WORLD BANK DISCUSSION PAPER NO. 424 Work In progress WDP424 for public disOuIOWl2 May 2001 Farm Debt in the CIS A Alulti-Country Study of the AMajor Causes and Proposed Solutions I Ai (saba Csaki Zv>i L.ermnan Sergey Sotnikov Recent World Bank Discussion Papers No. 351 From Universal Food Subsidies to a Self-Targeted Program: A Case Study in Tutnisian Reform. Laura Tuck and Kathy Lindert No. 352 China's Urban Transport Development Strategy: Proceedings of a Symposium in Beijing, November 8-10, 1995. Edited by Stephen Stares and Liu Zhi No. 353 Telecommutnications Policiesfor Sub-Saharan Africa. Mohammad A. Mustafa, Bruce Laidlaw, and Mark Brand No. 354 Saving across the World: Puzzles and Policies. Klaus Schmidt-Hebbel and Luis Serven No. 355 Agricultuhre and German Reutnification. Ulrich E. Koester and Karen M. Brooks No. 356 Evaluating Health Projects: Lessonsfrom the Literature. 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Garry Christensen and Richard Lacroix (Contintued on the inside back cover) WORLD BANK DISCUSSION PAPER NO. 424 Farm Debt in the CIS A Multi-Country Study of the Major Causes and Proposed Solutions Csaba Csaki Zvi Lerman Sergey Sotnikov The World Bank Washington, D.C. Copyright i 2001 The International Bank for Reconstruction and Development/THE WORLD BANK 1818 H Street, N.W. Washington, D.C. 20433, U.S.A. All rights reserved Manufactured in the United States of America First printing May 2001 1 23404030201 Discussion Papers present results of country analysis or research that are circulated to encourage discussion and comment within the development community. The typescript of this paper therefore has not been prepared in accordance with the procedures appropriate to formal printed texts, and the World Bank accepts no responsibility for errors. Some sources cited in this paper may be informal docu- ments that are not readily available. The findings, interpretations, and conclusions expressed in this paper are entirely those of the author(s) and should not be attributed in any manner to the World Bank, to its affiliated organizations, or to members of its Board of Executive Directors or the countries they represent. The World Bank does not guarantee the accuracy of the data included in this publication and accepts no responsibility for any consequence of their use. The boundaries, colors, denominations, and other information shown on any map in this volume do not imply on the part of the World Bank Group any judgment on the legal status of any territory or the endorsement or acceptance of such boundaries. The material in this publication is copyrighted. The World Bank encourages dissemination of its work and will normally grant permission promptly. Permission to photocopy items for internal or personal use, for the internal or personal use of specific clients, or for educational classroom use, is granted by the World Bank, provided that the appropriate fee is paid directly to Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, U.S.A., telephone 978-750-8400, fax 978-750-4470. Please contact the Copyright Clearance Center before photocopying items. For permission to reprint individual articles or chapters, please fax your request with complete information to the Republication Department, Copyright Clearance Center, fax 978-750-4470. All other queries on rights and licenses should be addressed to the World Bank at the address above or faxed to 202-522-2422. ISBN: 0-82134943-0 ISSN: 0253-7494 Csaba Csaki is lead agricultural adviser in the Environmentally and Socially Sustainable Development unit of the World Bank's Europe and Central Asia Region. Zvi Lerman is a professor at Hebrew University of Jerusalem and a consultant to the World Bank's Development Economics Research Group. Sergey Sotnikov is a consultant to the Environmentally and Socially Sustainable Development unit of the World Bank. Library of Congress Cataloging-in-Publication Data has been applied for. Contents Foreword ............................................................ iv Abstract .............................................................v Preface ............................................................ vi Acronyms ............................................................ vii Executive Summary ............................................................ ix Chapter 1. Introduction: Objectives and Methodology .............................................................I Chapter 2. Overview of the Farm Debt: History, Current Level, and Composition ................. ...................7 Chapter 3. Major Reasons for Farm Debt Accumulation ............................................................ 19 Chapter 4. Social Implications of Farm Debt ............................................................ 27 Chapter 5. Country Initiatives for Resolution of Farm Debt ................................................... ......... 33 Chapter 6. A Proposed Solution to the Farm Debt Problem .................................................... ........ 43 Appendix A. Annex Tables from the Main Text ............................................................ 57 Appendix B. Statistical Tables with Debt-Related Data by Country - 1994 and 1998 ..... . ....................... 67 Appendix C. The Moldova Farm Debt Restructuring Program - A Unique Approach .............................. 81 Selected References on Farm Debt and Farm Restructuring in Transition Economies ............................ 115 iii Foreword Agriculture remains the main source of employment and livelihood for the large rural population of many transition countries, especially among the former Soviet republics. Accordingly, the World Bank continuously monitors the progress of land reform and farm restructuring in the region because of the potential impact of these processes on rural development and poverty alleviation in rural areas. The World Bank has published a long and growing series of publications on land reform and farm restructuring in the former socialist countries of Europe and Central Asia. The unique features of all these publications is their reliance on first-hand empirical information collected through extensive fann surveys of various rural constituencies, as well as detailed analysis of farm budget information. Farm surveys have been conducted by the World Bank in many countries of the CIS (Russia, Ukraine, Belarus, Moldova, Armenia, Georgia, Turkmenistan, Kazakhstan), and Central and Eastern Europe (Poland, Romania, Bulgaria, Hungary, Albania). Analysis of survey findings enables the World Bank to base its policy dialogue with governments in the region on solid empirical facts, making the Bank's recommendation much more credible and relevant. This study is the latest addition to the series, which does not focus on only one country. Instead it investigates the complex issue of farm debt across the region, using comparative analysis of country-level information on farm indebtedness, as well as individual farm case studies. I am convinced that the new findings in this study will prove to be a very valuable additional resource to supplement the World Bank's country-specific monitoring work on land reform in the region. We trust that the study will create a basis for useful policy discussions with country governments and supply the many international donors active on the local scene with essential information for the design of their strategic programs. Kevin Cleaver Director Environmentally and Socially Sustainable Rural Development Europe and Central Asia Region iv Abstract The objective of this study is to support the farm privatization and restructuring process in CIS by presenting a wide range of strategic and tactical options that could be applied to eliminate, or at least reduce, the main factors responsible for the destructive accumnulation of debt in large farm enterprises. This objective has accomplished by documenting and analyzing the indebtedness of large-scale farms in five countries of CIS (Belarus, Kazakhstan, Moldova, Russia, and Ukraine) developing appropriate proposals, and initiating a dialogue with the government on the subject of farm debt resolution. The study presents a region-wide analysis of the farm debt problem based on data collected from selected countries in CIS, and develops proposals for the respective countries as well as for the region as a whole. v Preface This study, sponsored by the World Bank and USAID, presents the results of the multi- country study of farm debt in five CIS countries (Belarus, Kazakhstan, Moldova, Russia and Ukraine). The study provides a comparative analysis of the level and composition of farm debt in these countries, examines the major reasons for farm debt accumulation in the 1990s, evaluates the policy responses to the problem, highlights the major constraints for the resolution of farm debt, and describes the best practices adopted in the region. The study was prepared in close cooperation with agricultural policy experts from the Agrarian Institute and RosAgroFond in Russia (V. Uzun, N. Shagaida, E. Gataulina, S. Strokov, V. Saraikin, E. Malygina, S. Terentiev, A. Korbut), the Inter-Governmental Committee for Agricultural Policy and the USAID/Word Bank Agricultural Policy Unit in Ukraine (D. Sedik, N. Seperovich, N. Pugachev, I. Chapko, I. Kobuta, V. Noga, V. Zhygadlo), the Ministry of Agriculture and the Institute of Agricultural Economics in Belarus (B. Shapiro, V. Ilchik), the Ministry of Statistics and the Institute of Agricultural Economics in Kazakhstan (M. Sigarev and D. Shaidildinova), and the USAID-sponsored Center for Private Business Reform in Moldova (D. Dumbraveanu, R. Flick, A. Muravschi, S. Shapa, and C. Tanase). David Epshtein from the North-Western Institute of Agricultural Economics in St. Petersburg prepared a supplementary analysis of farm debt in Leningrad Oblast in Russia. Mariusz Safin from the World Bank Resident Mission in Warsaw prepared an overview of farm debt in Central and Eastern Europe. The local counterparts in each country collected a database of major financial indicators for the farm sector and prepared a comprehensive country report on farm debt. The full country reports for Russia, Ukraine, and Moldova are published as separate volumes in the World Bank's Environmentally and Socially Sustainable Development Working Papers series. The study was managed by Csaba Csaki for the World Bank's Environmentally and Socially Sustainable Development Unit, Europe and Central Asia Region. Zvi Lerman and Sergey Sotnikov developed the methodological framework for the study. The field work and database development were carried out by the local teams in each country. Valuable research assistance with data analysis and report preparation was provided by Pepijn Schreinemachers and Yulia Rabinovich. The study was peer-reviewed by Laura Tuck, Lily Chu, Gershon Feder, and Rodrigo Chaves, whose valuable comments were incorporated in the published version. Editorial support was provided by Alan Zuschlag. The initial findings of the study and the individual country case studies were discussed in a seminar in Chisinau, Moldova on June 12-14, 2000, organized jointly by USAID and the World Bank. Unless otherwise noted, all sources for the tables and figures listed in the report are the authors' own calculations. vi Acronyms CEE Central and Eastern Europe CIS Commonwealth of Independent States CIS-5 Belarus, Kazakhstan, Moldova, Russia, Ukraine CIS-4 Belarus, Moldova, Russia, Ukraine CPI Consumer Price Index vii Executive Summary The accumulation of debt in large-scale farm chapters that follow. CIS-5 denotes that the data enterprises in CIS is regarded as a major obstacle have been aggregated for all five countries to successful privatization and restructuring of the participating in the study (Belarus, Kazakhstan, agricultural sector. The objective of this study is Moldova, Russia, and Ukraine). CIS-4 denotes to support the farm privatization and restructuring aggregation for four countries (Belarus, Moldova, process in CIS by presenting a range of strategic Russia, and Ukraine, excluding Kazakhstan) in and tactical options that could be applied to cases when the data for Kazakhstan were judged eliminate, or at least reduce, the main factors to be substantially less reliable than for the other responsible for the accumulation of debt in large countries. farm enterprises. This objective has been accomplished by documenting and analyzing the Many recommendations in this report are indebtedness of large-scale farms in five CIS aimed at the government. The term "government" countries (Belarus, Kazakhstan, Moldova, Russia, is used in the broadest possible sense: it denotes and Ukraine), developing appropriate proposals to not only the central government (including both deal with farm debt, and initiating a dialogue with the legislative and the executive branches), but the governments on the subject of farm debt also all levels of sub-national government, down resolution. Although based on the analysis of farm to provincial (oblast) and district (raion) debt in selected CIS counties, the analytical authorities (local councils still do not have enough approach and the proposals may be appropriate power in CIS to matter). The changes and reforms for the region as a whole. advocated in this report cannot be successfully implemented without the full support and The study was motivated by the concerns that cooperation of sub-national levels of government, CIS counterparts voice repeatedly in various as the example of recent reforms in Moldova has forums regarding the dire financial situation of the so strikingly shown. farm sector. In discussions with World Bank representatives and other western experts, officials and economists in CIS stress that the large farrn The Magnitude and Nature of Farm Debt: A enterprises, which still control most of the Deteriorating Situation agricultural resources in the region, are chronically unprofitable and unable to repay their The most significant feature of farm debt in accumulating debt. It is often claimed by the CIS is its steady growth in real (CPI-deflated) authorities in Russia and Ukraine, for instance, terms in recent years. The real debt per farm in the that 80% of the farm enterprises are "on the verge five CIS countries increased by more than 45% of bankruptcy" and are unable to function between 1994-1998 (Figure 1). The total farm normally because of restraints that the government debt in the five CIS countries reached nearly $30 and other creditors place on their bank accounts billion in 1997, more than double the level of debt and operating assets. Unfortunately, these claims in 1994 (Table 1). The sharp devaluation of the are generally made without adequate quantitative Russian ruble in 1998 produced a pronounced substantiation, and the present study is an attempt downward adjustment of the dollar farm debt in to clarify the seriousness of the farm debt situation Russia, and because of Russia's sheer size this in CIS by applying standard tools of financial was reflected in a decline of CIS-5 total farm debt analysis. in 1998. On a per-farm basis, the average debt in CIS-5 increased from about $200,000 in 1994 to a The Executive Summary is generally based on peak of $500,000 in 1997, thereafter declining to aggregated CIS data, while the detailed country- $400,000 in 1998 as a result of the ruble by-country information is presented in the devaluation (Figure 1). ix x Farm Debt in the CIS Table 1: Total Farm Debt in CIS-5: 1994-98 Figure 1: Real Debt per Farm: Index and US Dollars (US$ '000,000) 1994 1995 1996 1997 1998 Belarus 320 489 779 734 950 nt of 1994 US Dollars 160 pecnt0019 Kazakhstan 1684 1919 2053 1502 1219 Moldova 292 372 525 482 539 . _.s Russia 7021 13036 17865 21103 11535 120 Ukraine 3004 2375 3901 5901 5718 100 CIS-5 13540 19168 26066 29840 19962 80 300 _ 300 m 60 w The second significant feature of farm debt in 200 CIS-5 is the shift of the term structure of debt 40 100 since 1990 toward short-term, current liabilities 20 (Figure 2). The old long-term debt, never a major 1 1 1 1 1 component of farm liabilities during the Soviet 1994 1995 1996 1997 1998 period, was completely wiped out by the galloping Figure 2: Term Structure of Farm Debt inflation of the early 1 990s, and in the absence of appropriate indexation mechanisms the sources of new long-term lending largely disappeared between 1990 and 1993. The growing farm debt 10% in the region is thus generally new and fairly recent debt, not debt inherited from the Soviet 80% period. 60% : Long-term Ci Shot-ter Government and Commercial Suppliers Are 40% i ;Short-term the Farms' Main Creditors I 20% All through the 1990s, about half the farm debt came from the government and banks and the 0% other half from supplier credit and wage arrears 1990 1991 1992 1993 1994 1995 1996 1997 1998 (Table 2). between commercial banks and the government Table 2: Sources of Farm Debt in CIS-4 became much sharper and clearer than in the past, 1990 1994 1998 the share of bank lending in farm debt shrank to a minimum, and debt to the government became a dominant component. Institutional credit 57 46 50 Commercial banks 39 19 7 Contrary to bank debt, which is usually Government 18 27 43 classified as "active debt" in the sense that it Wage arrears 21 22 16 involves active application to the lender, government debt in recent years is mostly Supplier credit 22 33 35 "passive debt". These are not formal loans received from the government, but generally The exact role of the banks in the early years accumulations of various arrears in the formn of of the decade is unclear: some of the debt taxes and levies payable or amounts due in unpaid recorded as bank loans (especially long-term deductions to pension and health insurance funds loans) may in fact have been government debt for farm workers. This component of farm debt is channeled through state controlled agricultural "passive" in the sense that it accumulates banks. During the recent years, when the division automatically, simply as a result of the farms' x Executive Summary xi failure to make the statutory payments. The CIS-4 (Russia, Ukraine, Belarus, and Moldova) government imposes draconian penalties on these this ratio rose from 0.6 in 1990 to over 4 in 1998. arrears, which contribute to the growth of this This means that the liquid assets, when converted passive debt component over time, but does not into cash at their full book value, will cover less really enforce a strict collection discipline. than 25% of current farm debt. The corresponding ratio for US farms is 1.5, i.e., liquid assets of US Another feature in the development of the farms cover 67% of current debt. Moreover, for sources of farm debt over the last decade is the US farms all three ratios have remained perfectly substantial increase in the share of suppliers' steady over the years: there has been no credit, which nearly doubled from about 20% of deterioration in the solvency of US farms, while total debt in the early 1990s to 35% in recent CIS farms have become much less solvent over years (Table 2). While this may be a sign of the decade of transition. progress toward commercial normalization of financial transactions in agriculture, it is Table 3: Financial Ratios: Averages for CIS-4 explainable, at least in part, by the privatization of 1990 1994 1998 formerly state-owned suppliers (including power Debt to sales 0.16 0.49 1.20 companies), which were formerly recorded as debt to the government. Contrary to the prevailing Debt to current assets 0.28 0.60 0.89 impression, wage arrears are not and have never Debt to liquid current assets 0.58 2.27 4.27 been a significant component of sources of farm credit. Their share of farm debt actually declined There is an apparent contradiction between over time from slightly more than 20% in the the ratio of debt to liquid assets, which presents a early 1990s to 16% in 1998 as the government grim picture of debt repayment capacity, and the and suppliers gained in importance as sources of ratio of debt to sales, which optimistically farm credit. suggests that debt can be repaid from just one year of sales revenue. The reason for the contradictory Overall, farm debt in CIS originates primarily conclusions presented by these two basic ratios is from "passive" or "spontaneous" credit sources, that farm sales in CIS simply do not produce which grow simply because farms do not pay their profits, while it is profits that are needed to repay obligations. These sources include all levels of debt. government (central, provincial, and district), trade credit from suppliers, and to a certain extent The proportion of farms reporting losses has also farm workers, who extend involuntary credit increased markedly since 1994, and well over to farms through wage arrears. "Active sources" - 50% of farm enterprises are unprofitable in recent commercial banks - are of marginal importance years (Figure 3). Sales revenue is entirely accounting for less than 7% of total debt. absorbed by wages and other production costs, which add up to 140% of sales. In other words, farms are losing on average almost 40% on each Measuring the Burden of Debt at the Farm ruble of sales revenue (Figure 4). Farm operations Level do not generate net income that can be used to repay debt, however small. All three basic ratios measuring the capacity of farms to repay their debt - the ratio of debt to Declining profits (and increasing losses) sales, the ratio of debt to current assets (including appear to be the major technical determinant of inventories), and the ratio of debt to liquid current debt accumulation in CIS farms. The level of debt assets (excluding all inventories) - increase over increases in inverse proportion to the level of time, which is a definite sign of rising profits: as profits decline and losses grow, the real indebtedness (Table 3). Yet while the values of level of farm debt increases. This result, observed the first two ratios are not particularly alarming by both for the entire farm sector over time and world standards, the ratio of debt to liquid current across thousands of farms in one year (1998), is assets rises to stratospheric levels. On average in naturally understandable: debt is repaid from xii Farm Debt in the CIS profits, and lack of profitability makes it countries, where farm debt has risen to levels that impossible for farms to repay their debt, are not negligible compared with budget revenue inevitably leading to a vicious circle of debt and even GDP. accumulation. Figure 5: Farm Debt as a Macroeconomic Burden Figure 3: Percentage of Unprofitable Farms: CIS-5 40 0perent of farm enterpnses 30 tOO farm debt/budget revenue 80 20 ___ 60 _10______ farm debt/GDP 40 /_.__.__.__.__0 l l_ l / ~~~~ ~ ~~~~1994 1995 1996 1997 199% 20 -__ _- - Figure 5 plots the ratio of total farm debt to 90 9 budget revenue and GDP in CIS-4 for the period 1990 1991 1992 1993 1994 1995 1998 1997 1998 1994-98. Outstanding farm debt in CIS-4 increased from about 25% of budget revenues in Figure 4: Profit-to-Sales Ratio: CIS-5 1994 to nearly 40% in 1998. It exceeded 10% of GDP in 1998. Farm debt today constitutes a significant burden on the economy as a whole, and the state budgets in CIS cannot continue to 0.4 deal with this problem according to traditional prescriptions of periodic debt rescheduling and 0.2 forgiveness. Despite frequent writeoffs in the past, the amounts involved have become too large for the budget to continue absorbing every three to o five years. Table 4: Farm Debt as a Macroeconomic Burden 1994-98 -0.2 - _ __ . 