted research «Reorganization of cooperative enterprises (shirkats) into farms» where conclusion was made that for successful, sustainable development of farms creating favorable conditions is necessary for complex serving of their production activity by encouraging establishing enterprises of corresponding infrastructure. The need to establish and develop infrastructure on serving farms is related with the fact that existing infrastructure is meant for serving large shirkats. For farmers both location (remoteness from the zone of farmers activity) and lack of adequate market mechanisms of interrelations between infrastructure enterprises and agricultural consumers are inconvenient. In this context the subject of this paper is to research efficiency of state regulation of developing market infrastructure on serving farms predominantly in those industries and areas where market at first stage itself is not able to ensure its development (so-called «market failures»). Individual sectors of market infrastructure on serving farms and farms themselves were the object of research. Taking into account diversified nature of market infrastructure on serving farms and impossibility to illustrate all existing problems in one paper, major objects of present research are those sectors of infrastructure where at initial stage of mass establishing farms state took up temporary organizational role on their establishing and regulating activity. Major focus is on: General principles and approaches to developing market infrastructure; Efficiency of state support to developing such major directions of establishing market infrastructure without which it is impossible to start activity of farms (trade network on selling fuel and mineral fertilizers, MTP and mini-banks). Partially problems of organizing irrigated water-supply and rendering zoo-veterinary services were touched upon. At that the present paper did not set objectives to research development of such important directions of market infrastructure (marketing, consulting etc.), which primordially should be developing on a market base. The goal of the paper is working recommendations on improving development of market infrastructure on serving farms in general and on individual specific sectors which according with conclusions of previous research is one of major factors of sustainable activity of farmers. In this respect the present paper has analyzed development of agricultural infrastructure, current procedure of establishing infrastructure objects, revealed major systemic reasons and problems of low efficiency of steps taken in this direction. Current laws regulating establishing and operation of enterprises of agricultural infrastructure have been studied as well, appropriate proposals have been worked out on improvement, raising efficiency of steps being taken on establishing and developing agricultural infrastructure based on results special researches conducted by authors, critical financial analysis of operation of individual infrastructure objects, studying of best practice in that area. Information base of the research includes not only data of State Committee on Statistics, the Ministry of Agriculture and Water Resources, the Ministry of Economy and the Committee on Issues of Economic Insolvency of Enterprises, but also results of specially conducted survey. Financial state of 24 farms in seven regions have been surveyed and studied under the research, which allowed determining financial sustainability and entrepreneurial attractiveness of an average farm. 4

5 5 In addition, 155 farmers from the same regions have filled in questionnaire to learn efficiency of agriculture market infrastructure operation. It is suggested to use he results of the research in the activity of economic, financial bodies of the country, the Ministry of Agriculture and Water Resources, the Ministry of Justice. Chapter 1. Major preconditions for establishing market infrastructure elements in the rural area 1.1. Reform of agrarian sector of the economy and development of agricultural infrastructure Major direction of modern stage of agrarian reforms in Uzbekistan is creation of private farms, first of all on the base of economically insolvent, loss-making and low-profitable shirkats. The process of transformation of shirkats into private farms has had accelerating dynamics in recent years. If in shirkats were transformed into farms and only over single 2004 almost the same number 326 were transformed (Table 1). In line with the Concept of developing farms in large agricultural enterprises (55 % of their total number) of the republic should be transformed into farms. However due to the fact that financial and production indicators of farms activity on results of turned to be better than those of their predecessors reorganized shirkats, the government has made decision and at present is preparing proposals on revising of these indicators in order make the process of establishing farms more large-scale. Table 1. Transformation of loss-making, low-profitable and having no prospects shirkats into farms Regions (oblasts) Share Number of from Number of In that number reorganized total reorganized shirkats reorganized in shirkats in number in (%) Republic of Karakalpakstan Andijan 40 5 Bukhara Jizzakh Kashkadarya Navoi Namangan Samarkand Surkhandarya Syrdarya Tashkent Fergana Khorezm Total At the same time establishing private farms requires fundamental change in approaches to creating conditions necessary for their production activity. 2 ) approved by the Resolution of the Cabinet of Ministers of the Republic of Uzbekistan of #