1994 1995 1996 1997 1998 Farm debt as % of GDP .0.4 Belarus 7 5 6 5 7 1990 1991 1992 1993 1994 1995 1996 1997 1998 Kazakhstan 14 12 10 7 6 Moldova 22 22 27 22 29 Farm Debt is a Significant Burden on the Russia 3 3 4 5 6 National Economy Ukraine 8 6 9 12 13 Farm debt as % of budget revenues In CIS, the traditional way of dealing with Belarus 14 12 14 12 14 accumulation of farm debt has been through Kazakhstan 78 67 71 51 40 periodic rescheduling and forgiveness of overdue obligations. Since the state budget ultimately Moldova 64 65 85 61 83 bears the cost associated with debt writeoffs, this Russia 8 10 13 13 18 policy is tenable only as long as the level of debt Ukraine 19 17 24 31 38 is relatively low. This is no longer the case in CIS xii Executive Summary xiii Beyond aggregated tendencies, it is important include an implicit component that arises when to stress that different countries face different the government's does not insist with all strictness levels of macro-economic burden associated with on collecting tax arrears or, even more indirectly, the outstanding farm debt. In Moldova, the farm signals suppliers or banks not to press too hard for debt reached 29% of GDP and 83% of total collection of overdue obligations from farms. budget revenues in 1998 - a much higher burden on the economy than in other CIS countries The mentality of soft budget constraints (Table 4). It is therefore not surprising that continues to persist in CIS countries during Moldova is a lead player in developing a debt transition. Unprofitable farms with steadily rising resolution strategy, as is discussed in the body of levels of debt do not go bankrupt. There are no the text. Farm debt also appears to have reached self-limiting risk mechanisms on the amount of the level of a serious a macro-economic problem accumulated debt. They are able to continue in Ukraine and Kazakhstan. borrowing from suppliers, from the state, and sometimes even from commercial banks, presumably because everybody - the borrowers Why Debt is Accumulating and the lenders - believe that the government will not let the large farm enterprises go bankrupt and Technically, farm debt is growing because of will continue to arrange for periodic bailouts. inadequate farm profits. On a substantive level, however, the accumulation of debt is attributable Persistence of soft budget constraints makes to lax financial discipline made possible by the debt accumulation possible, while lack of persistence of soft budget constraints. profitability makes debt accumulation necessary. Without profits farms do not generate sufficient In market economies, the allowable level of funds to finance their operations and must resort debt is limited by the risk of bankruptcy. Farms, to borrowing. Lack of profitability in CIS farms as all business enterprises, operate under hard can be attributed to a mix of two broad groups of budget constraints: if they are unable to generate factors: external policy-related factors and internal sufficient profits to repay their financial farm-level factors. obligations, they go out of business. In socialist economies, on the other hand, farms operated External factors related to government under soft budget constraints: they always relied policies - elimination of direct producer support, on flows of funds from the state to cover their control of food prices exacerbating the losses and repay their debts. deterioration of terms of trade for agriculture, restrictions on trade in agricultural commodities - Janos Kornai, in his classical work on the certainly have a negative impact on farm socialist economic system, characterizes the profitability and thus lead to accumulation of debt. softness of budget constraints by the commitment More important and more fundamental, however, of the bureaucracy (i.e., the government in our are the internal farm-level factors related to the terminology) not to tolerate persistent loss- traditional collective farm structure, which making. Soft budget constraints prevail when basically has not changed during the decade of economic agents believe that they can negotiate farm reorganization in the CIS. various benefits after the fact in case of adverse outcomes (lack of profitability). The feasibility of * The farm enterprises have not reduced their this vertical negotiation process stems from the size to more manageable dimensions. paternalistic attitude of the government toward the farn enterprises, which according to Kornai is ' Farm managers are still committed to provide akin to the attitude that parents show toward all members with jobs, regardless of cost- financial difficulties of their children, regardless efficiency considerations. of age. In this conceptual setting, soft budget * Farm enterprises are obliged to maintain the constraints are not limited to actual allocation of social infrastructure in the village, including subsidized credits or debt write-offs. They often the traditional free support to household plots. xiv Farm Debt in the CIS * Farm operations remain largely production efficiency and higher productivity. This is what oriented, with no overriding emphasis on farms in market economies normally do to remain markets, consumers, and sales: farm managers profitable in a changing world, and this is the are still production maximizers, not profit lesson that CEE farms successfully adapted to maximizers. their transition in the 1990s. The combination of * Member-workers continue to function in a external and internal changes - introduction of traditional collective environment, without hard budget constraints and restructuring for cost- traditional collective environment, without efficient operation -will provide the ultimate any direct accountability for the results of solu tion tir ing provid reducingte their effort or their contribution to profits and burden of debt. losses. All these internal reasons are obstacles to Unsuccessful Attempts to Stop Farm Debt improving the cost-efficiency of farms and Accumulation necessarily lead to suboptimal profits. As long as CIS farms continue their strategy of formal CIS goverments have tried a wide range of reorganization, avoiding radical intemal policy instruments to address the issue of farm restructuring prescribed by market principles, they debt. These instruments include: will not be able to improve their efficiency and profitability. a) Price support and input subsidies b) Subsidized government credit and commodity Yet the governments' attitude and policies in credit CIS create only modest incentives for the farms to c) Debt write-offs restructure. Persistence of soft budget constraints d) Debt rescheduling allows unprofitable farms to continue to exist and e) Inter-enterprise offsets and barter transactions does not create any pressure for restructuring and to settle claims internal reform. While production targets have f) Financial rehabilitation through farm been largely eliminated, both central and regional reorganization governments in CIS countries often set fixed g) Bankruptcy and liquidation procurement prices and demand preferential deliveries to state organizations instead of The cross-country analysis indicates that these purchasing food products through market instruments have been applied in an inconsistent, channels at competitive prices. In return, the ad hoc manner. Nor have they addressed the two governments compensate the farms with soft major roots of farm indebtedness, namely the lack credits for these loss-making operations, as well of profitability associated with insufficient as for their special role as caretakers of the social restructuring of the inherited farm structure and rural infrastructure and providers of lifetime the persistence of soft budget constraints linked employment to rural population. with continued government intervention in farm operations. It is not surprising therefore, that these Government policies must be changed to instruments have not produced any real relief. eliminate the disincentives that have so far prevented most farms from switching to a genuine market orientation. Specifically, governments The Debt Problem and Its Farm-Level Impacts should stop imposing loss-making activities on farm enterprises, on the one hand, and cease The farm debt problem in CIS is not a allocating soft credits, on the other. Banks should problem of the magnitude of debt, as the stop lending to non-creditworthy farms in accumulated liabilities are not excessively large anticipation of write-offs and bailouts. Farms, in compared to the asset base of farm enterprises. turn, must respond to these changes in the The debt problem is associated mainly with the economic and political environment by, the farms farms' inability to repay their debt because of reorganizing and restructuring for greater cost inadequate profitability. Farm enterprises in CIS xiv Executive Summary xv suffer from a debt overhang relative to their internal factors related to farm organization and cashflows, not relative to their assets. structure that lead to low productivity and growing losses. Effective resolution of farm debt Inability to service the current debt is highly requires governments to address both sets of disruptive to nornal operation, as it forces factors. Only then can they decide to invoke creditors - both government agencies and bankruptcy, which is the standard market tool for commercial organizations - to impose various dealing with highly indebted insolvent farms. restraints on the defaulting farms. Farm enterprises are thus exposed to conflicting and Why not traditional court-driven bankruptcy confusing signals: on the one hand, they are given proceedings? access to soft credits through government policies (explicit or implicit) and the lenient attitude of the In market economies, unprofitable farms that banks predicated on these policies; on the other are unable to repay their liabilities are declared hand, they are harassed by collection efforts, bankrupt by a court of law and go into liquidation. which often look quite arbitrary and may take Perhaps the most obvious option for resolving highly aggressive forms. This situation inevitably farm debt would be to follow the practice of encourages the farms to shift to barter operations, market economies and the experiences of some and thus contributes to demonetization of their countries in Central Eastern Europe. Insolvent activities and further exacerbates their inability to farms would be declared bankrupt and go into repay the outstanding debt. liquidation, clearing the stage through debt restructuring for the creation of new financially The unresolved debt problem is also an viable units. This is how insolvent farms are obstacle to effective privatization and treated in mature market economies, and how the restructuring of farm enterprises. First, asset more successful transition countries, such as shares are distributed to individual members net Hungary, have dealt with the resolution of farm of liabilities, and individuals may be hesitant to debt problems since the beginning of transition. leave the farm enterprise in favor of private Indeed, many experts recommend following this farming as long as their entitlement to assets is path in the CIS countries as well. All CIS shrouded in uncertainty and lack of transparency countries have bankruptcy laws that in principle because of outstanding debt. Second, and perhaps can impose liquidation of insolvent farms with the much more importantly, outside creditors objective of satisfying the creditors' claims (at generally refuse to distinguish between the least partially). original debtor farm and any new farms created in the process of restructuring. They regard these However, the present study and certain new farm structures as responsible with their experiences in other parts of the world suggest assets and cashflows for the debt of the original that the traditional court-driven bankruptcy farm enterprises, even if there is no strict legal procedures may not offer a desired solution given justification for this attitude. They may the specific circumstances in the CIS. First, a very accordingly refuse to do business with the new large number of farms (in some countries more farms as long as the old debt remains outstanding, than 50%) are technically bankrupt in the sense thus severely hampering the prospects for that they report losses and cannot repay any debt profitable operation after genuine restructuring. from current cashflows. A strict approach to bankruptcy would require initiating court proceedings in a volume that is simply not What Can be Done to Resolve the Farm Debt practicable given the fragile administrative and Problem judicial structures in CIS. There are no effective bankruptcy courts, and very few bankruptcy cases Accumulation of farm debt is caused by two have actually been tried to completion in any of sets of factors: external factors related to the CIS countries. government policies that produce a non-conducive economic environment for farm operation, and xvi Farm Debt in the CIS Second, the experience in the few farm this is another argument against imposing bankruptcy cases launched in CIS indicates that traditional bankruptcy proceedings on CIS farms. the lack of potential buyers for farm assets is another obstacle to formal court-driven General principles for resolution of farm debt procedures. In CEE, subsidized credit schemes problem were offered by the governments to support the purchase of farm assets in the process of Given the actual conditions in CIS, the liquidation. Such schemes do not exist in CIS, and optimal approach to resolving the farm debt the rural population suffers from a severe shortage problem should include a set of actions that of capital. The absence of potential buyers would address both macro- and micro-level factors. be a significant constraint in a mass bankruptcy and liquidation of insolvent farm enterprises. * Creation of an incentive system and a macro- policy framework for agriculture that allows Third, mass bankruptcy and liquidation of efficient agricultural producers to make farm enterprises will affect the very large rural profits and to invest. population in CIS, which is basically dependent * A one-time process of expedited debt for its livelihood on these farm enterprises, settlement conditioned on genuine intemal however unprofitable. By satisfying the claims of restructuring and privatization of the farrns the creditors, the traditional bankruptcy rticipatnggand privaizationt ofmthe frm. procedures are likely to cause irreparable social participating in the debt-settlement program. damage to the rural population, thus producing a * Creation of necessary economic conditions for politically untenable situation in the transition the recovery of the restructured farms countries, which still have no alternative emerging from the debt-settlement procedure. employment opportunities for their farmers and peasants. This danger is particularly acute because * Introduction of hard budget constraints of the unclear standing of collectively shared land forcing the farms to operate under strict in bankruptcy proceedings: courts may decide to financial discipline. auction off not only buildings, tractors, and * Reorientation of the banking sector to lending livestock, but also farmland, leaving the rural on strict creditworthiness principles. families without any sources of income. Implementation of a working bankruptcy If an industrial enterprise goes bankrupt, the system to prevent accumulation of new debt employees lose their work place; if a farm in farms created through the process of enterprise goes bankrupt, the rural population restructuring and debt settlement. loses its livelihood and the entire village community may be destroyed. Since this effect The unique feature of this general program is will be multiplied by tens of thousands of villages the integration of debt resolution (handled as an that are dependent on failing farm enterprises, the out-of-court managed process) with internal process may spell the destruction of the entire restructuring of farms and a shift to hard budget rural sector. In the end of the day, when constraints. Experience shows that if debt is politicians, social scientists, and even economists written off while the farm organization remains have to weigh the interests of creditors - unchanged, the result has never prevented re- businesses or government - against the interests accumulation of new debt. In parallel with treating of a large rural population, the balance naturally the outstanding debt, it is essential to implement a tilts in favor of the rural population. It can be genuine restructuring of the farms based on argued that the creditors were lending to the farm market principles with the goal of improving enterprises in the expectation of making a profit, productivity and profitability. Without addressing and if they have miscalculated, they should bear at basic ownership and management problems, least part of the responsibility. Since courts would including the development of realistic business not necessarily be guided by such considerations, plans, debt restructuring programs have very little value. We recommend starting the process of xvi Executive Summary xvii restructuring with the allocation of physically * The debt settlement process is managed by a identified land parcels with ownership titles to debt-settlement committee appointed by a individuals. national body and consisting of local and outside experts. The committee announces the Implementable framework for out-of-court debt start of the process and collects the claims settlement andfarm restructuring from the creditors. Instead of invoking blanket bankruptcy * The outstanding debt is settled primarily from procedures, we recommend an approach that the assets of the farm enterprise. Land implements a one-time comprehensive out-of- remains outside the debt settlement procedure. court debt settlement linked with farm The non-land assets are divided into three restructuring and introduction of hard budget groups: (a) machinery and livestock, which constraints. Such a process has been recently are earmarked for distribution to farm implemented in Moldova. It is still too early to members and are exempt from the debt- judge the long-term impacts of the process, but it settlement process; (b) inventories, cash, has certainly met with initial success: the receivables, other current assets, and all outstanding farm debt was practically liquidated production fixed assets (i.e., storage, farm within one year, in part by transfer of assets and in buildings, processing facilities, etc., excluding part by offsets between the government and housing and social infrastructure), which are commercial creditors; the rural population was not used for settling the debt of commercial deprived of its rights to land, livestock, and farm creditors; (c) social assets and non-privatized machinery; and the former collective farms were housing, which are used for settling the debt restructured into new debt-free entities based on to the government and to payroll. private ownership of land and assets. * The full settlement of debt to commercial The Moldovan experience is an example of an suppliers is an integral part of the process. All integrated approach to managed out-of-court assets under lien are automatically transferred settlement of farm debt. The more general features to the entitled creditor. The residual farm of this approach could be applied also in other assets, excluding the portion distributed to countries in the region. Following is a brief farm members and used for settlement of characterization of these general features. wage arrears and government debt, are offered to the creditors up to the limit of the debt. The * The major objective of the one-time managed unsettled debt, if any, is taken over by the intervention is to create new farm entities that budget and used as a future tax credit for the are free of past debt burden and have the suppliers or in the form of long-term bonds. potential to become economically viable. The goal is not reorganization of existing * The debt settlement process is implemented enterprises, but actual creation of new entities with the full support of the government, and compatible with market principles of the budget acts as a last resort to reach a full operation. settlement of all residual amounts remaining after the farm assets are exhausted. Usually, * The decision to launch the debt settlement this is not a serious constraint, as in most process in each farm enterprise and the choice cases farm assets are more than sufficient to of the form of the new entity is left to farm satisfy all obligations. members. The decision-making process is supported by sufficient information outlining * The process ends with the full liquidation of in detail all implications and alternatives, the old entity, without any legal successor, informing the members of the basic market and registration of new entities by the former principles of farm organization and farm members. management. xviii Farm Debt in the CIS The process should have a definite completion * There is political consensus for a complete date for each farm (four-five months duration), and comprehensive approach to farm and the overall time frame for the entire project privatization and farm debt settlement; nationally also should be set in advance. A core . The task is of manageable size and the group of experts should be assembled to work on technical implementation is feasible (e.g., the preparation of detailed procedures and adequate donor support is available). manuals, and to travel across the country with the objective of training local forces and supervising the implementation. The specific implementation of the debt- settlement program will naturally vary from Pre-conditionsfor success ofdebt-settlement country to country, but the general principles program adopted in Moldova appear to be valid and workable for all CIS countries. The larger Certain conditions are essential for successful countries, such as Russia and Ukraine, may implementation of such a framework: prefer to adopt a regional approach, first implementing the debt-settlement program in the * Legal framework for land ownership and most progressive regions. The experiences of this titling is in place; approached can be extended to a national * Procedures for farm privatization have been program at a later stage. adopted; xviii 1 Introduction: Objectives and Methodology The process of land reform and farm The aggravating problem of farm debt, restructuring has been under way for almost a combined with the continuing decline in decade in the former socialist economies of agricultural production and farrn incomes in CIS, Europe and Central Asia. While significant calls for an urgent solution. Traditional progress has been achieved in most Central and interventionist measures by CIS governments, Eastern European (CEE) countries, the process including periodic debt forgiveness and debt has not resulted so far in noticeable efficiency and rescheduling, have had a very limited success. productivity improvements in the Commonwealth Most governments are justifiably concerned about of Independent States (CIS). The World Bank has the short-lived, transient effect of these actions carried out a series of studies that monitor the and their negative long-term impact on producer progress in land reform and farm restructuring and incentives. Moreover, CIS governments no longer identify the critical issues for the success of future have the financial resources needed to continue reforms. These studies and the actual experiences with the traditional policy of periodic write-offs of the transition countries have highlighted the and bailouts. accumulation of debt in farm enterprises as one of the most important constraints that prevents In CEE countries, farm debt inherited from mneaningful privatization and restructuring of the socialist era was a significant issue during the existing large farms, obstructs their normal day- early phases of transition. The problem of to-day operation, and thus impedes progress insolvent farms was quickly resolved in CEE by toward higher productivity and efficiency. elimination of soft budget constraints and adoption of strict bankruptcy procedures. Large-scale farm enterprises in CIS are Bankruptcy is also proposed by some experts as a increasingly unable to repay their debt, which is tool for the resolution of farm debt in the CIS growing over time in both dollar and real terms. countries. Here, however, the magnitude of the Researchers and experts in both CIS and Western problem is much greater than in CEE, and Europe repeatedly stress that large farms in Russia standard court-driven bankruptcy procedures, like and Ukraine are "on the verge of bankruptcy". those implemented in CEE countries, do not seem Frequent defaults trigger administrative restraints to be feasible for CIS. The main reasons against on farm bank accounts and sporadic seizure of straightforward application of court-driven farm assets by creditors. This is highly disruptive bankruptcy mechanisms in CIS include missing or to normal operation of financially strapped farms non-functioning institutions and inadequate and encourages a shift from monetary to barter judicial frameworks. Another serious obstacle to transactions in an attempt to conceal some assets the implementation of standard bankruptcy from creditors. The atmosphere of general default, proceedings is the lack of clearly defined property with the uncertainty surrounding the disposition of rights in former collective farms, which still assets, is also an obstacle to the restructuring of largely rely on joint shared ownership of land and existing farms into new, potentially more assets without unambiguously distinguishing efficient, private entities. Yet the insolvent farms between corporate and individual property. are not forced into bankruptcy and continue to Finally, the potential social damage to the large survive by virtue of various soft credit facilities rural population makes a mass bankruptcy process and government bailout programs. politically untenable in CIS countries. I 2 Farm Debt in the CIS Since traditional bailout remedies have been of the outstanding amount of debt, its unable to stop continued debt accumulation and composition, and possible macro-economic court-driven bankruptcy proceedings are judged to consequences of the farm debt overhang. be inappropriate given the scale of the farm debt problem in CIS, alternative approaches must be 2. Analyzing the underlying factors responsible devised to comprehensive debt settlement. These for the accumulation of farm debt in CIS. approaches ultimately must include a carefully managed out-of-court liquidation program. Old 3. Collecting information on debt resolution insolvent farms must be liquidated, giving way to measures and efforts that have been applied new debt-free genuinely privatized farms that will by governments in both CIS and CEE, be forced to operate under a strict financial examining the actual impact of these discipline. The introduction of hard budget measures on agriculture, and identifying the constraints for the restructured farms will require "best practices" implemented across the a radical change in government policy toward region. agriculture and will imply initiation of strict bankruptcy proceedings for farms that fail to 4. Developing country-specific and region-wide achieve financial health and continue to proposals and recommendations for the accumulate new debt after restructuring. Genuine settlement of farm-enterprise debt in CIS. debt restructuring thus requires strong political resolve at the level of government and parliament. Methodology Objectives The regional farm debt study is based on five individual country studies for Belarus, The objective of this study was to support the Kazakhstan, Moldova, Russia, and Ukraine. Each farm privatization and restructuring process in country study consists of four empirical CIS by presenting governments with a range of components: (a) a database of financial strategic and tactical options that could be applied information relating to farm debt (including farm- to eliminate or at least reduce the main factors level and national data); (b) a database of relevant responsible for the destructive accumulation of legislative information; (c) a database of measures debt in large farn enterprises. This objective has implemented to treat farm debt; (d) case studies of been accomplished by documenting and analyzing the debt situation in three-four farm enterprises the indebtedness of large-scale farms in five CIS based on structured interviews with managers and countries - Belarus, Kazakhstan, Moldova, other stakeholders. Russia, and Ukraine - that account for 87% of agricultural product, 85% of agricultural land, and The quantitative financial information was 70% of rural population in CIS. and developing obtained from the consolidated financial reports - proposals for debt resolution. The study will be balance sheets and profit-and-loss statements - used to open a dialogue with governments in the that the statistical organs of each country provided region on the subject of farm debt and its for its agricultural sector. The study also resolution. examined World Bank and IMF reports on farm restructuring and the general enterprise debt The study presents a region-wide analysis of problem in CIS. Debt-related reports and studies farm debt based on data collected from five CIS by international donor organizations and domestic countries and develops proposals that are relevant institutions in CIS were collected and analyzed. In for the region as a whole. The study undertook addition to the five CIS countries, a special review four specific tasks: of the experiences with the farm debt problem in CEE countries has been prepared. 1. Assessing the historical development and the current level of indebtedness in large farm Overall, the present study used the following enterprises in the CIS, including a description sources: (a) information about the development of Chapter 1. Introduction: Objectives and Methodology 3 farrn restructuring in CIS; (b) the experience of independence. Other modifications adopted by the other regions and other sectors with debt countries during the 1990s actually improve the settlement; (c) country-level quantitative data and cross-country comparability, as they are mostly descriptive information; and (d) farm-level case directed toward better implementation of studies. Financial ratio analysis was the main international accounting standards in CIS. To analytical tool applied to evaluate the debt exploit the benefits of comparability, standard situation of farm enterprises in CIS and to assess table templates were prepared and distributed to their ability to repay the debt. the participating countries for data collection and data entry. The five countries selected for this study represent the bulk of the rural population and The present analysis suffers from the well- agriculture in CIS. At the same time, they provide known weaknesses that affect every study based a varied cross-section of different policies and on financial reports, even in market economies. approaches to farm reorganization and debt These weaknesses primarily include reliance on restructuring. The comparative cross-country cost-based data instead of true market values, use approach based on CIS and CEE practices has of nominal (and not real) values, and the danger of allowed us to highlight country-specific features, under-reporting, over-reporting, or otherwise some of which might be transformed into a concealing information from the outside user. Yet, workable list of recommendations for the region despite these acknowledged weaknesses, financial as a whole. reports are universally accepted for analytical (and of course other) purposes all over the world, as they provide the best possible data based on fairly Data Sources, Quality, and Limitations standard and comparable principles One of the major goals of this study is to The quality of financial data in CIS is of provide a quantitative assessment of the farm course lower than in Western countries. First, the debt, its level, structure, and evolution through the institution of external audit does not exist for 1990s in five CIS countries (Belarus, Kazakhstan, financial reports of farm enterprises. The Moldova, Russia, and Ukraine). To accomplish correctness of financial reports depends on the this goal, we collected the consolidated financial integrity of the farm accountants, which is reports of the agricultural sector for each country enforced to a certain extent by very detailed and for the period 1990-1998. The financial reports strict professional instructions. Second, the data included the balance sheets and the profit and loss collection system in CIS is under severe financial statements consolidated for all large farmn constraints, and as a result the coverage and the enterprises reporting their financial results to quality of the data are deteriorating. Before the statistical authorities. The data covered farm reforms, all farm enterprises were required by law enterprises only, as private farmers and household to send their financial reports to regional plot owners do not routinely report financial data authorities, which then checked and consolidated to statistical organs. The basic financial data were the farm-level data according to established supplemented with information on farm numbers, standards. The CIS countries continue to land, and labor. State Statistical Committees in implement this system for their farm enterprises, each country were the primary source of all but the reporting requirements have been relaxed quantitative information. with the general disappearance of central controls. The extreme example is Kazakhstan, where in The consolidated financial reports of the some regions the collection of statistical and agricultural sector in most CIS countries are financial data has been abolished by the decision generally prepared according to standard of regional authorities (akims). The number of principles established back in the Soviet era. This reporting farms in Kazakhstan has been declining ensures fundamental comparability of the over time, and the consolidated financial reports financial data across countries despite the in this country have become less representative of transition from rubles to national currencies since the agricultural sector. 4 Farm Debt in the CIS The reported value of fixed assets - always a assets, which are not affected by these distortions problematic issue in accounting - differs in two to the same extent, and current flows (sales and important respects from the prevailing Western profits) as the basic indicators for calculating practice. These include the omission of land from indebtedness and repayment capacity. the farm balance sheet and periodic indexation of farm fixed assets. Another weakness of farm financial data concerns the profit calculation. Three technical The fact that the value of land is not shown on factors act to depress the reported profit. the farm balance sheet in CIS is a carryover from Overvalued assets produce higher depreciation the Soviet era, when all land was owned by the charges. The traditional responsibility of farm state. Although today land is privately owned, the enterprises for rural social infrastructure mandates property rights remain ambiguous: it is not clear if the inclusion of social expenditures in farm costs. jointly shared land is the property of individuals The special relationship between the farm or the property of the farm enterprise. This enterprise and the employee household plots leads ambiguity, combined with the virtual absence of to transfer of inputs and services at below-market market valuation of land, has discouraged the prices or sometimes free of charge. There are no attempts to show land on the farm balance sheet. reliable data and furthermore no accepted This may severely understate the total farm assets, methodology for calculating the combined effect as in the US the value of land is the single largest of these three "cost-increasing" factors. The component in the farm balance sheet (about 50% estimates published by researchers and of total farm assets, according to USDA). international experts vary between wide limits (e.g., between 15% and 50% of total costs) and The practice of periodically adjusting the are highly tentative. Correct estimation of these value of fixed assets to inflation (indexation) is an cost distortions is essential if we seek to compare outgrowth of the galloping inflation that affected the level of profits in CIS farm enterprises with all the CIS countries in the 1990s. As in other the level of profits in market economies, where countries in the world where asset indexation is farms are free from these distortions. The impact practiced, this adjustment usually leads to of cost distortions is less relevant for our overvaluation of fixed assets compared to any immediate task of tracking the financial reasonable market value. There can be no reliable performance of CIS farms over time, as it is estimates of this overvaluation in the absence of reasonable to assume that the systematic effect of functioning markets for farm assets, but work by all these factors generally remained the same international and local experts in Russia, Ukraine, during the 1 990s. and Moldova suggests that overvaluation may range from a few tens of percent to several times Despite these caveats, financial reports are the the market value. As a result, the fixed assets (and only source of data that can be used to analyze the correspondingly adjusted equity component) farm debt in CIS in a regional perspective. In the dominate the farm balance sheet in CIS to a future, the quality of financial data should be totally unrealistic extent, which is unprecedented improved to provide a less distorted picture of the in international experience. financial situation of farm enterprises. Meanwhile, we have no choice but to use the available data, Because of the two difficulties with the fixed bearing the various caveats in mind and always assets in farm balance sheets, the standard ratios remembering that the difficulties with farm of debt to total assets had be to ignored in this financial statements in CIS are basically similar to analysis. Instead, the analysis focused on current those in market economies, but only larger. Chapter 1. Introduction: Objectives and Methodology 5 Structure of the Report experiences from CEE countries. Details of the unique approach to farm debt resolution The chapters that follow present a implemented in Moldova are presented in comparative cross-country analysis of the farm- Appendix C at the end of the study. Appendix B is debt data collected by the counterparts in Belarus, a collection of statistical tables with full country Kazakhstan, Moldova, Russia, and Ukraine. First, data for 1994 and 1998 collected for the present we review the history, current level, and study. Appendix A is an annex of tables relating composition of farm debt in CIS. Then we to the main text: it tabulates the CPI and exchange examine the major reasons for farm debt rate data used for calculations in Chapter 2; accumulation, including macro-economic policy provides quantitative details of farm case studies reasons and internal, farm-level reasons. This is in Belarus, Kazakhstan, and Russia discussed in followed by a discussion of the implications of Chapter 4; and presents a graphical overview of farm debt for the rural population and an overview policy instruments used for farrn debt resolution of specific country initiatives for the resolution of by each of the five CIS countries in this study (as farm debt. The last chapter summarizes the discussed in Chapter 5). findings of the study and incorporates some 2 Overview of Farm Debt in CIS: History, Current Level, and Composition Debt is an essential component of the the same general principles of debt management financing mix of any business entity, be it a apply in both market and transition economies. manufacturer, a service corporation, or a farm. Without access to debt, the organization is limited However useful, debt is a risky financing to activities that can be financed only from instrument, because borrowing always involves a internally generated cash flows (or sale of equity - contractual obligation to repay after an agreed a costly and relatively complicated transaction). period. In this sense, debt constitutes a liability or This would be a severe constraint on day-to-day an obligation, and these three terms are used operations and on growth prospects, and all synonymously. In market economies, if the business organizations resort to external financing borrower is unable to repay the amounts falling in the form of debt to alleviate this constraint. In due, the borrower is considered in default of a what follows, we focus on farm debt, although contractual obligation and may be subjected to virtually in all respects the debt of agricultural bankruptcy proceedings that lead to liquidation. producers is governed by the same principles as The ability to repay the debt is thus an inseparable the debt of any business organization. Moreover, component of any debt management decision. Figure 2.1: Composition of Total Farm Debt Total farm debt = Long-term liabilities + Current liabilities Long-term bank loans Long-term government credits Short-term loans Accounts payable Supplier credit Wage arrears Social funds Taxes Chapter 2: Overview of Farm Debt in CIS: History, Current Level, and Composition 8 We usually distinguish between two and the repayment capacity of the farm sector in components of debt financing. One component these countries. can be characterized as "intentional borrowing," when the farm turns to banks or other formal lenders to raise debt. The other component is "spontaneous borrowing," which arises in the course of conducting normal business operations. Farm balance sheets report debt in cuffent courseo codctn nr.a buies opratos. values in domestic currency. The CIS countries Spontaneous boffowing, often called working- have dlfferent domestic currencies - hrivna in capital financing (or accounts payable, to use a Uaie deient Momeova, tenge i K hstain technical accounting termn), includes primarily ruble i Russia, and Belarusian ruble in Belarus supplier credit for purchase of inputs and other inventories, accrued amounts due for utilities or (which is different from the Russian ruble). This nmakes direct cross-country comparisons impossible. Moreover, reported current values are Alongside this classification into "intentional" affected by inflation, and this complicates and "spontaneous" borrowing, debt is also comparisons over time within each country. classified by repayment term, i.e., the length of Two techniques were applied to make time to agreed repayment. Short-term debt has to financial data comparable across countries and be repaid within the current year, while long-term over time. First, the relevant components in the debt has to be repaid after a period longer than 12 months. "Intentional borrowing" is done for short agricultural sector's balance sheet and income statement were converted to US dollars using the or long term (i.e., for periods of less than one year prevailing exchange rates to bring the absolute or more than one year), depending on availability values for each country to a common currency. and expected uses. "Spontaneous borrowing" is Second, the same components were also deflated typically short-term, with repayment expected by the consumer price index (CPI) of the within 30 to 90 days. In the balance sheet, long- byethe contrie mdeal, oflthe term dbt is suall in th formof loas fro respective countries to obtain real, inflation- term debt IS usually in the forrn of loans from aduse vaus h xhne ae n h P or th goenet rersnin ato adjusted values. The exchange rates and the CPI banks . , value used in this study are given in the annex at "intentional borrowing." Short-term debt, the end of the chapter. designated by the accounting term current liabilities, consists of short-term bank loans and acout paabe Th.omrae heann Neither the CPI nor the dollar exchange rate is pacr of "inteoal. bormro we the leattr a perfect deflator for financial analysis. The CPI partof"ntentiona borrowin," while thela does not fully allow for the changes in various represent the "spontaneous" component of debt. components of farm debt, yet it is the best and most universally reliable measure of inflation Figure 2.1 visualizes the components of total aalbefrrcia ss xhnertsi farm debt. Total farm debt is defined as the sum available for practical purposes. Exchange rates m ... long.tern liabiitieplucurentlabCIS during transition have been subject to high it is often called total liabilities. The farn debt volatility (especially in Russia and Kazakhstan) or data analyzed in this chapter are derived from the strict government controls (in Belarus). All CIS consolidated financtalscatereare der ived countries experienced a long period of real corporate and state farms in each country. In this exchange rate appreciation during most of the corporate, and rsetathefarsiegac c eut on thi 1990s. This trend reversed abruptly with the sharp sense, they represent the aggregated debt Of the devaluation of the Russian ruble in September agricultural sector in each country.deautoofheRsinrbenSpemr 1998, and the effects of this event quickly spread This chapter examines the growth of farm across the region. Yearly averages were Thlschaner xamles he vowt of arm accordingly used for exchange rates to smooth debt over time and the structure of debt by sources shortrn uations. and repayment terms in five CIS countries. It analyzes the standard financial ratios with the The changes in farm debt over time are shown objective of determining the financial situation in Figures 2.2 and 2.3. Figure 2.2 plots the farm Chapter 2: Overview of Farm Debt in CIS: History, Current Level, and Composition 9 debt in US dollars for the period 1990-98. the lion's share of total farm debt in CIS: 70% of Although debt is converted to nominal US dollars, the five-country debt in 1997. It is followed by the dollar is a useful yardstick for assessing the Ukraine (20%), Kazakhstan (5%), and Moldova magnitude of debt over time and across countries and Belarus (2% each). The sharp devaluation of in a single currency because of its stability relative the Russian ruble in 1998 produced a pronounced to the various national currencies in CIS. Figure downward adjustment of the dollar farm debt in 2.3 plots the change in real farm debt between Russia. Because of Russia's relative size this was 1994-98. In this graph, the real farm debt is reflected in a decline of CIS-5 total farm debt in calculated by deflating the domestic currency 1998, although the dollar debt in the other four values by CPI, and the real debt series are then CIS countries did not show a consistent decrease. expressed in percent of 1994 to ensure comparability across countries with different domestic currencies. The real debt graph shows Table 2.1: Major Indicators of Farm Debt, 1994-98 growth, not level of debt across countries 1994 1995 1996 1997 1998 A. Total farm debt in US$ (US$ '000,000) Figure 2.2: Changes in Farm Debt (million dollars) Belarus 320 489 779 734 950 25sen 25-)6) Kazakhstan 1684 1919 2053 1502 1219 \ 21)66) ~ - \ 266h06| Moldova 292 372 525 482 539 Russia 7021 13036 17865 21103 11535 Ukraine 3004 2375 3901 5901 5718 1666 1)6661 A / / lCIS-5 13540 19168 26066 29840 19962 966ee < >d~ = = 6~ 5l)6) B. Changes in real (CPI-deflated) farm debt d____________________ ,_________ Belarus 100 59 71 81 107 1990 1991 1992 1993 1994 995 1996 1997 1996 Kazakhstan 100 40 34 24 19 -Q-- l11 (Idt s0k) -.4-Wmk.. (W e) - ,,( . j. 7 Rn-s- R...i. n~ght .) -x - Uk.i.. (dgi.ht .k) Moldova 100 126 150 128 157 Russia 100 104 121 143 141 Ukraine 100 77 87 116 134 i _ _ _ _ __ _ _ _ _ _ ~~~~C. Farm debt as %/ of gross agricultural product Figure 2.3: Changes in Real Value of Total Debt per Farml Belarm t of go g l prouc Belarus 26 23 26 23 29 166 Kazakhstan 88 116 99 79 160 s1'40e ~ t Moldova 74 67 88 73 99 5no me < = C x aRussia 37 49 47 63 84 66\ Ukraine 37 30 44 68 93 l 401n ~ _ _ D. Farm debt