6 6 This is related to the fact that on the base of each shirkat farms are created and therefore per unit financial, time and other transactional costs of agricultural commodity producers increase considerably to make trips to the district center for banking service, purchasing raw materials. Such high financial and time pressure on each farm would reduce efficiency of its activity and create high risks for sustainable management. That s why agrarian reform being conducted assumes not only forming market oriented producers (farmers) in agriculture itself but also creating fundamentally different market agricultural infrastructure allowing provision of wide spectrum of necessary production, banking, insurance, consulting, trade, zoo-veterinary and other services to a farm and also efficient relocation of product from fields to the final consumer from one hand and from the other hand efficient delivery of market information, signals from consumer to producer as well. Without creating such infrastructure forming financially sustainable farming sector in agriculture and hence development of agrarian reforms would not be possible. Market agricultural infrastructure Production: MTP, Alternative MTP, repair enterprises, organization of irrigated water supply, zoo-veterinary centers, production and selling seeds etc. Trade: shops and centers on selling fuel, mineral fertilizers, seeds, chemical protection means of plants etc. Procurement: procurement enterprises and centers of delivering agricultural production Banking: commercial banks, bank affiliations and mini-banks Insurance: insurance companies Consulting: consulting, marketing, engineering firms Communication: telephone, fax, telegraph, Internet Educational business schools, colleges, skills development programs etc. The Government has made decision over first years of reforms to support newly emerging farming sector and provide organizational support in establishing branchy and well coordinated network of market infrastructure objects. That is related to the fact that development of market and first of all of production infrastructure objectively requires certain time as costs to create numerous new infrastructure objects, fitting them out with necessary technique and equipment, skilled labor are quite high. At the same time without some branches of infrastructure it is impossible even to start farming activity (trade network on selling fuel and mineral fertilizers to farmers, alternative MTP, organization of irrigated water supply system and also banking service centers). Therefore these infrastructure branches are still created in rather non-market way through state assignments to 6

7 7 respective state joint-stock companies, executive power authorities at local level, commercial banks and also by providing benefits and preferences to them. In accordance with these assignments in on the territory of 337 reorganized agricultural enterprises 246 mini banks, 278 centers of fuel supply, 266 warehouses on supplying mineral fertilizers, 312 alternative MTP, 294 associations of water consumers and other facilities serving newly established farms were established. The Concept of farms development for approved by the Government also envisages along with the process of reorganizing shirkats into farms establishing a wide network of minibanks, small wholesale enterprises, shops, service stations on selling mineral fertilizers, fuel to farmers, other facilities servicing them (Table 2). Table 2. On establishing infrastructure objects serving newly created farms # Infrastructure objects Created in Being created 3 in Mini-banks Network on selling fuel Network on selling mineral fertilizers and plants protection means Association of water consumers Alternative MTP Network on purchasing agricultural production Network on selling bloodstock and zoo-veterinary services Network of information provision and consulting Agrarian reform and development of market infrastructure are interrelated. Establishing tens of thousands private farms creates real demand for various types of services which earlier were insufficiently developed in the rural area. Brining infrastructure on serving farms to locations of their immediate production activity reduces production costs of agricultural production for farmers, increases their profit and by that creates financial possibilities to pay for listed services. At the same time bringing infrastructure to locations of farmers production activity makes deals on purchasing goods and services necessary for farmers more rhythmical, accelerates settlements and accordingly movement of real financial means to producers. Thus, with increasing financial resources of farmers in near future in economy as a whole more favorable conditions can be created for development of industry as well on producing mineral fertilizers, plants chemical protection means, oil products, agricultural equipment and also servicing sectors rendering market servicing banking, insurance, consulting etc. This is related to enterprises on production and selling mineral fertilizers, fuel, rendering veterinary, consulting, banking and other services. In addition it is very important that establishment of infrastructure allows involving a certain part of rural population freed from shirkats due to their reorganization into labor activity not related with agriculture directly and by that to reduce social cost of agrarian reforms. 3 )- according with Program of developing production and market infrastructure in rural area for the period of approved by the Resolution of the Cabinet of Ministers of # 476 7