as % of GDP 6 Belarus 7 5 6 5 7 Kazakhstan 14 12 10 7 6 rlel m. e-Kkb.t.n_btoov. - RW. arn, F.d ..011- Uk-i-6e -- -=--=---=== - - Moldova 22 22 27 22 29 Russia 3 3 4 5 6 Both views of farm debt over time - in Ukraine 8 6 9 12 13 nominal US dollars (Figure 2.2) and in real index E. Farm debt as % of budget revenues numbers (Figure 2.3) - show significant Belarus 14 12 14 12 14 accumulation of debt during the 1990s. Kazakhstan 78 67 71 51 40 Moldova 64 65 85 61 83 The total farm debt for the five CIS countries Russia 8 10 13 13 18 reached nearly $30 billion in 1997, more than Ukraine 19 17 24 31 38 double the dollar level of debt in 1994 (Table 2.1). Because of its sheer size, Russia accounts for Chapter 2: Overview of Farm Debt in CIS: History, Current Level, and Composition 10 Allowing for the impacts of the 1998 The Burden of Farm Debt for the Economy devaluation, the farmn debt expressed in US dollars increased by nearly 50% between 1994-98 (Table Can agriculture repay its accumulated debt? 2.1, panel A). This aggregate value conceals Or will the governments need to intervene in the considerable variability across countries: the near future with massive debt write-off programs dollar farm debt changed in this period by 200% at the expense of the taxpayer? The output in Belarus, by 90% in Ukraine and Moldova, and produced by the agricultural sector is the main by more than 60% in Russia. The real (CPI- source of repayment capacity. Table 2.1 (panel deflated) farm debt rose between 1994-98 by 57% C) shows that the ratio of farm debt to gross in Moldova, 41% in Russia, and 34% in Ukraine agricultural product increased significantly for all (Table 2.1, panel B). The increase in real farm CIS countries (except Belarus). The level of farm debt for Belarus was much less significant (only debt in 1998 is practically equal to the annual 7% during the same period). Kazakhstan is the agricultural product, up from about 50% of only country in the study that shows a substantial product in 1994. One full year's agricultural decline both in real farm debt and in dollar debt product is thus needed to repay the sectoral debt. between 1994-98. This appears to be due to In the US, farm debt is less than 40% of output, generally low reliability of the financial data for and this ratio has remained constant over time. Kazakhstan agriculture, where the number of The increasing trend and the actual level of farm farms and the data collection procedures changed debt relative to agricultural product in CIS seem significantly during transition. to suggest that debt repayment from resources generated by the sector itself may be problematic. In general, the increase in dollar debt between 1994-98 was larger than the increase in real CPI- Figure 2.4: Percentage Change in Farm Debt in CIS: 1994-98 adjusted debt (Figure 2.4). This provides an indirect indication of the strong overvaluation of domestic currencies in CIS during the 1990s. The Belarus gap is particularly large for Belarus due to persistent government intervention in the Moldova exchange rate of the Belarusian ruble. _OOer debt UReal debt The pattern of increases in farm-level debt Russia (i.e., debt per farm enterprise) between 1994-98 is - on the whole similar to the pattern of growth in Ukraine total country-level debt shown in Figures 2.2 andi 2.3. This is so because the number of farms in 0 50 100 150 200 250 each country remained relatively constant, and the perrentags change fm 1994 to 1998 per-farm debt generally tracks the total farm debt. Another indication of an increasing burden of The average debt per farm in 1998 was about farm debt in CIS is provided by the ratio of farm $400 thousand, with little variability across debt to GDP (Table 2.1, panel D). The share of countries (Table 2.2). farm debt in GDP increased between 1994-98 for Table 2.2: Average Debt Per Farm, 199498 (US$ '000) all countries (except Kazakhstan). Moldova had by far the highest share of debt in GDP (20%-30% 1994 1995 1996 1997 1998 of GDP all through the 1990s), because of the Debt per farm enterprise (US$ '000) importance of the agricultural sector to its Belarus 108 169 272 262 345 economy. Analysis of accounts receivable, i.e., Kazakhstan 706 843 709 428 394 amounts owed to farmn enterprises, shows that they Moldova 281 359 507 461 386 are very small relative to GDP (of the order of Russia 253 482 663 787 421 1%-3% for most countries) and do not offset a Ukraine 218 203 335 486 465 significant proportion of the outstanding farm debt. Chapter 2: Overview of Farm Debt in CIS: History, Current Level, and Composition 11 The burden of farm debt on the government Loans, both short-term and long-term, are a budget is expressed in Table 2.1 by the ratio of relatively small residual component of total farm farm debt to budget revenues. This ratio is a debt. Farms do not intentionally borrow by measure of the share of budget revenue that would applying to financial institutions. Farm debt in have to be expended if the government decided to CIS is predominantly of the "spontaneous" or assume full responsibility for outstanding farm "involuntary" variety that arises in the normal debt and to write off all liabilities without any course of doing business. contribution from agricultural producers. In Russia and Belarus, farm debt does not appear to Despite the smallness of the loan component, be a major public-finance problem. In these two a definite change in the term structure of loans countries, 18% and 14% of budget revenues, was observed between 1994-98. While long-term respectively, would be sufficient to pay off the debt had been virtually wiped out by inflation by entire debt of the agricultural sector. The situation 1993, short-term debt began to be converted into is less favorable for Kazakhstan and Ukraine. long-term debt as a result of government debt These countries would need to allocate almost rescheduling policies after 1994. Debt 40% of budget revenues to achieve the same goal. rescheduling was intended to postpone the In case of Moldova, the potential burden of farm repayment of loans that were falling due while the debt on public finance is much higher: more than farms suffered from a liquidity and profitability 80% of budget revenues would be required to pay crisis. off the entire debt of agricultural producers. These macroeconomic implications of farm debt Table 2.3: Structure of Farm Debt (percent of total debt) accumulation may be used as an indicator of the 1994 1995 1996 1997 1998 urgency of farm debt resolution for a particular A. Accounts payable country. The magnitude of the problem in Belarus 67 74 74 71 69 Moldova in 1998 probably explains why this Kazakhsta 76 75 86 85 88 country assumed a lead role in developing a comprehensive debt-settlement program in 1999- Moldova 88 90 86 88 72 2000. Russia 44 52 62 72 78 Ukraine 64 82 85 85 77 B. Short-term loans Structure of Farm Debt Belarus 28 24 24 26 17 Kazakhstan 22 7 4 3 3 Accounts payable constitute the largest Moldova 9 5 8 5 4 component of farm debt (70%-80%) in all CIS Russia 9 5 8 5 9 countries (Table 2.3). The share of accounts Russia 23 16 16 12 9 payable in total debt generally showed an upward Ukraine 33 14 13 6 3 trend over time (Figure 2.5). C. Long-term debt Belarus 5 2 2 3 13 __ _ __ _ _ _ _ _ Kazakhstan 2 18 10 12 9 Figure 2.5: Share of Accounts Payable in Total Debt Moldova 1 4 4 5 17 toe Russia 25 22 16 13 11 Ukraine 1 2 1 7 18 60 s0 The main creditors comprising the accounts 40 payable of agricultural producers in CIS are the government, input and energy suppliers, and the 20 1990991 1992 1993 1994 19 1997 1 payroll (Table 2.4). Farms are liable to both -- - - ------------- --------,l F~mcentral and local government mainly for unpaid - -=--~--- --=---==-_- ~- =~--~- ==- taxes, overdue contributions to unemployment and social security funds, and workers' medical Chapter 2: Overview of Farm Debt in CIS: History, Current Level, and Composition 12 insurance. Suppliers of various organizational Kazakhstan, government debt is 30% of accounts forms (state-managed, parastatal, and private payable. By allowing farms to accumulate unpaid companies) have claims on farms for prior taxes and social contributions, the government deliveries of farm inputs and energy. Member- effectively transfers to agriculture financial workers of farm enterprises are represented as resources that are used in lieu of commercial and creditors on account of unpaid wages. bank credits. Table 2.4: Structure of Accounts Payable (%) Supplier credit contributes roughly the same 1994 1995 1996 1997 1998 share of accounts payable as debt to the A. Government, total (social funds and taxes, B+C) government (Table 2.4). This is an important and Belarus 8 13 21 17 16 stable source of working capital, which has remained at a level of 40%-50% of accounts Kazalhstan 2 1 26 34 4 payable since 1994. Such levels of supplier credit are not abnormal in market economies, provided Russia 24 34 42 47 52 farms can repay this credit within the agreed Ukraine 25 29 34 37 30 period of 30-90 days. Unfortunately, the share of B. Social funds overdue payables and receivables (debt to other Belarus 5 8 10 7 5 firms and debt of other firms to agricultural Kazakhstan 13 12 14 15 20 producers) has been increasing (see the section on Moldova 15 17 17 16 18 overdue debt below). Russia 15 22 30 34 40 The share of wage arrears in accounts payable Ukraine 10 16 21 23 17 is generally low (Table 2.4). Workers provided C. Taxes about 10% of total credit through accounts Belarus 3 5 11 10 11 payable, and their role decreased over time. Kazakhstan 12 5 12 19 15 Ukraine in an exception, with wage arrears rising Moldova 14 26 3 1 23 27 to 17% of accounts payable in 1998. Overdue Russia 9 13 12 13 12 wages thus do not appear to be a major problem in U3most countries (see also Chapter 4). UJkraine 14 14 13 14 13 D. Suppliers Belarus 48 53 55 60 65 Overdue Debt Kazakhstan 57 58 51 47 47 Moldova 42 34 34 41 41 Debt accumulation is a normal business Russia 48 46 41 38 35 practice if the firm is growing and is able to repay its obligations in both the short and the long run. Ukraine 38 42 38 36 39 Increasing debt levels in a stagnating or shrinking E. Wage arrears firm (and such are the farm enterprises in CIS) is Belarus 14 14 8 8 8 generally an unhealthy sign. Moreover, if debt is Kazakhstan II 11 12 12 10 not repaid on time and becomes overdue, this is Moldova 12 10 8 10 10 usually a symptom of a serious management Russia 16 12 11 9 8 problem that may ultimately lead to insolvency Ukraine 13 12 13 15 17 and bankruptcy. Table 2.5 shows that the share of overdue The government' s role as a creditor of agiuTural produermens r as aovreritim for o payables increased for all countries between 1994- agricultural producers s increasing over time for 98. The sharpest increases were observed in all countries (Table 2.4). In Russia and Moldova, Kazakhstan (from 44% of accounts payable in the government is the major creditor of farm 1994 to 87% in 1998) and in Russia (from 34% to enterprises, with 50% of accounts payable 56%, respectively), but the levels of past-due representing government debt. In Ukraine and Chapter 2: Overview of Farm Debt in CIS: History, Current Level, and Composition 13 accounts in Moldova and Ukraine were also quite enterprises have reached a level of debt that high by all accepted standards. restricts their ability to borrow. After all, most borrowed funds derive from non-budgetary Another symptom of lax and irresponsible government sources rather than commercial and payment discipline in CIS is the high share of bank credit (Table 2.6). Yet when credit is accounts receivable not collected on time. primarily needed to meet working capital Accounts receivable of one enterprise are requirements, the atmosphere is not conducive to accounts payable of another enterprise, and a high investment borrowing. proportion of overdue receivables in some enterprises automatically translates into a high Table 2.6: Major Sources of Investment in Agriculture proportion of overdue payables in other (% of total investment) enterprises. Moreover, failure to collect the 1994 Bel Kaz Rus Ukr accounts receivable leaves the enterprise without Investment (mln. US$) 122 149 2493 873 sufficient funds for repaying its accounts payable. Total investment 100 100 100 100 This interlinked effect is clearly observed in the Own financial resources 64 93 65 65 first two panels of Table 2.5, where the increase Depreciation 33 27 52 9 in the share of accounts receivable is seen to be Dereciaton 33 7 5 9 positively correlated with the increase in the share Borrowito 3 7 3 3 of accounts payable. Bank credits 0 0 0 0 Other enterprise debt 9 0 14 1 Non-budget funds 20 0 19 22 Table 2.5: Overdue Accounts Payable and Accounts Other 4 0 1 0 Receivable Receivable 1998 Bel Kaz Rus Ukr 1994 1995 1996 1997 1998 -_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ Investment (mln. US$) 375 12 1997 820 A. Overdue accounts payable as % of total payables Total investment 100 100 100 100 Belarus 7 5 6 5 7 Own financial resources 55 98 94 76 Kazakhstan 44 76 87 89 87 Depreciation 42 52 62 69 Moldova 25 10 6 1 1 36 Borrowing, total 45 1 6 24 Russia 34 36 49 52 56 Bank credits 0 0 0 0 Ukraine 26 26 27 26 30 Other enterprise debt 28 0 1 0 B. Overdue accounts receivable as % of total receivables Non-budget funds 8 0 3 21 Kazakhstan 33 63 64 62 82 Other 2 0 0 0 Russia 12 26 29 32 34 Ukraine 23 33 36 40 42 Major Indicators of Farm Solvency The fact that farm debt is increasing over time Effects of Debt Accumulation on Investment does not necessarily imply that the financial situation of farm enterprises is deteriorating. If The volume of agricultural investment farms have adequate debt repayment capacity, declined in most countries between 1994-98 debt accumulation does not present a problem, but (Table 2.6). This is probably attributable to lack rather is a sign of expanding business. In CIS, of profitable investment opportunities in a however, increasing debt levels are not associated generally declining economy. Yet farm enterprises with the need to finance growth. Farm debt is in 1998 obviously faced more severe borrowing increasing while the volume of operations is constraints than in 1994. The share of investments actually contracting. Figure 2.6 shows the change financed with borrowed resources declined in real (CPI-deflated) sales per farm between sharply in Russia, Ukraine, and Kazakhstan. This 1994-98. There is a clear downward trend in farm is not necessarily an indication that farm sales during these years. The decline in sales in Chapter 2: Overview of Farm Debt in CIS: History, Current Level, and Composition 14 Figure 2.6 should be compared with the increase CIS excludes agricultural land, which results in a in real farm debt in Figure 2.3 to appreciate the strong downward bias in the value of fixed assets. gravity of the situation (the time series in both As a result of these factors, the fixed asset graphs were derived by the same methodology). component of the farm balance sheet in CIS is highly unreliable, and should not be used for Asset-based debt repayment measures evaluating the indebtedness and repayment capacity of farms. In market economies, the financial health of a firm is evaluated by various financial ratios based In practice, instead of planning for the on the information reported in the firmn's balance repayment of liabilities through liquidation of all sheet and the income statement. A popular assets, including the dubiously valued and highly criterion is the ratio of total liabilities (total debt) illiquid fixed assets, it is more appropriate to to total assets, which shows the ability of the firm focus on liquid assets as the source of funds for to cover the debt by liquidating all its assets. The debt repayment. The ability of a farm to pay off higher this ratio, the less likely it is that its debt from relatively liquid assets is usually liquidation of assets will enable the firm to repay analyzed by financial ratios based on current its entire debt. assets (excluding the fixed asset component of the balance sheet). Figure 2.6: Changes in Real (defalted by CPI) Sales per The ratio of liabilities to current assets is used Farm (1994=100) to assess the capacity of a farm to cover its debt - - - - - - - - - - - - - - - - -- [ from current assets. One of the major components of current assets are inventories, which include inputs, stores of products ready for sale, and unfinished production (e.g., crops in the field). Inventories have to be sold and realized before they become cash, and they are much less liquid than other components of current assets, such as X 9~4 e9 E cash and accounts receivable. A more stringent _4_ ___ __9__ _ __ 7 smeasure of the farms' capacity to repay its debt is -C- Bd.,.=--= == =-Moldo,. -j-R.,m -X-Uk~ therefore the ratio of liabilities to current financial assets, i.e., the most liquid components of current assets excluding all inventories. In CIS countries, the ratio of debt to total assets is not very useful due to difficulties with Repayment of debt from current assets does valuation of assets in general, and fixed assets in not necessarily imply liquidation of the farm, as particular. Because of high inflation rates, the repayment from fixed assets would. Current assets fixed assets are revalued, but the revaluation is are converted into cash and replenished in the based on administratively prescribed "adjustment" course of the farm's daily operations, and in this coefficients, and not true market values. This way they are expected to provide a steady flow of leads to strong upward biases in fixed asset values funds for repayment of obligations. This process in the balance sheet. Anecdotal evidence suggests does not assume any drastic asset restructuring. that the "adjusted" balance-sheet value of fixed assets may be 2-3 times higher than a realistic For the liabilities in the numerator of both market price (TACIS, Farm Insolvency in Russia: ratios based on current assets we can put either Identified Problems and Possible Solutions, total debt or current liabilities only. The Project RF27, Brussels, August 1999). Moreover, alternative calculations produce conceptually the revaluation is carried out repeatedly, but not different ratios - the former measures the systematically every year, and the time lags sufficiency of current assets for the repayment of introduce further distortions in the time series of total liabilities, while the latter only measures asset values. Finally, the farm balance sheet in their sufficiency for the repayment of current Chapter 2: Overview of Farm Debt in CIS: History, Current Level, and Composition 15 liabilities, a subset of total debt. Yet the difference Table 2.7: Asset-Based Financial Ratios for the Average between the two ratios for CIS countries is not Farm Enterprise, 1994-98 very pronounced, because current liabilities 1994 1995 1996 1997 1998 (primarily accounts payable) represent the bulk of A. Current liabilities/Total assets farm debt in CIS (see Table 2.3). Belarus 0.02 0.09 0.07 0.07 0.11 Kazakhstan 0.44 0.44 0.48 0.50 0.59 Various ratios of liabilities to current assets Moldova 0.14 0.19 0.18 0.14 0.20 are calculated in Table 2.7. These ratios have one feature in common: they increased between 1994- Russia 0.14 0.09 0.07 0.10 0.15 98 for all five CIS countries. This essentially Ukraine 0.39 0.16 0.08 0.11 0.13 means that farm debt grew faster than farm B. Total debt/Current assets current assets, and the ability of farms to repay Belarus 0.31 0.44 0.47 0.43 0.45 their liabilities from current assets deteriorated Kazakhstan 1.27 1.39 1.39 1.62 2.18 over time. Moldova 0.85 0.88 1.11 1.09 1.42 Up to 1995, farm current assets in all Russia 0.93 0.82 0.86 0.99 1.22 countries (except Kazakhstan) were sufficient to Ukraine 0.57 0.48 0.65 0.85 1.09 cover not only the current liabilities but actually C. Current liabilities/Current assets the total debt of farm enterprises (Table 2.7, Belarus 0.29 0.43 0.46 0.42 0.39 panels B, C). The situation had changed radically Kazakhstan 2.16 1.84 1.89 1.56 1.98 by 1998: farm current assets were no longer Moldova 0.84 0.84 1.07 1.04 1.18 sufficient to repay the total farm debt in most CIS Russia 0.70 0.64 0.72 0.86 1.09 countries, and even the ratio of current liabilities Ukraine 0.57 0.47 0.65 0.79 0.89 to current assets generally exceeded 1. D. Current liabilities/Current financial assets Belarus 2.13 2.83 3.87 4.23 4.30 Figure 2.7:Current Liabilities to Current Financial Assets Ratio Kazakhstan 7.84 7.79 7.99 4.97 4.74 Moldova 2.37 2.27 2.73 2.65 2.77 7 Russia 3.06 3.08 4.19 4.83 5.10 6 Ukraine 1.52 2.51 3.44 4.12 4.91 E. Accounts receivable/Accounts payable 3 1 / _ . Belarus 0.53 0.42 0.29 0.27 0.23 2 Kazakhstan 0.28 0.22 0.19 0.22 0.21 x_____________________________________ _ . . | Moldova 0.45 0.44 0.36 0.35 0.39 1999 991 1W2 1993 1994 1995 1996 197 Im Russia 0.40 0.35 0.24 0.18 0.15 -O-fld~,,._ u _U M _d, _ -1 -X-lJko.i.e ] Ukraine 0.87 0.41 0.29 0.22 0.18 Table 2.7 also presents the ratio of accounts The deteriorating indebtedness of CIS farmns receivable to accounts payable for the agricultural is strikingly illustrated by the ratio of current sector in the five CIS countries (panel E). The liabilities to current financial assets, i.e., current widening gap between receivables and payables assets excluding inventories (Table 2.7, panel D). during 1994-98 in all countries indicates that the This ratio more than doubled from an average of obligations of agriculture to other sectors of the about 2 in 1994 to about 5 in 1998, and the long- economy, to the government, and to workers are term increase since 1990 was even greater growing faster than the amounts owed to (Figure 2.7). The most liquid component of agriculture by marketers, processors, and other current assets used to be sufficient to cover one buyers of farm products. Receivables offset a half of the current liabilities, or even more. In relatively small portion of payables: 15%-20% in 1998, it covered only 20%. Chapter 2: Overview ofFarm Debt in CIS: History, Current Level, and Composition 16 most countries (with a surprisingly robust 40% in It is naturally net profits, and not gross sales, Moldova). that provide residual cash flows for debt repayment. Unfortunately, the debt to profit ratio Cash-flow based debt repayment measures (Table 2.8, panel B) was negative for all countries (except Belarus) since 1994, because the The ratios presented in Table 2.7 focus on the agricultural sectors in CIS consistently reported "liquidation" approach to debt repayment. They losses each year during this period. This assess the sufficiency of the stock of farm assets essentially means that farms did not generate for the repayment of farm debt. An alternative profits that could be used to repay any debt, approach focuses on cash flows generated from however small. In Belarus, the only country farm sales as a source of repayment capacity. reporting positive farm profits, the ratio of debt to Table 2.8 presents several financial ratios of profit in 1998 was so high (16.3 times the profits) increasing stringency that measure the ability of as to make debt repayment from profits farms to service debt from their cash flows. inconceivable Table 2.8: Cash-Flow Based Financial Ratios for the Adjusting the reported profit for depreciation Average Farm Enterprise, 1994-98 (which is a non-cash expense originally subtracted 1994 1995 1996 1997 1998 from sales revenues to calculate the net profit), we A. Farm debtfarm sales ratio significantly reduce the level of losses. Yet Belarus 0.35 0.30 0.35 0.31 0.42 depreciation is insufficient to produce positive net Kazakhstan 1.50 1.38 1.26 1.42 2.37 cash flows for debt repayment: the ratio of farm Moldova 0.83 0.83 1.14 0.98 1.83 debt to profit adjusted for depreciation remained Russia 0.81 0.87 1.07 1.32 1.65 generally negative in 1998 (Table 2.8, panel C). Ukraine 0.55 0.58 0.87 1.25 1.75 B. Farm debt/profit ratio Net Debt and Repayment with Social Assets Belarus 3.38 2.46 3.99 3.67 16.33 Kazakhstan -19.32 -7.19 -5.75 -4.79 -4.46 Total fann debt is a measure of obligations Moldova 6.52 -0.65 -12.64 -5.30 -3.83 that farms have toward outside entities. Yet Russia -6.21 -27.67 -3.43 -3.73 -4.50 outside entities also owe money to farms, usually for farm products. The obligations of outside entities appear in current assets in the form of C. (profit + annual depreciation)/total debt accounts receivable. Any drastic repayment Belarus 0.51 0.84 0.51 0.74 0.37 strategy would naturally first collect the amounts Kazakhstan -0.05 -0.17 -0.08 -0.15 -0.17 owing from outsiders in accounts receivable and Moldova 0.16 -0.01 -0.04 -0.02 -0.12 then sell the inventories for cash. If the realized Russia 0.19 0.30 0.14 0.00 -0.05 value of current assets is not sufficient to cover Ukraine 0.65 0.35 0.08 -0.05 -0.11 the total debt, additional solutions will need to be found. Net farm debt is calculated by subtracting the The simplest cash-flow measure is the ratio of current assets firom total debt. Table 2.9 (panel A) total debt to sales, which assumes (somewhat shows that up to 1995-96 net farm debt was unrealistically) that all sales proceeds are negative: cunt assets exceeded total farm debt. available for repayment of liabilities. The debt to ne1998,ehowever,tfulleliquidation oftcurrent asset sale rato grw rpidl ove tie (Tble .8, In 1998, however, full liquidation of current assets sales ratio grew rapidly over time (Table 2.8, was no longer sufficient to cover the farmn debt in panel A). In 1994-95, it took less than one year of all countries (except Belarus). The net debt sales to liquidate the entire outstanding debt. In calculations are equivalent to the ratio of debt to 1998, on the other hand, it took between 1.5 and 2 current assets in Table 2.7: if the ratio of debt to years of sales to repay the farm debt for most current assets is gate than 1f the net debt is countries (except Belarus). current assets IS greater than 1, the net debt IS countrles (except Belarus). ~positive. Chapter 2: Overview of Farm Debt in CIS: History, Current Level, and Composition 17 Table 2.9: Net Debt Position of the Average Farm defined component of fixed assets occupies a Enterprise, 1994-98 special place in the rural sector. This is the 1994 1995 1996 1997 1998 component of social assets and social A. (Total debt - Current Assets)/Total debt infrastructure, which for traditional reasons is Belarus -2.25 -1.30 -1.13 -1.32 -1.21 carried on the farm balance sheet. Properly Kazakhstan 0.21 0.28 0.28 0.38 0.54 speaking, social assets are the responsibility of the Moldova -0.17 -0.14 0.10 0.08 0.30 government and should be transferred by the farms to local authorities. The farms, in return, Russia -0.08 -0.22 -0.16 -0.01 0.18 should be credited with the value of the social Ukraine -0.74 -1.09 -0.54 -0.18 0.08 assets transferred to the municipality, and these B. (Total debt - Current Assets - Social Assets)ITotal debt credits can be used to partially offset and reduce Belarus -6.64 -3.13 -3.61 -3.88 -2.34 the outstanding farm debt. Kazakhstan 0.00 0.16 0.18 0.30 0.46 Moldova -0.17 -0.14 -0.82 0.08 0.30 If social assets were included alongside Russia -0.09 _0.19 -0.24 -0.20 -0.14 current assets in the calculation of net debt, agricultural producers in Russia and Ukraine Ukraine -0.82 -1.63 -2.22 -1.13 -0.66 would be able to pay back their entire debt (Table 2.9, panel B). Such procedure of total debt settlement does not seem to be sufficient for the In our analysis of solvency and repayment average farm in Moldova and Kazakhstan, where capacity we consistently focused on current additional asset components need to be factored assets, ignoring the farm fixed assets because of into the debt resolution program. their illiquidity and uncertain value. One well- 3 Major Reasons for Farm Debt Accumulation Technically, farm enterprises accumulate debt deviates too much from the accepted prudent because they do not generate enough profits for standards, the corporation may be unable to meet repayment of liabilities. More substantively, farms its repayment obligations as they fall due and will accumulate debt because their creditors are eventually face bankruptcy, which is a painful willing to continue extending credit - mainly in process for shareholders, managers, and workers the form of spontaneous or involuntary credit alike. Banks limit corporate borrowing, because it (from suppliers and the government), but also as is generally impossible to recover the full amount intentional lending (from banks). We start this of the loans from a failing corporation that goes chapter with a discussion of soft budget into bankruptcy, even if these loans are originally constraints as a factor in farm debt accumulation fully secured and collateralized. The bank itself and lack of profitability. We then analyze in detail usually does not face bankruptcy when one of its the policies and internal organizational factors that normal clients goes bankrupt, but no financial are directly responsible for lack of farm institution likes to report bad loans and collateral profitability, and thus indirectly contribute to losses to its shareholders. Unsecured creditors - accumulation of farm debt in CIS. mainly suppliers - are even more cautious than banks in extending credit to corporations: they do not watch the telltale financial ratios, and instead The Damaging Impact of Soft Budget they simply stop new deliveries (i.e., stop Constraints "lending") when current repayment schedules are not met by the corporation. As noted in Chapter 2, business entities borrow as a matter of course to the extent that The self-imposed restrictions on borrowing their intemally generated funds are insufficient to (by corporations) and lending (by financial meet all financing needs. Debt is typically repaid institutions and commercial creditors) constitute from profits, but corporations do not strive to the mechanism of hard budget constraints, which repay all their debt. Instead, corporations have a is essentially driven by the tangible risks that long-term target level of debt, which they bankruptcy involves for all parties. Since maintain by balancing debt repayment from corporations in market economies operate under profits with new borrowing. Empirical evidence hard budget constraints, debt accumulation is shows that corporations in market economies limited. Since debt accumulation is limited, carefully watch their so-called target capital corporations have to pay attention to their structure, as expressed by the level of debt on the profitability, which is the only guarantee against balance sheet. If new borrowing exceeds inadvertently reaching the borrowing limit and repayment of outstanding debt, the result is debt risking bankruptcy. accumulation, which leads to deviation from the target capital structure and immediately shows in The opposite of hard budget constraints is the increase of debt-related financial ratios, such known as soft budget constraints. This term as liabilities to assets or liabilities to sales. characterizes an environment in which debt is not limited and borrowers enjoy relatively Debt accumulation in market economies is unrestricted access to credit. Soft budget limited by both the borrower and the lender. constraints emerge when corporations can default Corporations self-limit the amount of borrowing on their liabilities, i.e., delay or stop repayments, due to the risk of bankruptcy: if the level of debt without facing a tangible risk of bankruptcy. In Chapter 3: Major Reasons for Farm Debt Accumulation 20 both theory and practice, the elimination of the sustaining a sufficient flow of funds to risk of bankruptcy essentially implies that an agricultural enterprises. The CIS governments outside guarantor takes over the corporate continue to do their utmost to ensure that the liabilities in case of default. Normally, this outside financial state of farm enterprises does not guarantor is the government, which bails out the interfere with the goal of stabilizing production. failing corporation by its policies. The governments pursue the interests of production in a very similar way to that done in The bailout erases the liabilities in default, the Soviet economy, making various adjustments reduces the level of accumulated debt, and to "normalize" the financial state of farm effectively gives the corporation a new lease on enterprises as needed. life by setting the clock back to the pre-default situation. In addition to these direct, explicit CIS governments generally implement effects, the mere possibility of a bailout by the policies that support large farms irrespectively government creates strong psychological of their financial state. These policies include pressures on the creditors to continue lending: debt relief in the form of periodic write-offs, tax there is no motivation for creditors to stop dealing deferments, and debt rescheduling. They also with the corporation if it is implied or understood include various input supply schemes in which that the government will step in and cover the the financing arrangements are driven by obligations in a crunch. production considerations instead of profitability and creditworthiness. The various government All socialist economies in the Soviet era were policies are discussed in detail in Chapter 5. Here characterized by pervasive soft budget constraints, it suffices to state that these policies are typical of his is a typical feature of central planning, when an environment with soft budget constraints, on the one hand the corporations are told what breeding the same lax financial discipline that (and how) to produce, and on the other hand all characterized socialist farms in the pre-reform era. their input needs (including money) are supplied from the center. One of the items on the agenda of The negative behavioral effects of soft budget transition from plan to market accordingly constraints are further reinforced by the virtually stipulated elimination of soft budget constraints total lack of working bankruptcy institutions for and introduction of hard budget constraints. Since farms in CIS, especially in Russia, Ukraine, and soft budget constraints typically go together with Belarus. Farms are offered "credit as needed" '4cost-plus" accounting, which removes all without facing the penalty of bankruptcy for incentives for improving cost efficiency and irresponsible financial behavior. This inevitably increasing profitability, the transition to hard leads to debt accumulation and deprives farmt budget constraints was expected to accomplish a mans o the main incniepfieving shift to relsial.ihrpoisi diint managers of the main incentive for achieving shift to realstically higher profits n addition to profitability, i.e., generating enough funds for stopping debt accumulation. timely and orderly repayment of liabilities. Unfortunately, the transition from soft to hard It may be constructive to conclude this budget constraints is one of the most neglected discussion of the impact of soft budget constraints items of the reform agenda, especially in CIS. with an illustration (admittedly anecdotal, but Formally, central planning has been eliminated in otherwise very meaningful) from Ukraine. One all CIS countries (except Belarus). Yet one of the farm manager in Odessa oblast in southern central goals of agricultural policy in CIS remains Ukraine sympathetically described the fate of the "stabilization of farm production." Since the another farm manager who had made the mistake govermments in the major CIS countries adhere to of paying off his tax debts only to find that that the traditional view that the large farm enterprises debt was written off for other farms in the country are the backbone of agriculture (a view which, shortly afterwards. The lesson of such debt relief incidentally, is no longer supported by empirical is clear. Many farm managers interviewed for this evidence), this goal naturally requires ensuring study stated their confidence that the government supply of inputs for production, or more generally Chapter 3: Major Reasonsfor Farm Debt Accumulation 21 would soon write off their debt obligations. In The macroeconomic changes triggered by the such an atmosphere it is difficult to see why farms transition to market affected the terms of trade for should make strenuous efforts to pay back debt it agriculture, the real exchange rate, and the level of it is eventually to be forgiven anyway. The budget resources available for producer support. financial policies of CIS governments have had We now proceed to discuss the impact of these the effect of convincing farm managers that they factors on the ability of agricultural producers to need only wait and debt forgiveness will be generate profits and pay back loans. forthcoming. This attitude provides a natural behavioral explanation for the accumulation of Changes in Terms of Trade. Price disparity debt and lack of profitability in farm enterprises (higher rate of growth of farm input prices that operate under soft budget constraints. compared to farm output prices), or deteriorating terms of trade for agriculture, is commonly regarded by agricultural economists in CIS as the The Impact of Macroeconomic and Policy most important factor responsible for the declines Factors in profitability and accumulation of debt in the 1990s. In mature market economies, deterioration Two major sets of factors explain the dramatic of terms of trade for agriculture is a natural, long- decline in farm profitability in CIS during the run trend connected with differences in factor 1990s. The first group of factors is related to productivities between agriculture and the rest of changes in the macroeconomic environment the economy. In CIS, terms of trade deteriorated caused by the transition to a market economy. The in the early l990s because price liberalization second' set is associated with the failure of farm produced a much greater upward adjustment of managers to restructure the farms in response to the deeply distorted industrial prices (prices of the changing economic environment, farm inputs) than food prices. Deterioration of terms of trade with farm input suppliers leads to The profitability of any enterprise in a lower profit margins if the agricultural production centrally planned system could be assured by technology (input use) is unchanged. Agricultural adjusting the prices and quantities of outputs and producers in CIS countries do not have the inputs used in production. Price support and input financial resources for radical improvement of the subsidies were accordingly the main policy production technology, but producers can adapt to instruments that governments used before 1990 to changes in terms of trade by adjusting their input maintain a sufficient level of profitability and thus use patterns, i.e., by changing the structure of their reduce debt accumulation. Price liberalization in internal operations. the early 1 990s precluded the use of price controls as a method of delivering subsidies to agricultural The pattern of change in terms of trade in producers. Input subsidies also declined in CIS (Figure 3.1) reflects the abrupt initial importance due to lack of tax revenues to finance adjustment in relative prices for agricultural them. Instead, government credits at subsidized producers in 1990-93. The main reason for a interest rate began to be used as a form of sudden change of such magnitude was the producer support, but the volume of subsidized accumulation of relative price distortions over credits to agriculture also shrank over time for years in the Soviet era. In 1990, a tractor was budgetary reasons. The combination of lower worth 32 tons of wheat in the USSR and 243 tons govemment support with inability or in the USA, a ton of fertilizer was worth 0.2 tons unwillingness of farm mangers to adjust to market of wheat in the USSR and 1.5 tons of wheat in the conditions has resulted in lack of profitability, USA, and a ton of diesel fuel was worth 0.7 and which in turn has led to accumulation of debt. 2.2 tons of wheat in the USSR and the USA, Debt writeoffs remained as the major instrument respectively. The need for major adjustment in to combat debt accumulation, and this in itself relative prices had become obvious by 1992, when carried a substantial indirect subsidy component prices of manufactured goods were liberalized in to farm enterprises. Russia. Despite the resistance of agricultural Chapter 3: Major Reasons for Farm Debt Accumulation 22 interests, prices had been liberalized by the mid- two-three years of transition, and the real 1990s in all CIS countries (except Belarus). exchange rates remained relatively stable after Figure 3.1: Terms of Trade in Agriculture 1994. In the CIS countries, real exchange rate (Index of prices received by agricultural producers appreciation continued until 1998. Between 1995- to pnces of manufactured inputs, 1990=1) 1.2 98, the natonal currencies of Russia, Ukraine, Belarus, and Kazakhstan appreciated in real terms 1.0 -- - by 100%, 60%, 40%, and 30%, respectively. The 0.8 - _ appreciation of national currencies in CIS has led 0.6- _ t ______ __ . _ 0 to a decline in both domestic and international ____ ____ competitiveness of local agricultural producers. O.: Foreign competition has increased and revenue- 0.2- _ __ > generating opportunities in domestic markets have 0.0 shrunk. 1990 1991 1992 1993 1994 1995 1996 1997 1998 Belarus -Russia -O-Ukraine -=Modova The negative impact of overvalued national currency on farm profitability is illustrated by the The initial sharp adjustment of relative prices outcomes of the 1998 devaluation of the Russian reduced the terms of trade index in CIS to about ruble, which produced a ripple effect among other 20% of its 1990 level. The terms of trade for national currencies in CIS. In 1998, the real agriculture stabilized after 1993 (Figure 3.1), but exchange rate of the Russian ruble was halved, the the relative prices received by agriculture Ukrainian hrivna depreciated by more than 60%, producers remain far from their pre-reform level, and the Kazakhstan tenge lost 15% of its value. The current relative prices of inputs and outputs Devaluation of national currency usually are close to world levels, and any attempt at price encourages consumers to substitute domestically correction for the purpose of restoring price parity produced commodities for imports. There is some between agriculture and other sectors, which is evidence that new domestic marketing often advocated in CIS as a solution to the opportunities are opening for agricultural interlinked problems of low farm profitability and producers in CIS. Following the devaluation of farm debt accumulation, will create new price the ruble, the percentage of profitable farms in distortions and lead to unrealistically high levels Russia increased from 12% in 1998 to 41% in of govemment expenditure on agricultural support 1999, despite bad weather conditions. A similar programs. change in farm profitability was observed in Kazakhstan, where the domestic currency was Real Exchange Rate Appreciation. During also allowed to adjust to equilibrium (Figure 3.2). the 1990s, the real exchange rates appreciated for Figure 3.2: Share of Unprofitable Farms in Total all transition economies, but at a different pace'. Number of Farms In Central and Eastem Europe, real appreciation of the national currencies occurred in the first . _ The discussion is based on data from the following . ' v j_ IMF reports: Republic of Belarus: Recent Economic Developments, IMF Staff Country Report No. 99/143, BI X c_ Nov. 1999 (Fig. 10, p. 35); Republic of Kazakhstan: 1aru n _ se Selected Issues and Statistical Appendix, IMF Staff ue999| Country Report No. 99/29, March 2000 (Fig. 23, p. 75); Russian Federation--Recent Economic In Ukraine, the effect of devaluation on the Developments, IMF Staff Country Report No. 99/100, number of unprofitable farms was much less Sept. 1999 (Fig. 5, p. 14); Ukraine: Recent Economic pronounced, apparently because of significant Developments, IMF Staff Country Report No. 99/42, pronounced, any becuse of ican May 1999 (Fig. 11 p. 51). deficences in many other agricultural policies. In May ~~~~~~~~~Belarus, on the other hand, the number of Chapter 3: Major Reasons for Farm Debt Accumulation 23 unprofitable farms actually increased in 1999, policy decisions, including setting producer because the Belarusian ruble remains heavily subsidies, has shifted from to regional overvalued and the government insists on governments. Regional governments in Russia are introducing new price controls instead of currently responsible for more than half the liberalizing the economy. subsidies to agricultural producers. In Ukraine, the regional governments have recently been Lower Level of Producer Support. The entrusted with the authority to collect the debt of goals of macroeconomic stabilization prompted farm enterprises to the state. These developments reduction of government subsidies, price supports, endow regional governments with leverage for and producer grants2. Direct price and product enforcing their own priorities in agriculture and subsidies were mostly abolished already during strengthen their role in agricultural policymaking. the early years of reform, with obvious negative While central governments have abandoned direct impacts on farm profitability. Subsidized intervention in farm production, regional government credit became the major form of governments continue to influence production and producer support, but eventually the inflationary marketing decisions of farm managers through effects of subsidized credit programs brought administrative trade restrictions, state orders, and about severe cuts in the amount of new de-facto planning of the herd size. Pressures for government credit available to agriculture. As a regional self-sufficiency and the goal of result, government expenditure on agriculture as a maintaining full employment in the region force percent of GDP declined in all countries, except farm enterprises to continue the production of Belarus (Figure 3.3). unprofitable commodities and drive them deeper into losses. Figure 3.3: Government Expenditures on Agriculture (% of GDP) ____ Government intervention not only affects profitability, but also contributes directly to debt 3- -- ,__ _accumulation and thus sets the stage for future K azak writeoffs. The penalties for overdue taxes and \Russam deductions to non-budgetary funds (social l -_ ___ ___ security, unemployment, health insurance) are . _ _______________ ~draconian. In Russia, these penalties are 0.3% of 1WS 1996 1997 191 the overdue amount per day (1% before 1996). Penalties for deductions to social funds continue to be assessed on a daily basis even if the farm has The cuts in direct and indirect government not paid the wages due to lack of liquidity. As a support came at a time when the banking sector result, the share of penalties in total overdue debt focused its attention almost entirely on investment is up to 30% for social security payments and up in high-yield government bonds and practically to 50% for payments to other non-budgetary abandoned lending to the real economy. These funds. The penalty component of farm debt changes in fiscal policy forced farm enterprises to requires periodic attention as part of debt relief look for alternative sources of credit to finance measures. working capital, and they began to resort in an increasing degree to commercial credit and arrears A common way of dealing with overdue taxes to the government (see Chapter 2). and social deductions in CIS involves blocking or freezing of bank accounts almost immediately Government Intervention. Simultaneously when a farm misses its payments to the with the decline in the level of support to government. All moneys subsequently paid into agriculture from the central government budget in the blocked account are automatically used in the 1990s, the authority to make agricultural settlement of farm liabilities for taxes or social funds. Banks are thus forced to act as tax 2 For a detailed analysis of fiscal policy issues see the collectors for the government. These measures IMF reports listed in footnote 1. naturally encourage farms to shift to various Chapter 3: Major Reasons for Farm Debt Accumulation 24 barter or in-kind transactions in an attempt to as a guarantor of food self-sufficiency and full avoid the banking system. They also motivate a rural employment. The political-economic view of variety of opaque transactions that involve flows regional governments is that large farm of inputs and products between farm enterprises enterprises must survive with government support, and household plots without generating any cash. and this view naturally eliminates most of the High penalties for tax arrears and administrative incentives for managers to restructure their farmns. arrest of bank accounts certainly contribute to the It is easier to live in harmony with regional demonetization of farm transactions, which reduce authorities by doing what is expected and required the cashflows available to farms and thus lead to a rather than risk conflict and friction by adopting vicious circle of debt accumulation. an independent strategy for internal restructuring. The failure of farm enterprises to restructure The Impact of Farm-Level Factors their operations in response to changes in the macroeconomic environment accelerated the Farn profitability, and with it the ability for general decline in the ability of farms to generate debt repayment, have been hit hard by the profits. The number of non-profitable farms macroeconomic and policy changes during increased dramatically during the 1990s (Figure transition. In a market environment, farms would 3.4), and almost 90% of all farms in Russia, respond to such changes by adjusting their Moldova and Kazakhstan were unprofitable in product mix and their cost structure so as to 1998. Unwillingness or inability to change the restore profitability and continue normal cost structure and the product mix led to the operation. In transition economies, farms were unpleasant situation whereby, after 1994-95, each expected to undergo deep internal restructuring, unit of sales generated losses, which furthermore replacing the command economy attributes of grew over time (Figure 3.5). their operations with market-oriented attributes. Such restructuring would improve the efficiency Figure3.4:PercentageofUnpmfltableFari Enteprses and productivity of former socialist farms and l Fte enable them to cope successfully with the changes in the macroeconomic and policy environment. so 70 60 So far, farm enterprises in CIS have largely so 40 failed to restructure in line with market principles. 