8 8 At the same time, administrative nature of establishing infrastructure cannot be long term. As financial state of farms strengthens truly market mechanisms of emerging private infrastructure enterprises in rural area should take over. In this connection strengthening financial sustainability of farms is a key moment in assessing prospects of developing market infrastructure for farms Evaluation of financial possibilities of farms to use infrastructure services Though in many regions majority of farms were given land resources with low fertility, less water supply, insufficient equipment, crop capacity in farms often is higher than in shirkats and loss-making is considerably lower. In 2003, the number of loss-making cotton growing farms in comparison with previous year reduced almost 1.5 times. As a result, reducing share of lossmaking farmers from 5.9 % in to % in 2003 is being observed (Table 3). Table 3. Loss-making farms of the republic Years Total number of farms Loss making farms Number. Share, in % Losses of farmers in % to total amount of losses of agriculture Deviation ( ) At the same time relatively low indicator of loss making of farms is only an indirect confirmation of farmer potential solvency. To assess financial possibilities of a farm special study under present research has been conducted based on data from 24 farms across 7 oblasts of the republic. 4. Financial analysis of activity of farms has been conducted with determining such indicators as NPV (net present value), IRR (internal rate of return) and indicator of profitability of main activity (net profit /incomes) 5. From 24 analyzed farms 18 or 75% of total number had positive indicator of net present value. Absolute indicator of NPV varied from Soum to Soum depending on scale of farm s activity. Positive net present value indicates about exceeding of discounted future monetary flows over monetary outflows, which were deposited by their owners. That confirms that farming as entrepreneurial activity is attractive and accordingly has prospects. As in the case with NPV 18 out of 24 analyzed farms (75% of total number) had positive IRR exceeding established discounting rate (18% based on CBU refinancing rate) 6. This indicator on six farms did not exceed given discount rate 18 % per annum, from them only 4 farms (16.7% of total farms studied) had a negative result which as a rule is explained by high cost of services on 4 The survey was conducted in the Republic of Karakalpakstan, Andijan, Bukhara, Navoi, Tashkent, Fergana and Khorezm oblasts. 5 Methodology mentioned is shown in more details in Annex # 1. 6 From December 2004 CBU refinancing rate was reduced to 16%. 8

9 9 attracting agricultural equipment from outside and low fertility of land assigned to them. Average level of IRR on farms being analyzed has made 21%, and average indicator of profitability of agricultural production (net profit/incomes) has formed at the level of 12% computed on median value. Table 4. Indicators of net present value and level of profitability of studied farms Farm Location Specialization Net Present Value (NPV) (in Soum) Internal Rate of Return (IRR) (in Soum) Farm #1 Tashkent oblast Vegetable-growing % 7.00% Level of Profitability (in % of total income) Farm #2 Tashkent oblast Cotton-growing % 6.05% /grain-growing Farm #3 Tashkent oblast Cattle breeding % 24.23% Farm #4 Tashkent oblast Wine-growing % 15.95% Farm #5 Bukhara oblast Cotton-growing % 10.82% /grain-growing Farm #6 Bukhara oblast % 7.70% Farm #7 Bukhara oblast Cotton-growing % 24.07% Farm #8 Navoi oblast Cotton-growing % 28.94% /grain-growing Farm #9 Navoi oblast Cotton-growing /grain-growing Farm #10 Navoi oblast Cotton-growing /grain-growing Farm #11 Navoi oblast Cotton-growing /grain-growing Farm #12 Navoi oblast Cotton-growing /grain-growing Farm #15 Republic of Karakalpakstan Farm #16 Republic of Karakalpakstan Farm #17 Khorezm oblast Cotton-growing / horticulture Farm #18 Khorezm oblast Cotton-growing /ricegrowing Farm #19 Khorezm oblast Cotton-growing / Negative -5.84% % 22.75% Negative % % 1.94% % 25.91% Farm #13 Khorezm oblast Cotton-growing /grain-growing Farm #14 Khorezm oblast Cotton-growing /rice % 3.07% growing Cotton-growing % 14.14% Horticulture % 12.03% Cattle breeding Cotton-growing /grain-growing Farm #20 Republic of Karakalpakstan Farm #21 Andijan oblast grain-growing / Cattle breeding Farm #22 Andijan oblast Cotton-growing /grain-growing Farm #23 Fergana oblast grain-growing / Cattle breeding Farm #24 Fergana oblast Cotton-growing /grain-growing % 18.40% % 10.19% % 12.45% % 31.49% % 15.18% Negative 4.41% Negative -5.75% % 34.51% 9