30 They remain unmanageably large, controlling 20 (with very low efficiency) thousands of hectares I of land and employing hundreds of workers. They 199 11 1M 1993 m194 19 1996 197 199I continue to be committed to a policy of lifetime F-o---_Kk a-Mold --Rus.- ._-*-Uki employment and do not adjust their labor force in response to changing costs. They continue to maintain unprofitable activities in their product - mix. They continue to focus on production instead u gue 3.5: Profi*t-to-Ses-Ratio of marketing objectives, and follow inherently M wasteful "cost-plus" accounting instead of profit- 0,2 oriented accounting. They remain responsible for _ maintaining the rural social infrastructure and for v 9w92 1993 supporting the production on their employee 4 household plots. v The persistence of these traditional _ --- ---i u- . command-economy features is attributable largely ___ to pressures applied by regional governments, which continue to view the large farm enterprises Chapter 3: Major Reasonsfor Farm Debt Accumulation 25 Table 3.1 shows the factors underlying low or The attitude toward livestock production is an negative profitability of the farming sector in CIS. example of the farms' failure to adjust their product mix toward more profitable commodities. * The share of output sold in total gross output While crop production has been generally is declining. This implies that less cash profitable, livestock production has been revenue is generated per unit of production unprofitable since 1992 (Figure 3.6). Yet and more of the output is used for internal agricultural producers in Belarus, Russia, and needs, consumption, and possibly barter. Ukraine have not made any significant * The efficiency with which assets are adjustments toward reducing the share of non- employed to generate sales (the sales-to- profitable commodities in their product mix current assets ratio in Table 3.1) is declining (Figure 3.7). Losses from livestock production over time for Russia, Moldova, and Ukraine. are offset with profits from crop production by a * Beginning from 1996, the value of sales was traditional mechanism of intemal cross- not enough to cover current liabilities of the subsidization, which is encouraged by local average farm in all countries, except in policies emphasizing preservation of the livestock Belarus. herd. * Since 1995-96, cost of goods sold exceeded IU1r-e3.6:TheRatio of ProfitLmsin livestock Prodtion to Total Sales sales revenue, and each additional unit of sales generated only increasing losses in all 04 CIS countries (except Belarus, but even here . 3 the profit rate in 1998 was a negligible 3% of i.2- sales). ,- Table 3.1 Major indicators of sales performance and debt 1994 1995 1996 1997 1998 Sales in percent of gross agricultural output AZ' Belarus 72 76 75 74 70 \0,/ Kazakhstan 59 84 79 61 71 Moldova 89 80 78 75 54 _0_4,J_ Russia 46 56 44 48 51 r- -Bel. _ Kazakh. . .1I - Rjs.-K-Ukr Ukraine 67 51 51 54 53 --- Sales-to-current assets _ _- Belarus 0.87 1.45 1.36 1.39 1.08 Xgure3.7: Share of Costs in Livestock Producdon in Total Costs Kazakhstan 0.84 1.00 1.11 1.14 0.92 Moldova 1.02 1.05 0.98 1.12 0.78 6 r Russia 1.14 0.94 0.80 0.75 0.74 a I Ukraine 1.68 1.01 0.92 0.84 0.76 5I Cost of goods sold per unit of sales M \ Belarus 0.90 0.88 0.91 0.92 0.97 4S Kazakhstan 1.08 1.19 1.22 1.30 1.53 4 Moldova 0.89 1.03 1.09 1.09 1.19 M_ Russia 1.13 1.03 1.30 1.34 1.36 3 Ukraine 0.54 0.78 1.00 1.13 1.25 __ Labor cost per unit of sales 19" 199, im LS S9 19X 1io Belarus 0.21 0.27 0.26 0.21 0.25 L -Bei -.Rki d -* R"-Ukr Kazakhstan 0.36 0.29 0.25 0.31 0.34 Moldova 0.44 0.38 0.35 0.29 0.33 Russia 0.55 0.36 0.38 0.37 0.35 Two additional factors inherited from the Ukraine 0.34 0.35 0.41 0.45 0.47 command economy are generally regarded as effectively reducing the level of farm profits. * Labor costs per unit of sales are generally These factors are maintenance of rural social declining. This, however, is primarily a infrastructure and support of the production reflection of the faster increase in the cost of activity of household plots. Expenditures on social industrially manufactured inputs, and not the infrastructure are included into production costs of result of a decreasing labor force. typical farm enterprise and may lead to lower Chapter 3: Major Reasonsfor Farm Debt Accumulation 26 profitability. The decision to transfer the enterprise. Yet these services must continue to be responsibility for social assets to local extended in the present environment, as without governments was made in most CIS countries in them a large segment of the rural population the mid-1990s. These decisions have not been would be unable to survive. implemented, however, due to insufficient budgets in local communities. On the other hand, As with the cost of social services, there has the compensation that farms receive from the been no serious research to determine the cost of central government for social infrastructure support services to household services that farrn maintenance has decreased. In Russia, only 10% enterprises absorb. It would be interesting to try to of the actual expenses on provision of social construct a "consolidated" profit-and-loss services is reimbursed from the budget. There are statement of a farm enterprise with the household no reliable estimates of the share of social plots of its employees. Such a profit-and-loss infrastructure costs in total farm costs. The statement may turn out to be much healthier problem is probably less serious than is generally looking than the profit-and-loss statement of the believed, because the overall level of social farm enterprise alone. It could be argued that the expenditures is declining over time (see Chapter relationship between the farm enterprise and the 4). household plots is a case of spontaneous "privatization" of the resources of the farm There has always been a traditional symbiosis enterprises. The household plots reap the profits, between the farm enterprise and the household while the farm enterprise is left with the losses. plots of its employees. To this day, farm managers provide a range of support services to household Regardless of actual costs, farms' plots, which include use of farm machinery and responsibility for social infrastructure and for provision of farm inputs, such as animal feed, support services to household plots is a clear seeds, fertilizer, and fuel. Farm managers often example of inherited features that should have assume the responsibility for collecting, trucking, disappeared in the process of genuine farm and selling the products from household plots, be restructuring. These features persist because of it milk, meat, vegetables, or grain. These services political and social pressures, and in principle are provided at subsidized prices, or sometimes their impact on farm performance, profitability, even free of charge, which obviously has a and debt accumulation should not be ignored. negative effect on the profitability of the farm 4 Social Implications of Farm Debt The social implications of farm debt for the Moldova and Ukraine. In these two countries, rural population should be considered on two farm enterprises are respectively 4 and 7 months levels. The first, immediate level concerns the behind with salary payments to their employees. ability of indebted farm enterprises to continue In Kazakhstan, farm employees go unpaid "only" fulfilling their obligations toward their employees for 2 months. In Russia and Belarus wage arrears and the rest of the rural population. These are at a level of about one month, but the situation obligations include payment of salaries, as well as in Russia shows a serious deterioration: from provision of social services and maintenance of about one week in 1994 to nearly four weeks in social infrastructure, which traditionally has been 1998. the responsibility of the local farm enterprise in each village. The second, more indirect level Table 4.1. Number of Days that Wages are in Arrears concerns the rights of the rural population in any 1994 1995 1996 1997 1998 procedure that attempts to liquidate and Belarus 58 41 28 30 33 restructure the indebted farms, be it formal court- driven bankruptcy or any out-of-court debt Kazakhstan 147 123 119 91 64 settlement program. Moldova 84 76 87 98 124 Russia 6 10 13 19 24 This chapter starts with an examination of the Ukraine 7 8 122 170 232 direct impacts of farm debt on the welfare of the rural population and continues with some thoughts The growth in farm debt has led to increased on their rights during liquidation and inability of farm management to pay wages to restructuring. The chapter ends with a summary of their workers on time and in full. Although wage farm-level interviews in four of the five countries .. . . . ~~~~~~~arrears have remained relatively constant as a participating in this study. share of accounts payable since 1994, the overall increase of farm debt has naturally pushed their absolute value up. In most ClS countries The Impact of Farm Debt Accumulation on articiatni thi study, wav arrears Wages and Social Deductions participating in this study, wave arrears have reached absolute levels that are certainly Wage arrears are a relatively minor uncomfortable for the employees. component of farm debt, reaching about 10% of The real increase in wage arrears has been total short-term liabilities (accounts payable) of accompanied by an increase in arrears to social farm enterprises (see Table 2.4). This measure, funds, which include deductions on behalf of however, does not reflect the importance of wage employees to social security, medical insurance, arrears importance for individuals who are forced and the unemployment fund. In Moldova and by the farm enterprise to wait for the monthly Ukraine, every dollar increase in farm debt salaries. An appropriate indicator of the burden of between 1994-98 added 10-20 cents to arrears in delayed wages for employees is the number of social deductions (Figure 4.1). In Russia, every days that their expected wages are in arrears dollar increase in farm debt resulted in an increase (Table 4.1). This indicator, calculated as the ratio oflas mcheas 70 cent resuto m an in r s s r s s .s ~~~~~~of as much as 70 cents in arrears to social funds in of the volume of wage arrears to the daily payroll this period. or wage expense, has reached alarming levels in 27 28 Farm Debt in the CIS Fpme 4.1: oeme in Wae and Sda Fhmd Arn per Unit Cbange In Fann De In 1994-98 (cents per dolar) Table 4.2 presents some data on the 70 efficiency of collection of taxes and social o0 ideductions from farm enterprises. The collection efficiency for social deductions in 1998 reached a healthy 90% in Moldova and Belarus, but was 40 lvery low in Ukraine, Russia, and Kazakhstan. The 301 low compliance with the legally required social deductions also explains the increase in the level of arrears to social funds in these countries. e0 lu= _ l l _ .Arrears of farm enterprises to social funds do not Ida= MMdm Ulffjim PAMb jeopardize the cash flows to individuals in the saw R.& _n _short run, but they certainly endanger the viability . _ _ _ _, of the national system of social payments in the longer run. The main increase in the real value of arrears to social funds occurred between 1994-96 (Figure Table 4.2: Collection Efficiency from Farm Enterprises: 4.2). By 1998, the situation was under control in Actual Collection of Taxes and Social Deductions in most countries in the sense that the real level of Percent of Assessed Obligations arrears to social funds had returned to the 1994 Social deductions Taxes level. Both the increase and the subsequent 1994 1998 1994 1998 decrease in social fund arrears were largely the Belarus 81 91 83 91 result of government policies. The process started Kazakhstan 50 17 48 53 because farms allowed themselves to build up arrears to social funds (and wage arrears) as part Moldova 32 94 36 84 of the overall accumulation of debt. The Russia 65 30 99 28 governments responded to this component of debt Ukraine 62 39 79 54 accumulation by imposing draconian daily penalties, which drove the real value of social Increasing wage arrears and low compliance fund arrears up by 50% or more. When it became with social deductions are just one symptom of a clear in 1996 that the farm enterprises would generally decreasing attention to the social sphere. never be able to repay the arrears with the While farm enterprises are fighting for physical penalties, the governments rescheduled the arrears survival against a background of declining and waived most of the penalties. A semblance of production, lack of profits, and accumulating debt, normalcy was restored to the system at the cost of they are forced to reduce the level of social completely destroying the managers' incentives to benefits and services to their employees and the keep social fund arrears under control in the future rest of the rural population. Data for Russia show (not to mention the immediate fiscal cost to the that real expenditures of farm enterprises on social budget). services are negatively correlated with changes in .7-- Rga42.Uunun i - - - - _________ - Fig-4-Omo"RealValue(dollaldCPI)ofhMiut A-ui Flowa 4.3 Rbm. Real 'V 1fftmk sai Soad P*afn1m lo to&mDi Furmis(1994=100) FnmMs(19940 _ - L.- an 612 7- o-- R- s---- -- - -*-U_m. so 199 1999 1996 1997 1996 95 196 17 19 Chapter 4. Social Implications of Farm Debt 29 real farm debt (Figure 4.3). The real value of The decline in resources available for social farm debt in Russia almost doubled between services and benefits on the farm level has 1994-98, while social expenditures declined by naturally led to a decrease in the number of 80%. workers employed by the farm enterprise in social services. As a result, the number of farm workers A different view of the negative correlation "served" by one "social worker" increased sharply between the level of debt and the expenditure on between 1990-98 (Figure 4.6). This is a positive social services and benefits in Russia is presented effect from the point of view of overall in Figure 4.4. Here, the farm-level social productivity of labor in farm enterprises, which expenditures are expressed as the ratio of the total has been always advocated by market-oriented cost of social services and benefits bome by the experts. Yet we have to realize that the rural farmn enterprise to its wage bill. This ratio in effect population is now enjoying a much lower level of shows how much social services provided by the social services and benefits than in the past. farm enterprises add to the wages of the average worker. The relative benefits that farm members r - -- derive from farm-provided social services decline 6C Nnbi rpwSo d ntFa over time as the level of debt increases. A similar s pattern of declining social benefits is observed 1 also for Ukraine and Belarus (Figure 4.5). 1 Incidentally, this pattern suggests that the social l expenditures of farm enterprises cannot be held responsible in any measurable degree for the accumulation of farm debt, although in principle 30 they of course act to lower fann profits. 2l Figure 44: Ruis: Fim Debt Cm billuib US dRllm r scale) _D 1991 1992 19_9 1955 1996 1997 191 (P -% -e 1 U - 25 Legal Rights and Liabilities of Farm Members 12 20 in the Context of the Farm Debt Problem I WWW \ \EThe legal framework for land reform and farm I 6 7 \ 10 rd restructuring in CIS designates the members of 4 v - . 5 ___._ . the former collective farm as the owners of land l -4---- -Y}--------t+- --- - and other farm assets. These resources are ! 19 two IM a,s 19a 1"S 19W6 197 19m distributed to individuals in the form of shares, ! _ _ _- _ _ _ ~ ------ _________J which entitle them to fractional ownership in accordance with clear allocation rules. Since land 1 w4 S96 F*nb%oflm%*d does not have a balance sbeet value in CIS, it is ! l allocated to farm members regardless of the is ----- outstanding debt of the farm enterprise. Non-land 16 _ __ _ ___ assets, on the other hand, are assigned to 14 z \ \ - ------- -_--__. .__- individual shares net of outstanding debt. In those 12 - --- ------- -- relatively infrequent cases when the accumulated e0 _ |\\ \ __ _ _ _!77Fdebt of the farm enterprise exceeds its total assets, 8 --_ - 5E __- r:-__ t I 6 ----- . members do not get any asset shares, but they are 4 ------- - -- still entitled to share ownership of land. In the [ 2 - -majority of cases, individuals receive both land jI4 19%I'M 1991 191 1914 19 1997 1998 and asset shares, although their entitlement to 30 Farm Debt in the CIS assets may be severely reduced by the outstanding population is exposed by the indebtedness of farm farm debt. enterprises in the absence of clear property rights in land and assets. In Kazakhstan, the land and The effect of farm debt on the entitlement to asset shares distributed to individuals become part productive assets deters individuals from taking of the asset pool available for liquidation when a advantage of the opportunity to exit the collective farm enterprise goes into bankruptcy. Moreover, and establish an independent private farm. The the members of a production cooperative (a asset share that remains net of farm debt may former collective farm) bear unlimited liability for simply be insufficient for starting a new operation the debts of the farm enterprise. The list of outside the collectivist framework. In addition to personal property protected from bankruptcy this physical factor, there is a psychological proceedings in a farm enterprise includes the deterrent associated with the uncertainty regarding house, one cow, one horse, and a limited list of protection from potential claims by creditors of essential personal belongings. To avoid being the former collective farm. Commercial creditors stripped of all property in farm bankruptcy do not necessarily distinguish between the large proceedings, individuals can take their land and farm enterprise, which is the legal debtor, and the asset shares out of the production cooperative and new private farms or other entities carved out with lease them to a limited liability partnership, where net assets. There is no legal way for the leased assets are not subject to bankruptcy sale. commercial creditors to seize the assets of an Although originally recommended in good faith independent private farmer in repayment of farm by local experts, this option has been hopelessly enterprise debt, but there is the danger that the abused in Kazakhstan by unscrupulous farm former collective farm member will be tainted as managers, who register a limited liability uncreditworthy by association. As a result, partnership, entice cooperative members to lease commercial suppliers may refuse to deliver inputs their land and asset shares to the new entity and services on credit to the new private farmers, (which effectively means to the manager just as they refuse credit to the defaulting farm personally), and then exploit their inexperience to enterprise that the private farmers have left. This cheat them out of their legal rights and dispossess is naturally a serious impediment to normal them of all property by a combination of real and operation of independent farmers. imaginary threats. Because of these and many other factors, the While Kazakhstan is certainly an extreme individual shareowners do not withdraw their case without a parallel in CIS, it is an example of shares of land and assets from the farm enterprise how the rural population can be affected by farm and leave the resources in joint use, under the debt and impending bankruptcy proceedings as corporate management of the farm enterprise. The long as the property rights of the members in farm property rights to land and assets that remain in enterprises are not explicitly protected. The only joint use of the farm enterprise are extremely way to ensure protection of individual property opaque and uncertain. There is absolutely no rights is by withdrawing the assets in physical guarantee that these assets will not be seized by form from the farn enterprise for individual use creditors, even though legally they are private or by issuing legally binding and universally property of individuals, and are not owned by the recognized title documents to individual farm enterprise. When bailiffs arrive with a court shareowners (as is the current practice in order to seize a tractor or a cow, they do not Moldova). inspect the legal ownership of each asset as recorded in some sort of a share register in the The experience in Kazakhstan and less manager's office: they usually seize the tractor or extreme lessons from other CIS countries strongly the cow as if it were the property of the indebted suggest that any debt settlement program must farm enterprise. ensure, at the ground level, the basic rights of the rural population to land and other assets in farm The case of Kazakhstan provides an extreme enterprises. It should be recognized that the farm illustration of the dangers to which the rural assets were accumulated over the years by the Chapter 4. Social Implications of Farm Debt 31 labor and efforts of the members and that farm force managers to resort to payment of wages in debt, in turn, was accumulated due to the kind. There appears to be a negative correlation incompetence of the management and the between the practice of using farm products to pay irresponsible policies of the government. The wages in kind and the practice of selling farm attempts to resolve the debt overhang from the products to the members: the two courses of past should not penalize the farm members. Their action seem to be mutually complementary. entitlement to a share of land and productive There is no clear pattern concerning the effect of assets must remain inviolate and outside any farm debt on managers' labor policy: neither the bankruptcy proceedings. Deviation from this low-debt nor the high-debt farm has plans to fundamental prescription will inevitably lead to a change its labor force in the near future. social disaster, which will probably prove to be much more expensive than any alternative debt Kazakhstan. Five farms were interviewed, settlement program. three in the northern part of the country and two in the south. One farm was characterized as having a low level of debt, one as a medium-debt farm, and Evidence of the Social Impact of Farm Debt three as high-debt farms. The results of the from Farm-Level Interviews interviews with the farm managers are summarized in Table A4.2 (Appendix A). The national-level statistical data used in this study were supplemented with a limited number All farms irrespective of the level of debt had of farm-level case studies. Several farms arrears to social funds. The low-debt farm was the representing various levels of indebtedness were only one that had managed to reduce the level of selected by the counterparts in each country, and its liabilities to social funds; in all other farms, the farm managers were then interviewed with the level of social fund arrears increased over time. purpose of identifying the major factors The low-debt farm was also the only one without responsible for farm debt accumulation. This wage arrears. In high-debt farms, wages had not section summarizes the results of these interviews been paid for 5-6 months. Farms with low and with respect to the social consequences of the medium levels of debt manage to pay higher farm debt problem. wages than the most indebted farms. There is no clear relationship between the level of debt and Belarus. Three farm enterprises were chosen the share of wages paid in kind, although the farm from the same district (Goretsky raion, Mogilev with the lowest level of debt also reported the oblast) for case studies. Although the three farms lowest level of in-kind wages. Curiously, all farms operated under similar natural conditions, they participating in the study expected increases of had different levels of debt: low (Gory), medium 10%-15% in their labor force in the near future. (Goretsky), and high (Pogodina). Table A4.1 in Appendix A presents the responses of the Russia. Six farms were surveyed in three managers to questions about social conditions on oblasts: in central Moscow and Orel in the center their farms. and Rostov in the south. Of the six farms, two had low levels of debt, one a medium level of debt, The farms with high and medium debt levels and three a high level of debt. The results are (Pogodina and Goretsky) reported arrears to the summarized in Table A4.3 (Appendix A). social funds, which were increasing over time. for these farms. The high-debt farm (Pogodina) also Most farms had arrears to social funds and the reported wages three months in arrears. The low- share of these arrears in total debt reached 30%- debt farm (Gory) farm did not have any social 65%, presumably because of the high component deduction or wage arrears, and paid all wages in of penalties added daily to accounts in arrears. cash. The share of wages paid in kind increased The high-debt farms reported wage arrears (and with the level of indebtedness: 5% in the medium- also payment of wages in kind), whereas the low- debt farm and 20% in the high-debt farm. Higher debt farms paid their workers on time. Managers debt levels obviously lead to cash shortages and of low- and medium-debt farms are planning to 32 Farm Debt in the CIS cut the labor force by half in the next five years. Maintaining full employment is still a major No comparable information was reported by the goal for many farm managers in Ukraine. Almost high-debt farms. two-thirds of managers (57% of profitable farms and 63% of unprofitable farms) report job Ukraine. The interviews covered 15 farms in preservation as a reason for continuing to produce five oblasts across the country. The farms were unprofitable commodities. Ukrainian managers subdivided into two categories: seven profitable are very conservative in their evaluation of farms and eight unprofitable farms. Although the possible solutions for the farm debt problem. value of current liabilities was practically the None of the managers of unprofitable farms same in farms of both groups, the structure of debt considered the use of land as collateral or the was different. Profitable farms had lower introduction of strict bankruptcy procedures as liabilities to social funds (18% of accounts desirable solutions. Support for these radical payable for profitable farms compared with 14% measures was also very weak among the for unprofitable farms). Almost two-thirds of managers of profitable farms: only 29% indicated unprofitable farms reported that the tax and social that land should be used as collateral, and only fund debt had increased in the last five years, 12% favored application of bankruptcy while more than two-thirds of profitable enterprise procedures. reported that this debt component had declined. Overall, the results of the case studies suggest Profitable farms had lower wage arrears (4% that farms with lower level of debt usually do not of total debt compared with 14% for unprofitable have wage and tax arrears. These farms pay their farms). Only two of seven profitable farms had workers on time and mostly in cash. There is no not paid wages for two months. For three-quarters clear pattern of future labor-force decisions of unprofitable farms wage arrears increased in among farms with different levels of debt. The the last few years; 75% had arrears of more that results of the case studies are not generalizable two months, of which 25% had arrears of more because of the very small sample size. Yet the than a year. Profitable enterprises were more impact of farm debt on social conditions emerging likely to pay their workers in cash than in kind: from the case studies is consistent with the the profitable farms paid at least 75% of wages in previous conclusions obtained from the analysis cash. Among the unprofitable farms, at least two- of aggregate data. thirds of the wages were paid in kind. 5 Country Initiatives for Resolution of Farm Debt Under central planning, before 1991, farm managers are still convinced that high costs, low debt was treated as a purely technical matter of profits, and debt accumulation are caused mainly redistributing financial resources between by unfavorable natural and climatic conditions, agriculture and the rest of the economy. This not by internal inefficiencies, and that their farms approach made sense, because enterprises did not should be subsidized to mitigate these effects. have financial independence: the state controlled Given past experience, most farm managers still the supply of inputs, production, and sales in all believe that their farm debt eventually will be enterprises, acting as creditor and debtor at the written off. Increasing the level of government same time. Mutual offsets between state- support is the most popular prescription that farm controlled enterprises in agriculture and other managers suggest for dealing with farm debt. sectors were the most common form of debt settlement. Procurement prices were adjusted periodically in an effort to ensure a certain level Major Policy Instruments for Farm Debt of reported profitability. Remaining losses were Resolution erased by paying farms extra subsidies to compensate for so-called unfavorable natural The policy instruments for dealing with farm conditions. Centralized investment funds were debt that governments used in the past and channeled to non-profitable farms to improve their continue using today fall into three broad capital assets in an attempt to increase categories: profitability-enhancing options, debt- profitability. Chronically non-profitable collective elimination options, and reorganization options. farms were often transformed into state farms and The menu of major options includes granted extra support through infusion of equity capital and state-financed investments. State- a) Price support and input subsidies directed changes in managerial personnel to b) Subsidized government credit and commodity improve farm performance were also common. credit However, these measures generally failed to c) Debt write-offs increase profits and reduce debt accumulation, d) Debt rescheduling and the government periodically (every five years e) Inter-enterprise offsets and barter transactions or so) resorted to debt write-offs for farm to settle claims enterprises. f) Financial rehabilitation through farm reorganization Most of these direct state interventions and g) Bankruptcy and liquidation subsidies have been abolished or significantly reduced since 1991 in CIS (with the except ion of The first five instruments on this list (a to e) Belarus). Yet policymakers in CIS continue to are inherited from the Soviet era. They were advocate similar measures as a way of resolving traditionally practiced in the centralized command the current farm debt problem. Some local economy and, despite their acknowledged failure governments propose to convert non-profitable in the past, remained an active part of the policy farm enterprises into farms in municipal menu during the transition. Farm reorganization ownership, which is equivalent to the former as a tool of financial rehabilitation (item f) was practice of converting non-profitable collective also practiced in various forms in the pre- farms into state farms. The goal of farm enterprise transition period, when non-profitable collectives managers remains production at all costs. Many were converted into state farms or merged with 33 34 Farm Debt in the CIS relatively profitable entities. Today farm accordingly shifted to various forms of farm reorganization has much broader implications reorganization, including mergers with solvent given the new organizational options in enterprises and financial rehabilitation procedures. agriculture. Only the last item on the list - A certain readiness to invoke bankruptcy bankruptcy and liquidation - is a completely new procedures for chronically insolvent fartn option: it is based on recent laws and procedures enterprises began to emerge in the late 1990s. that introduced previously unrecognized concepts into the legal vocabulary of CIS countries. The shifts in the relative importance of policy instruments that have been applied in the 1990s to The relative importance of the various policy deal with farm debt shows a progression from instruments has been changing in the course of reliance on profit-enhancing measures (in the transition. Tables A5.1-A.5.5 in Appendix A form of price support, input subsidies, tax breaks, provide detailed information about types of policy cheap credits) at the beginning of the transition, to instruments that have been used to deal with farm debt write-offs, inter-enterprise offsets, and debt debt in each country since 1992. Subsidies and rescheduling schemes in the mid-1990s, and price support measures, which were the basic finally to the recognition that the source of the instruments for maintaining farm profitability in debt problem is organizational: the collective the centralized market economy, have been organization of production in farm enterprises declining in importance over time, mostly due to does not encourage financial responsibility and is lack of budget resources to sustain agricultural inherently inefficient, leading to low profits and support programs at pre-reform levels. Subsidized debt accumulation. government credit had been used as an indirect instrument of delivering producer subsidies during Each of the five countries participating in this the early and the mid-1990s, but its importance study used different sets of instruments at declined at the end of the decade, also due to lack particular points in time, but nowhere in the menu of budget resources. of policy options do we find a prescription for hard budget constraints. Yet international In the second half of the 1990s, farm debt had experience clearly shows that hard budget reached a level that was judged to be constraints imposing a strict financial discipline unsustainable and required positive action. are the one key factor that can effectively reduce Continued reliance on traditional instruments, debt accumulation by restricting access to credit including debt write-offs, inter-enterprise offsets, and forcing the farms to restructure for greater and barter transactions to settle mutual claims, had efficiency and productivity in the interest of been ineffective. The attention of policymakers survival. Table 5.1: Relative Importance of Policy Instruments Used for Farm Debt Resolution in 1999 (ranking on a scale from 0 - not used to 5 - highly important) Price support Subsidized Debt Debt Mutual Farm reorganization Bankruptcy and input government and write-offs rescheduling settlements in collectivist subsidies commodity credit and barter framework Belarus 5 5 4 4 5 5 l Kazakhstan 3 2 3 3 4 4 5 Moldova 2 4 4 4 4 1 5 Russia 3 4 3 5 4 4 2 Ukraine 4 4 5 5 5 3 0 Chapter 5. Country Initiativesfor Resolution of Farm Debt 35 Table 5.1 summarizes the relative importance of farm debt. For example, payment arrears of the various policy instruments in 1999 in the between farms and their creditors were offset form of a quantitative ranking. The policy (cleared) twice a year by the National Bank, instruments are ranked for 1999 based on the which also issued credits for the amount that had qualitative information in the annex at the end of not been covered in these offset transactions. The the chapter. Each instrument is assigned an situation changed in 1998, when the relative share expert-judgment weight, which is determined of past-due credits increased dramatically (from from the policy changes described in the World the equivalent of $136 million to $230 million). Bank's agricultural policy matrices and the The debt repayment problem of 1998 was the country reports prepared by the counterpart teams result of strict price controls that had been for this study. Most countries continue to rely on imposed by the Belarus government following the methods that proved ineffective back in the Soviet Russian financial crisis. The number of farms period. Thus, in Belarus the main methods for reporting losses increased from none in 1990 to dealing with farmn debt are price support and inter- 369 in 1997 and 639 in 1998. It was decided to enterprise settlements; in Russia - debt deal with the problem by targeting the population rescheduling; in Ukraine - a mixture of debt of unprofitable farms with a combination of short- write-offs, rescheduling and inter-enterprise run measures of debt relief and support. settlements. Only Kazakhstan and Moldova resort to radical measures involving bankruptcy and All collective farms were divided into three liquidation as an option for dealing with the debt groups according to their financial status. The first of insolvent farms, although bankruptcy laws are group of enterprises consisted of profitable farms, in place in all other countries as well. which were profitable in part because of their better resource base and in part because of better management. The profitable group consisted of Country-by-Country Review of Debt 17% of farm enterprises in Belarus. These farms Resolution Measures were allowed to keep their identity, and it was believed that their efficiency could be improved Belarus. In 1990, the government wrote off by internal reorganization involving the creation $138 million of agricultural producers' debt of separate production and marketing units. The (Figure 5.1). Throughout the 1990s the level of second group (57% of farmn enterprises) included producer support provided by the government was farms that were breaking even. According to high enough to ensure accounting profits for most Belarus experts, the internal reorganization of farm enterprises. In addition, administrative these farms had to be supplemented with new methods were used to deal with the accumulation investment, which was necessary to make them Figure 5.1: Belarus - Government Credits to Agriculture (min. dollars) 300 rOJIlID Overdue credits owed to the government 250 IAmount of credits 200 written-off iS0 5 ~- )j-X- Credits owed to the government at the end of the /0 year Amount of credits paid bacl during the year 1 C r - - r -- -----_"m - I -Amount of government fl 1990 1991 1992 1993 1994 1995 1996 1997 1998 credits during the year L~~~~~~~~~~ 36 Farm Debt in the CIS profitable. To secure the required investment that at least part of the outstanding farm debt resources, these farms could merge with other could not be recovered. Between 1994-97, a total profitable farms or integrate vertically with of 53 billion tenge (half the outstanding farm agribusiness companies. debt) was transferred to the State Fund and 29 billion tenge was written off. Allocation of The third group included the loss-making government credits to agriculture virtually ceased farms (26% of farm enterprises in 1998). It is in 1998-99 (Figure 5.2), and bankruptcy began to impossible to determine if these farms were be enforced as the major method of dealing with "chronically" unprofitable due to poor farm debt. management or due to price controls and trade constraints imposed by government policies. The The Law on Bankruptcy was adopted in performance of the unprofitable farms was January 1997. At the end of the year, in December expected to improve after a government- 1997, the government issued a set of specific sponsored program that included postponement of recommendations concerning the implementation the financial liabilities to the banks and the of bankruptcy procedures in agriculture. Given government for three years and a holiday from that 80% of farm enterprises in Kazakhstan were land and property taxes for four years. If the unprofitable, with high levels of debt, unprofitable farms failed to improve their reorganization and liquidation of insolvent performance despite these measures, they would enterprises was declared a major goal of national be liquidated and reorganized into new legal agricultural policy. entities (presidential decree of March 1998). The main method of reorganization of insolvent farms As in Belarus, all agricultural enterprises in proposed by the Belarus government was merger Kazakhstan were divided into three groups with other profitable farms or with input suppliers according to their financial situation. The first and food processors. As an incentive to merge group included farmns in a stable financial with unprofitable farms, the profitable partners condition (19 % of all farm enterprises as of were allowed seven years to pay back the debts December 1997). The second group included loss- and were granted the same tax privileges making farms with overdue payables, which (presidential decree of January 1999). Raion and nevertheless had sufficient liquid assets and could oblast authorities have so far identified 249 probably recover if proper measures for financial "chronically" unprofitable farms eligible for stabilization were implemented by attracting new participation in this program. The option of investors (48% of farn enterprises). The third breaking up the existing unprofitable farms into group included the insolvent farms with debt smaller and more manageable units is not exceeding total assets (33% of farm enterprises). discussed in Belarus. Farms from the third group were to be declared bankrupt and liquidated. Farms from the second The Bankruptcy Law (last amended in June group that failed to recover despite appropriate 1993) allows creditors to sue in the courts for debt support measure (including injection of recovery through the sale of debtor's assets. So investment funds by new owners) would far, the Bankruptcy Law has not been applied to eventually be reclassified to the third group and agricultural producers. also liquidated. Kazakhstan. During most of the 1990s the The national program of farm restructuring in government tried to deal with outstanding farm Kazakhstan was launched in 1998. Of 1828 debt by rescheduling and write-offs. In 1994, the enterprises classified as insolvent (the third government rescheduled 1.2 billion tenge ($34 group), only 378 have been liquidated so far (132 million) until 2004. In 1995, the Council of through court procedures and 246 through out-of- Ministers decided to convert farm debt to state court settlement). Bankruptcy papers have been debt by transferring to the State Fund for filed for another 1034 farmn enterprises, which Financial Support of Agricultural Producers. By await court action. The liquidation of insolvent this decision, the government accepted de facto farm enterprises may take different forms: the Chapter 5. Country Initiatives for Resolution of Farm Debt 37 farm may be sold in its entirety to a single buyer, population, leaving them destitute without any the farm may be sold to the workers' collective, or land or assets. Agricultural economists in the farm may be split among several outside Kazakhstan therefore recommend speedy investors. conversion of agricultural production cooperatives into limited liability partnerships and encourage The Civil Code in Kazakhstan imposes a the members to lease their land shares to the serious asymmetry on member-shareholders in manager of the limited liability partnership, as agricultural production cooperatives (about half leased land in a limited liability partnership is the farm enterprises in the country) and other legal apparently not subject to bankruptcy sale. While forms, such as limited liability partnerships and this approach creates a shelter against loss of joint stock companies. Cooperative members in individual assets in case of bankruptcy, it clearly Kazakhstan do not enjoy the protection of limited puts the weak individuals at the mercy of the liability: first, their land shares (i.e., individual strong and experienced lessor, who is typically a land use rights) are treated as part of the asset pool former manager of the cooperative with available for satisfying the claims of the creditors; considerable intimidating influence on the second, if the assets of the cooperative (including residents in his village. These harmful the asset shares of the individual members) are implications of the Civil Code and the bankruptcy insufficient to repay the creditors, the members law highlight social deficiency of the present legal bear subsidiary responsibility for the residual debt framework, which must be amended to prevent with their personal property in proportion to their further damage to the rural population. share in the cooperative. In cases when the subsidiary responsibility of the members is Moldova. During the 1990s the government invoked, only the house, one cow, and a limited of Moldova periodically implemented debt write- list of household items are protected from the offs for farm enterprises (Figure 5.2), but the real bankruptcy sale. volume of farm debt continued to grow. The level of farm debt in Moldova as of January 1999 was 2 These legal provisions may clearly lead to billion lei, or more than 25% of GDP. The amount total ruin of large segments of the rural of overdue debt was also increasing over time. Figure 5.2: Moldova - Government Credits to Agriculture (mln. dollars) 