10 10 Analysis indicates that 75% of farms have rate of return allowing them to timely accomplish their financial commitments in full amount and get minimally required rate of return to capital invested. However in the conditions of constant increase of prices for these goods and bringing them near international level profitability and hence solvency of farms as well can drop. Therefore policy of the government on gradual increase of prices for resources supplied to agriculture to international level should be adequately accompanied by policy on approaching purchasing prices for this product to the level of international prices. In addition the government in line with international experience should continue implementation of policy in the area of improving reclamation state of lands, state regulation of system of water supply for large hydro economic facilities and interregional water and collector network. Along with steps taken by farmers on improvement of fertility of land sites assigned to them this will facilitate rise in fertility and accordingly profitability of farms. Sustainable operation of farms is affected by both profitability level and availability of adequate turnover capital. There are specific cycles for agricultural production, for instance 3-4 months for vegetables and fruit, 8-9 months for grain, and almost 18 months for cotton, including final sale of crop. Based on the survey, the government is advancing funds for farmers for production under the state order, from 22 to 50% (depending on the specialization of farming entity and crop pattern). In 2004 in 8 regions these resources were allocated as loans on preferential terms by commercial banks, and in 5 regions as tranches from the Fund for Settlements for Agricultural Produce under the State Order. Funds allocated by the government and commercial banks to some extent cover financial needs of farmers like purchasing of mineral fertilizers, fuel and lubricants as well as certain mechanized services by MTPs. However there are significant problems with full repayment for the necessary resources and services due to the following factors 1) Unlike advancing and final settlements cash flows for produced cotton are not arriving on timely basis disabling farmers to make timely and full settlements for purchased resources even under the state order. Figure 2 shows time lags between financial costs of one surveyed farming entity and allocation of funds from the Fund in the cotton growing season of (lagging of light column from the dark one) 7. Moreover, due to existing procedure of payment for cotton, when 20% of its cost are repaid to farmers in 6-8 months after delivery and processing, the revenue from cotton is decreasing in value. If we make re-calculations on the basis of 2003 data using the GDP deflator as the inflation indicator, it would be obvious that losses of farmers in 2003 reached at least 15% due to such process. In addition, farmers are incurring losses in terms of fines and penalties for untimely settlements with suppliers and the government budget. In the surveyed farming entities this amount accounted for 3% of the total income (or 5% of the total costs) of farming entities. 7 The analysis indicates that due to considerable lagging in financing by the government, the surveyed farms had to constantly mobilize their financial resources for covering funding gap. 10

11 11 Complete transition to funding through loans by commercial banks in 2005 shall make positive impact on financial state of farming entities given such resources would be used by farmers in efficient and flexible manner. November December January February Forescast April August September October November December Jan-Jun 2004 March May June July Comparative Analysis of Raw Cotton Funding Allocation of Funds for Funding Cotton Growing ( ) Amount (UZS 000) Buyer Farm Figure2. In addition, advances are not sufficient for full-fledged operations of farming entities. Given lack of own turnover capital farmers have to have access to loans by commercial banks. However, based on estimates 22 out of the 24 surveyed farms or 92% of them can not serve loans by commercial banks at current 24% annual interest rate. Estimates show that maximum feasible commercial rate for short term loans by commercial banks for farming entities may not increase 18% annually under current situation, and for areas with unfavorable land conditions this rate should be even lower. One more reserve for increasing financial sustainability of farming entities is establishing optimal purchasing prices. The sensitivity analysis of profitability of farms indicate that for cotton growing farms 5% increase of purchasing prices is in average improving their profitability by 2.0% 8. All farms with negative IRR and NVP indicators were engaged in growing of grain and cotton under the state order. This implies that farms growing other kinds of agricultural 8 Detailed computations are presented in Annex 1 11

12 12 produce for which prices are regulated by the market have lesser risk of inefficient operations due to subjective approach to forming purchasing prices. Table 5. Impact of Commercial Loans on Farms Profitability (based on actual cash flows in the surveyed farms) Farm NPV (in UZS) IRR) Profitability (in % ) (in %) Prior to loan After loan Prior to loan After loan Prior to loan After loan # % 16% 7.00% 4.15% # % * 6.05% -1.44% # % 10% 24.23% 16.54% # % -14% 15.95% 14.85% # % 4% 10.82% -3.88% # % 2.96% 7.70% 1.99% # % 14% 24.07% 17.24% # % 18.13% 28.94% 24.53% # negative * -5.84% % # % -5% 22.75% 17.38% # negative * % % # % * 1.94% -6.00% # % 17% 25.91% 23.79% # % -11% 3.07% -4.63% # % 4% 14.14% 7.32% # % 3% 12.03% 5.67% # % 16% 18.40% 11.74% # % 8% 10.19% 2.79% # % 0.34% 12.45% 4.42% # % 13% 31.49% 24.93% # % 5% 15.18% 8.17% # negative negative 4.41% -1.39% # negative negative -5.75% % # % 22% 34.51% 32.45% * the indicator can not be calculated due to negative cumulative cash flow. Summarizing the above, as well as the results of the earlier researches, we may conclude that major factor causing financial instability of farms and thus inability to pay for infrastructure services are the following 9 : 1) underdeveloped mechanism of advancing (crediting) of agricultural sector, settlements under the state order, pricing, inefficient subsidizing of the sector and so forth (Exhibit 1). 2) Poor condition of land reclamation, irrigation and technical equipment. Half of irrigated lands in the country s needs improvement. Annual clearing of collector and drainage system accounts for only 60-65% of the requirements due to lack of funding. 3) Low technological and mechanization level of production. Only 15% of farmers in the country have tractors, 2 % own trucks, only one farmer out of 50 owns plough and seeder and only one out of 62 owns a cultivator. Relatively small plots of land cause high indirect costs of 9 ) selected outcomes of the Report Organization of Cooperative Agricultural Enterprises (shirkats) into Farming Entities, CER, 2004, were used. 12

13 13 farmers in the environment of poor cooperation among farmers for joint lease of agricultural machinery. 4) Transfer to newly established farmers a portion of unsettled debt of reorganized shirkats, unjustified protraction of processes of transferring allocated plots of land to new farmers, low quality selection of contenders due to imperfect legislative mechanism also entails preconditions for insolvency. 5) undeveloped and inefficient market infrastructure. Although financial sustainability of farming entities is a key factor of accumulating positive cash flows by them, and thus, forming of solvent demand for market infrastructure services, the development of market infrastructure elements on their own as well as their efficient operations considerably impact ensuring financial sustainability of farming entities. Exhibit 1. Shortcomings of current mechanism of funding and state regulation of agriculture Centralized schemes of funding (crediting) are not taking into account specifics of every farm, while farms may not use funds (advances) at their discretion, based on prioritization and efficiency. Farms have to use funds for targeted purposes even in cases they do not have a need in such services or resources otherwise fund should be paid back to the Fund. Current mechanism of settlements is not allowing to make timely settlements with suppliers of goods and services and receive due profit. The mechanism of settlements under the state order envisages made up financial schemes of settlements with suppliers for deliveries within average standards vs. actual deliveries. Therefore often actual deliveries are not matching the ones envisaged in estimates by amount and time. This results in arrears. As of 1 January 2004 more than 15% of farms had overdue accounts payable to servicing sectors due to untimely settlements for the sold produce. Pricing of grain and cotton under the state order is not accounting for price increase for inputs. The analysis indicates than in prices for mechanized services and ammonium nitrate increased almost by 5 times while purchasing prices for cotton increased only by 3.7 times and grain by 3 times. Elimination of the above factors could have become an important condition of financial sustainability of farming entities and forming their solvent demand sufficient to afford infrastructure services. In addition, on the initial stage of new farming entities establishment, given their limited financial resources an efficient system of the government support and incentives is needed for setting up infrastructure serving farming entities. Besides, forming operational conditions for market infrastructure to some extent depends on availability of efficient and effective legislation. However there are also specific issues in this area which the government shall address Legal Basis for Establishment and Development of Agricultural Infrastructure. Legislation regulating processes of establishing and functioning of agricultural infrastructure proceeds from general civil, banking, tax and other areas of legislation fully applicable for establishment and operation of infrastructure serving the agricultural sector. Key specific feature of the agricultural infrastructure establishment process is its administrative character and economic entities are obliged to establish infrastructure elements in line with the effected government program. In addition, in line with the Presidential Decree and the Cabinet of Ministers Resolution (8 of 5 January 2002 and 476 of 30 October 2003 respectively) the number of regulations and procedures were developed regulating processes of establishment and operations of infrastructure elements (legislative acts, specifying processes of agricultural market infrastructure development are listed in Annex 2). 13

14 14 However, effective legislation is not always clearly regulating individual aspects of the processes of establishment and operations of agricultural infrastructure elements, and there are also issues related to implementation of legal norms and their improvement. 1. Banking Legislation First, the Law on Banks and Banking Activity lacks norms regulating unified procedure of establishment and operations of mini banks. Neither the definition of mini bank is available in banking legislation, nor its status, right and obligations. The legislation is determining procedure of establishment commercial banks branches. However the study indicates that in practice 95 percent of mini-banks are not complying with requirements for commercial banks branches, as they are basically incapable to perform operations of full-fledged branch of commercial bank. I.e. mini-banks could not be classified as branches of commercial banks. In order to streamline activities of emerging mini-banks it is necessary to amend the effective Law on Banks and Banking Activity by mini-bank definition and procedure of its operation. Second, the system of lending to newly-established farms on preferential terms and financial support by commercial banks shall be revised drastically. Individual regulatory acts are not implemented in practice at all. For instance, the Central Bank established procedure of issuing loans by commercial banks against the right of lease of the plot of land, as well as the expected crop (June, 2004). However, until present not a single loan was extended in the country (bankers explain this by lack of applications, while during interviews with farmers it was revealed that many farmers had no idea about this or the complicated mechanism of preparing all the necessary papers hindered the proper filing of application), i.e. regulatory document is not working. The similar examples could be listed on lending on preferential terms. In view of the above we recommend the Central Bank jointly with the Ministry of Agriculture and Water Management and Association of Farmers and Dekhkans to review the effective legal and regulatory acts on lending (including lending on preferential terms) to farming entities, with the special emphasis on implementation of individual norms of legislation. 2. Legislation on Selling Resources to Agricultural Sector First, although there are general requirements regulating procedures of storing and selling fuel, lubricants, mineral fertilizers and insecticides there are no regulatory documents specifying operations of these elements. Second, there is no procedure of transferring assets of reorganized shirkat to servicing organizations as a settlement of their outstanding debt 10. Networks for selling fuel, lubricants, chemical fertilizers and insecticides require premises, mechanisms, equipment and working capital. Reorganized shirkats have the required assets. In addition, reorganized shirkats have accounts payable to servicing organizations. Purchasing of these assets in line with the established procedure (after evaluation, competitive tender and so forth usually takes up to 3-4 months. Taking into account acute need to establish infrastructure as soon as practicable, we recommend to develop and approve documents regulating procedure of transferring the assets of the reorganized entity to servicing organizations to offset their debt. 3. Legislation on Establishing and Operations of MTPs. Due to lack of Uniformed procedure of transferring assets of the reorganized economic entity to Charter capital of newly established alternative MTP and water users associations (AWP), the issues of agricultural machinery distribution are resolved in different ways in localities. For instance, Committee for Reorganization is transferring portion of equipment to 10 ) proposals of the authors of the Report Reorganization of cooperative agricultural enterprises (shirkats) into farming entities 14

15 15 AWP in one locality, in the other locality they receive no equipment. There are many disputes about selling price (balance-sheet value, replacement cost, evaluation based and so forth). In addition there is no procedure of transferring assets acquired by reorganized economic entities on leasing terms and partially paid. It is not clear what should be done with such assets, either transfer to alternative MTP or sell to individual farmers? 4. Rendering veterinary services and developing pedigree cattle breeding There is no regulation of activity of enterprises engaged in selling pedigree cattle and zoo veterinary services. Existing facilities are partially funded by the government. There is actually no activity on selling pedigree cattle. Therefore it would be advisable for the Ministry of Agriculture and Water Management to develop Model Regulation on organization of such elements operations as well as the set of measures for their support and facilitation. 5. Legislation Applicable to Water Users Associations Effective legislation on AWPs is not clearly defining their status as legal entity. Having associations status pursuant to the effective legislation they can not perform the functions assigned on them by government decisions. Due to flaws in legal mechanisms of funding, AWP established on the territory of the reorganized shirkats do not receive funds for payroll and maintenance of their assets. It is recommended to develop draft government resolution envisaging AWP definition, as well as funding sources and organization and economic activities for improving water management relations among newly established farmers. 15

16 16 Chapter 2. Factors Increasing Efficiency of Market Infrastructure Elements General Principles of Agricultural Market Infrastructure Elements Efficiency Analysis Efficiency of agricultural infrastructure and capacity to implement its policy objectives to the great extent depends on its well-considered design and sound operation mechanisms, allinclusiveness of the services rendered and many other factors. Practices in developed countries are characterized by variety of elements forming agricultural infrastructure which are different by structure and interaction between them. Underlying principle of agricultural infrastructure forming is the market principle of economic feasibility. The elements are established by private entrepreneurs in the areas where solvent demand for them is in place and under the condition that their operations would generate at least average entrepreneurial income formed in the society. In addition, taking into consideration agricultural production specifics, governments of many countries, especially of the developed ones with high funding capacity, are indirectly supporting agricultural infrastructure development through the system of various benefits and subsidies provided immediately to their elements or to farmers using their services. Taking into account that agricultural infrastructure in Uzbekistan is still being established by non-market methods mainly, it is very unlikely to expect these elements to generate profit 11. Moreover while considerable part of infrastructure elements is supported by the government, there is a great risk of terminating their operations. Exhibit 2. Examples of non-efficient operations of agricultural infrastructure elements. For instance, in Yazyavan district of Fergana Region, where in 2002 all shirkat farms were fully transformed into farming entities 12, at present there are only 3 outlets selling mineral fertilizers out of 10 established in The similar situation is for outlets selling fuel and lubricants (2 out of 8) 13. Based on the survey data Given that major task of accelerated infrastructure development is support of financial sustainability of farming entities, the infrastructure development efficiency in the first years of their operation could be assessed on the basis of meeting the established objectives. Primarily, infrastructure capacity to satisfy the most critical needs of farming entities. Analysis of government programs and efforts of local governments demonstrates that larger part of acute issues is institutionally addressed by establishing appropriate infrastructure elements. Mini-banks, trade network for selling fuel and lubricants and mineral fertilizers, alternative machine and tractor fleets are being set up, as well as institutional structures for leasing agricultural machinery on the terms beneficial for farmers. Business schools were established in rural areas where newly emerged farmers may get free training in managements and entrepreneurial activity. 11 The reporting on profitability of these elements is not available. Taking into account that most of these elements are no legal entities, financial results of their operations can not be singled out from balance sheets of parent enterprises. 12 In line with the Cabinet of Ministers Resolution 8, dated Based on surveys undertaken by the authors 16

17 17 Secondly, conformity of the established infrastructure with the level of agricultural development and actual needs of farmers (carrying capacity, territorial accessibility of sector and functional specialization and so forth). Regions 1 Table 6. Data on Infrastructure Development in Number of reorganized shirkats, units Number of established farming entities, units Created Mini banks Network for selling mineral fertilizers Network for selling fuel and lubricants Alternativ e machine and tractor fleets Associ ations of water users Networ k for procur ement of agricul tural produc e* Network for selling of pedigree cattle and zoologica l and veterinary services* Karakalpakstan Republic Network for informati on and consultin g support* 2 Andijan Bukhara Jizzakh Kashkadarya Navoi Namangan Samarkand Surkandarya Syrdarya Tashkent Fergana Khorezm Total for Uzbekistan *) established in line with the Cabinet of Ministers Resolution 476 dated 30 October 2004 During on the territory of reorganized agricultural enterprises 442 mini banks, 471 warehouses for supply with mineral fertilizers, 514 outlets for sale of fuel and lubricants, 579 alternative machine and tractor fleets, 88 networks for procurement of agricultural produce, 91 networks for selling of pedigree cattle and 60 information and consulting support centers (Table 6) were established and put into operation. Considerable portion of the above facilities was established in Based on polling of farmers, the number and location of the established infrastructure elements is satisfactory, however the quality of provided services and possibilities of efficient operations of these facilities are not meeting market challenges so far. The results of sampling polling of farmers, undertaken under the framework of this research in 8 regions of Uzbekistan showed that 24.8% of the respondents were not satisfied with services provided by outlets selling mineral fertilizers, and 22% respondents stated that even opened outlets were not rendering necessary operations in full. 85.3% of the respondents were not satisfied with the services of mini-banks. At present there are 78 farming entities per a mini-bank, i.e. the most remote farming entities are located approximately km away from the nearest mini-bank which is acceptable from the accessibility standpoint. For fuel and lubricants outlets these indicators account for 67 units and km. respectively, for mineral fertilizers outlets 73 and km (Table 7). In 2004 alternative machine and tractor fleets rendered services worth UZS thousands per a newly established farming entity, water users associations for UZS thousands, agriculture producer procuring enterprises for UZS 77.1 thousands, zoological and veterinary stations for UZS 31.6 thousands and consulting firms for UZS 8.6 thousands. Every farmer on average purchased fuel and lubricants worth UZS 1034 thousands and mineral 17

18 18 fertilizers for UZS thousands. However, relatively small number of the serviced farming entities allows to make a conclusion that total scope of services per an infrastructure element is not high. For instance, based on the same estimates, one alternative machine and tractor fleet on average rendered services totaling UZS 22.3 million a year in 2004, and one water users association UZS 21 million a year. In general the above amounts are not significant and not sufficient to ensure profitable operations of the infrastructure elements. It means that the inflow of customers to the infrastructure is not high enough to ensure profitable operations of infrastructure enterprises. Table 7. Coverage of farmers by infrastructure services in Number of farming entities serviced by one Regions Mini-bank Fuel and lubricants selling outlet Outlet for selling mineral fertilizers Machine and tractor fleet Association of water users 1 Karakalpakstan Republic Andijan Bukhara Jizzakh Kashkadarya Navoi Namangan Samarkand Surkandarya Syrdarya Tashkent Fergana Khorezm Total for Uzbekistan Third, financial capacity of farming entities to timely and in full pay for infrastructure services. Infrastructure enterprises are providing services to farming entities on contractual basis and farmers are not always meeting their obligations basically on all types of services due to lack of adequate funds (Table 8). Established mechanism of mutual settlements is also triggering default of the agreements. Regulatively established advance payment for goods and services should account for 15-30% of their cost depending on types of the purchased resources. However, due to various objective and subjective reasons advance payment is not always followed by final settlement and infrastructure elements are not getting the due payment. Therefore the need of introducing a procedure for delivery of goods and services for agricultural producers after receipt of full payment in getting more insistent. To secure guarantees that the prepaid services are delivered to farmers in time and of the appropriate quality it would be practicable to gradually introduce a mechanism of prepayment by letters of credit. Implementation of prepayment mechanism, including letter of credit, in turn, would require restructuring of the mechanism of advance payments for agricultural producers by procurement organizations, banks and the government. However, this is the only way to establish efficient market incentives for agricultural production increase and improving financial sustainability of farming entities. Fourth, accessibility of infrastructure services (price wise, public awareness on possibilities of every infrastructure element). 18

19 19 Table 8. Data on Rendering Services for Newly-Established Farming Entities* by Infrastructure Objects in 2004 Regions Units Number of farming entities serviced on contractual basis Total amount of services, UZS million Per a farming entity, UZS thousands Execution of the signed contracts for rendering services, % Level of payment for the rendered services, % Alternative machine and tractor fleets Associations of water users Fuel and lubricants outlets Mineral fertilizers outlets Network for procurement of agricultural produce Network for selling pedigree cattle and rendering veterinary services Network of information and consulting support *) in line with the Cabinet of Ministers Resolution 476 dated 30 October 2003 In order to improve access to mineral fertilizers, fuel and lubricants which were previously allocated only to shirkats by the central government agencies, in 2004 for the first time a procedure of selling these commodities through free exchange trades was introduced. As a result during 11 months of 2004 farmers purchased more than 128 tons of fuel and lubricants and 20 thousand tons of mineral fertilizers thought commodity exchange. Fifth, degree of government participation (central and local governments) directly or through individual organizations in the equity of infrastructure elements and partial or full funding of their current operations. Establishing of infrastructure elements given large number of reorganized entities, as it has been already noted, requires significant capital investment. For instance for establishing 244 outlets selling fuel and lubricants, envisaged in the Program, unitary enterprises of the Uzneftmakhsulot Company would need UZS billion. Similar situation is characteristic for commercial banks as they need to invest large funds into setting up of mini-banks, equipping them with up to date computer equipment, communication facilities and so forth. The government partially addressed this issue by legislatively providing a number of tax benefits for enterprises supplying farmers with mineral fertilizers, fuel and lubricants as well as associations of water users. In addition, the government provides subsidies for leasing of agricultural machinery on preferential terms, exempts goods and services of machine and tractor fleets sold to agricultural producers from the VAT. However no benefits were granted to commercial banks establishing mini-banks therefore commercial banks have to embark on yet non paying back capital investment. Sixth, coordination of activity and streamlining of functions of various infrastructure elements within the same jurisdiction aimed at more efficient use of resources, integrity and 19