20 1 1Amount of credit paid back 20 - 18 6 during the year 16 - II Amount of credit that has 14 - been wirtten-off l 10 4Amount of government I \ I \ credits during the year(s) 64-A Credits owed to the 4 government at the end of the 2 year 0 -)K-Overdue credit owed to the 1992 1993 1994 1995 1996 1997 1998 government . . . _ . , , , . _ . = . _ = . _ = ~ ~ ~ ~ ~~~~~~~~~~~~~~~~~~~~~~~_____ =___ I 38 Farm Debt in the CIS Toward the end of the 1990s, the government * Debt to the state (central government, local realized that the policy of continuing soft budget authorities, social fund) is settled by swapping constraints for large-scale farm enterprises of social assets. unwilling to adapt to the new market conditions * Land, livestock, and machinery distributed to was the major cause of debt accumulation. In individuals in the form of shares are not 1997, Moldova developed an integrated plan for included in the pool of assets available for settlement of farm debt simultaneously with satisfying the creditors' claims. restructuring of farm enterprises. The idea was to eliminate the farm debt overhang from the past * Debt to private creditors that remains after and to present the farm members with an exhausting the pool of available assets is opportunity to start new, debt-free farm settled by the government in the form of non- operations. There was an understanding in tradable tax credits issued to the unsatisfied Moldova that farm debt had been created not only creditors. by farm management and the workers, but also by the actions of the government. The debt settlement The process ends with final liquidation of the program in Moldova carefully evaluated the original farm. No legal successor is created. responsibilities of the main parties (government, Instead, the former members are encouraged to management, workers) in creating the debt create new debt-free entities using their land and problem and proposed a scheme for equitable asset shares that have remained untouched by the sharing of the burden of debt settlement among liquidation proceedings. The individual property them. A detailed description of the National Land rights are further strengthened and protected by Program launched in Moldova in 1997 is given in conducting comprehensive land surveying and Appendix C. titling operations simultaneously with the debt settlement program. The debt settlement program in Moldova opts for managed out-of-court resolution instead of The out-of-court procedure is launched if the traditional court-driven bankruptcy proceedings. farm secures the agreement of all creditors. An The main principles of the managed farm debt alternative scheme based on formal court-driven settlement procedure implemented under the bankruptcy and liquidation can be implemented if National Land Program are summarized below. no agreement is reached with the creditors. * The decision to join the debt settlement The Moldova debt settlement model program is made voluntarily by the general acknowledges that all parties - the government, assembly of members of each farm. the management, the workers, and the outside creditors - bear a portion of responsibility for debt * An elected debt settlement committee accumulation and thus share in the costs and announces the decision and invites creditors outcomes of the process. to submit their claims. Russia. The policy instruments that were used * Debt not claimed within one month of the during the 1990s to deal with farm debt in Russia public announcement is written off without changed from write-offs and unconditional recourse. rescheduling to conditional rescheduling and financial rehabilitation (Figure 5.3). Application m The remaining debt is settled with farm assets, of the bankruptcy law to agriculture is still very including mutual offsets. Secured debt has limited. priority over unsecured debt. Collateralized assets are transferred in full to lien holders. Chapter 5. Country Initiatives for Resolution of Farm Debt 39 Figure 5.3: Russia - Government Credits to Agriculture (min. dollars) 7000 6000 - 5000 | 4000 | i;S-Amount of debt that has been rescheduled i 3000 A + Amount of government credits 2000 C 1000 1992 1993 1994 1995 1996 1997 1998 In 1998, the government decided on massive voluntary, and only few farms decided to take rescheduling of farm debt for five years, with part, presumably because of the compliance payments to start from January 2000 at an annual conditions attached to the scheme. Bankruptcy is interest rate of 5% on outstanding debt. The 1998 regarded as a viable altemative to debt rescheduling was conditional on the farms' ability rescheduling. So far, however, there have been to continue discharging their current obligations in very few applications of the bankruptcy law to a timely manner. The deferment included 5.7 farms. The government body in charge of billion rubles to the federal budget, 10 billion bankruptcy proceedings decided back in 1994 not rubles to the pension fund, 2.5 billion rubles to to engage in farm bankruptcies, concentrating its social security, 1.5 billion rubles to medical limited resources on monitoring the financial insurance, and 1.5 billion rubles to unemployment performance of much larger debtors. As a result of insurance. The social security fund and this policy, only 71 of 27,000 farms in Russia unemployment insurance wrote off all penalties were involved in bankruptcy proceedings as of for previous non-payments. Another 3.5 billion 1999. rubles was written off in 1999 as a compensation for regions with unfavorable natural conditions. The efficiency of the bankruptcy law depends on several criteria: One of the weaknesses of the present debt rescheduling schemes in Russia is the lack of a) The definition of insolvency; coordination between various creditors and b) Opportunities for financial rehabilitation suppliers that have the right to block the farms' c) The order of priority of creditors' claims on accounts in case of nonpayment. While relief from farm assets. government debt ensures that the government will refrain from blocking the farm's account, there is According to the Russian Law on Bankruptcy, no guarantee that another parastatal - a power any company (not necessarily a farm) can be utility or a fuel supplier - will not put a new declared bankrupt if it does not pay its obligations restraint on the farm. within three months after due date and the level of debt is at least 500 times the minimum wage. The The participation of agricultural producers in decision of the Arbitration Court is needed to debt rescheduling programs in Russia is declare a company bankrupt. debtors. 40 Farm Debt in the CIS In Russia, the bankruptcy law is biased Ukraine. The methods of addressing the farm against the rights of the creditors. The claims of debt problem in Ukraine have not changed secured creditors are preceded by the claims of significantly compared to the ones used under the bankruptcy administrators (court and centrally planned system. Write-offs, mutual administration expenses) and the claims of offsets, debt rescheduling, and acceptance of members and workers (disability and health settlements in kind are the most common claims, wage arrears, social payments), while instruments of debt relief. Grain is "legal tender" unsecured non-government creditors are at the for payments to tax authorities and the pension bottom of the order of priority. fund. Electricity arrears have been settled by mutual offsets for the amount that the government The Russian order of priority is similar to that owed farms for maintenance and construction in in Gernany, Holland, Hungary, and Poland the social sphere. Debt relief measures are (Table 5.2). In the USA and Czech Republic, on important, because the government freely resorts the other hand, secured creditors have the first to draconian administrative means of enforcing priority in settling claims. payments to the budget. If a farm is unable to pay its current tax liability, the farm's bank accounts In addition to the obstacles associated with the are blocked and all moneys paid into the blocked relatively low order of priority, creditors are accounts are automatically redirected to the tax deterred by the high cost of court proceedings and authorities. the low probability of being paid even in case of a favorable judgment. The total absence of a system Debt relief is the main policy aimed at of lien registration in Russia makes collateral and alleviating the financial difficulties of former state security extremely nebulous concepts. The and collective farms. Debt relief measures include secured creditor has no control over the routine (in 1992, 1993, 1997, 1998 and 1999) and collateralizing asset, and assets offered as unconditional writing off, extension, and collateral can and have been sold in the same pool restructuring of debt obligations of farms to the with other assets. government. Interviews with large farm managers indicate that such habitual actions have had the Because of these difficulties and effect of convincing farms that they need only complications, bankruptcy proceedings are wait and debt forgiveness will be forthcoming. seldom invoked for settling debts in Russia. Many farm managers interviewed in the course of Instead, creditors use the more flexible arbitration the study stated their confidence that the courts to get an order allowing them to seize some government would soon write off their debt of the most valuable assets without taking the obligations. In such an atmosphere it is difficult to debtor through full-scale liquidation. The seized see why farms should make strenuous efforts to assets are then auctioned to cover the debt. pay back debt to the state, if such obligations are to be forgiven anyway. Table 5.2: The Order of Satisfaction of Creditors' Claims Russia Kazakhstan USA Germany, Hungary Poland Czech Holland Republic Court expenses 1 1 2 1 1 1 1 Administrative expenses I 1 2 1 1 1 1 Creditors with collateral 3 2 1 2 2 2 1 Other creditors 5 5 3 4 4 4 3 Payment of wages 2 3 2 1 1 1 1 Tax authorities 4 4 2 3 3 1 2 Social funds 4 4 2 3 3 3 2 Source: TACIS, Farm Insolvency in Russia: Identified Problems and Possible Solutions, Project RF27, Brussels, August 1999, p. 36. Chapter 5. Country Initiatives for Resolution of Farm Debt 41 The tradition of debt write-off has continued intentional legislative efforts, has protected in 2000. A law passed in March 2000 ordered the Ukrainian large farms from their creditors and write-off of all tax and other government debt for effectively prevented their breakup despite severe farm enterprises that restructured in accordance financial pressures. with the latest presidential decree of December 1999. The law ordered that tax debt, penalty The goal of government policy has been the payment debt, and debt for input purchases "stabilization of farm production," and the (advanced by the government) for processors be government has done its utmost to ensure that the written off as well. The law called for additional financial state of agricultural producers does not legislation to write off debt for government credits interfere with fulfillment of these functions. The advanced to agricultural enterprises through government approach has been spectacularly processors and procurement organizations. unsuccessful in halting the accumulation of debt, raising farm profitability, or halting the decline in The significance of debt relief, i.e., written production that has been going on since 1990. The off, deferred, restructured, and overdue debt, government policy has failed, because it is suited compared to total farm debt to the government for a centrally managed economy where the state and banks can be seen in Figure 5.4. The portion has full control over farms, which is no longer the of total debt affected by relief measures was case in Ukraine or anywhere in CIS. All through growing over time, and by 1999 more than 80% of the 1990s, the traditional policies of write-off, outstanding plus written-off debt fell in this rescheduling, and in-kind payments treated the category. symptoms rather than the causes of the debt problem. The core reasons for debt accumulation, To date, Ukraine does not have effective i.e., the distortion of incentives by soft budget bankruptcy legislation for agricultural enterprises, constraints and the inability of farm enterprises to and in 1999 a five-year ban on bankruptcy was perform as profit-oriented firms, have not been imposed for large farms. This policy, combined addressed. with the absence of land markets due to Figure 5.4. Cumulative Percent of Farm Debt (plus writeoffs) to Banks and Government that is Overdue, Deferred, Restructured or Written Off, 1990-1999 90 80 - - - - - - - -- - 70 _ __ _ _- ---~------ - - -- -- -- - - - - 7 ' Overdue to Banks and GovernmentA 60 50 40 ---- - ------- --- - 30 - -- ------ 20 - - -- -- - - - State Loans De&rred, Restruct red Debt 10 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 Year 6 The Problem and a Solution Framework The main goal of the agricultural transition the symptoms and actually lead to further agenda in both CEE and CIS is to move toward a deterioration of the rural financial situation. market-oriented agriculture, while improving productivity and efficiency of resource use. This To resolve the farm debt problem effectively, requires a radical change in farm structure and governments need to apply measures that address operation, as the traditional large collective and the non-conducive economic environment of the cooperative farms differ radically from the farms farms, including the persistence of soft budget that actually exist in market economies. Hence the constraints, as well as the inherited unproductive persistent emphasis that the international experts internal organization. Effective resolution of the are placing, since 1990-91, on the need for deep farm debt problem will remove one of the major internal restructuring of farms in the interest of bottlenecks in the process of agricultural reform. achieving higher productivity and improving the living standards of the rural population. Nature of Farm Debt and Repayment Capacity Viewed in the context of these goals, farn The farm debt situation in the CIS has two debt is a serious constraint for the implementation characteristic features: first, the real debt of the of meaningful restructuring and resource farm sector has been rising since 1990 (Figure privatization in CIS agriculture. First, it prevents 6.1); second, the term structure of debt has shifted the exit of individual farm members from the almost entirely toward short-term, current collective structure, because they are responsible liabilities (Figure 6.2). The old long-term debt, for a portion of the debt and may not be able to boffow on their own through financial institutions never a major component of farm liabilities during to meet the operating needs of their new farms. the Sovlet era, was wiped out by the gallopbng Second, debt obstructs restructuring of the appropriatxinflation of the early 1990s, and in the absence of traditional collective enterprises into new viable appropriate idexation mechan sms the sources of becus th deinae shro.r h new long-term lending largely disappeared entities, because the designated shareowners-the between 1990 and 1993. The growing farm debt members of the farm enterprise - face uncertainty in the region is thus generally new and fairly regarding the net value of the assets they recent debt, not debt inherited from the Soviet potentially control and the creditworthiness of the new legal entities being created from the period. collective. Most CIS countries are struggling with the problem of debt overhang in farms. Many of Table 6.1: Selected Financial Ratios: Average for these countries have made attempts to solve the problem. However, the general lack of political 1990 1994 1998 will and the prevailing unwillingness to make Debt to sales 0.16 0.49 1.20 radical changes in the core of the inherited Debt to total assets 0.10 0.17 0.15 collective structure have resulted in temporary ad hoc solutions. Instead of treating the underlying causes, these ad hoc measures typically address Debt to liquid current assets 0.58 2.27 4.27 43 44 Farm Debt in the CIS Local experts and politicians as well as indexing to various components of price inflation, representatives of the international donors always and their reported book value appears to be talk about the farn debt problem in CIS. Western grossly overestimated. In other words, there is no scholars usually analyze farm debt and detect chance that the fixed assets of CIS farms will ever potential debt-related problems by calculating be realized at anywhere near their balance sheet various financial ratios based on the balance sheet value. As a result, the comfortable debt to assets and the income statement. The standard ratios ratios of CIS farms are totally misleading. calculated for the CIS countries in the course of this study certainly reveal a deterioration of financial situation over time as debt levels are Figure6.1:RealDebtperFarm:IndexandUSDollars seen to increase, but the values obtained for most of these ratios are not dramatically high. Thus the percent of 1994 US Dollars ratio of debt to total assets and even the ratio of 160 600 debt to current assets are both comfortably less 140 ---- - -------- --- _50_ than I (Table 6.1). This means that, in 120 500 conventional terms, the CIS farms are not 400 bankrupt at all: they have enough assets (even 10° __de only current assets) to cover the outstanding debt 80 -- - 300 j- US$ with a sufficient safety margin. The ratio of debt 60 0- - - - - - 0 to sales measuring the ability to repay debt from 40 current revenues is not alarming either (Table 100 6.1): farm debt is of the order of annual sales, 20 _ _ which means that one year of sales revenues is 0 l sufficient to repay the entire farm debt in CIS. 1994 1995 1996 1997 1998 Debt levels of one credit-year are not regarded as Figure 6.2: Term Structure of Farm Debt catastrophic anywhere in the world. Of course, the numbers in Table 6.1 are based on sector averages for each country, and do not allow for 100% the distribution of farms over the entire spectrum of ratios. Yet tentative distributional analyses 80% carried out by the counterpart teams indicate that the percentage of farm enterprises with critically 60% high indebtedness levels (measured relative to in .al3SLongnerm assets and sales) is on the whole very low. 40% The situation in the CIS farm sector, however, 20% is not really amenable to the application of standard financial ratios. The rationale behind the dh% ratio of total debt to total assets is that the assets 1990 1991 1992 1993 1994 1995 1996 1997 1998 can be liquidated at near their balance sheet value to repay debt. This is a valid assumption in market The problem of asset values is especially economies, where fixed assets are usually acute in the CIS, but companies everywhere in the reported in the balance sheet at their historical world face problems with estimating the realizable value (net of depreciation), which is substantially value of their fixed assets for purposes of debt below the current replacement or market value of repayment. Therefore, a common practice in the the assets. Therefore, even when companies and West is to replace total assets in the denominator creditors allow for the fact that during liquidation of the ratio with current assets, which do not the assets sell at a deep discount, the realized include fixed assets. The result is the ratio of debt value of fixed assets makes a substantial to current assets, which is a more strict measure of contribution to debt repayment. In CIS farms, the indebtedness. Current assets are usually less than fixed assets are periodically revalued upward by Chapter 6. The Problem and a Solution Framework 45 Figure 6.3: Share of Inventories in Current Assets: 1998 cover 67% of current debt. Moreover, for US farms all three ratios have remained perfectly 100%..,.,., steady over the years: there has been no 80% _i _ deterioration in the solvency of US farms, while CIS farms have become much less solvent over 60% C Liquid asset the decade of transition. Figure 6.4: Debt to Sales: CIS4 and US CIS us1.84_ a year old and their book value is therefore close 1__ to their cash value. Current assets are much more I-cs liquid than fixed assets, i.e., they are much easier 0.8 ---1 to convert into cash. They consist of accounts receivable, which are practically near-cash 0__ (assuming that they can be collected from 0__ 0 debtors), and inventories of inputs, raw materials, '194 1885 1998 1997 1998 finished goods, and unfinished work in process, all of which are also assumed relatively easy to Debt to Liquid Current Assets: CIS-4 and US sell and convert into cash. In CIS farms, inventories constitute a much larger component of 5 current assets than, for instance, in US farms (Figure 6.3). There are suspicions that much of 4 these inventories, whether finished products or old stocks of inputs, are not really saleable, certainly not for their book value, just like fixed assets. It is 2 [U-. _ ____ LzJS therefore advisable to measure farmn indebtedness in CIS by means of an even more stringent ratio. ' -_I__ ___ _ _ This so-called quick or acid ratio measures debt 0 only in relation to liquid current assets, i.e., cash 1994 1995 1998 1997 1998 and near-cash, excluding the less liquid and potentially unsaleable inventories. Debt to Current Assets: CIS 4 and US All three basic ratios measuring the capacity of farms to repay their debt - the ratio of debt to 0.8 __ _____-------- =.,,,-,_ sales, the ratio of debt to current assets (including inventories), and the ratio of debt to liquid current 0.8 ___IS I assets (excluding all inventories) - increase over 0.4 _ _ _. _ __ _ _U time, which is a definite sign of rising indebtedness (Figure 6.4). Yet while the values of 0.2 __-_______.___ _- ___ the first two ratios are not particularly alarming by 0 world standards, the ratio of debt to liquid current 1994 1995 1995 1997 19 8 assets rises to stratospheric levels. On average in Russia, Ukraine, Belarus, and Moldova this ratio While all three ratios point to increasing rose from 0.6 in 1990 to over 4 in 1998. This indebtedness, it is particularly the ratio of debt to means that the liquid assets, when converted into liquid assets that confirms the existence of a cash at their full book value, will cover less than serious problem in CIS farms: farms can only 25% of current farm debt. The corresponding ratio repay a small fraction of their debt from cash and for US farms is 1.5, i.e., liquid assets of US farms near-cash reserves. To repay the bulk of their 46 Farm Debt in the CIS debt, they have to rely on sale of inventories and * Farm managers are still committed to provide liquidation of fixed assets, which is a proposition all members with jobs, regardless of cost- with dubious and uncertain outcomes even in efficiency considerations. established market economies. * Farm enterprises are obliged to maintain the social infrastructure in the village, including Debt and Profitability the traditional free support to household plots. Why is there a contradiction between the ratio * Farm operations remain largely production of debt to liquid assets, which presents a grim oriented, with no overriding emphasis on picture of debt repayment capacity, and the ratio markets, consumers, and sales: farm managers of debt to sales, which optimistically suggests that are still production maximizers, not profit debt can be repaid from just one year of sales maximizers. revenue? The reason, quite simply, is that farm * Member-workers continue to function in a sales in CIS do not produce profits. The traditional collective environment, without proportion of farms reporting losses has increased any direct accountability for the results of markedly since 1994, and well over 50% of farm their effort or their contribution to profits and enterprises are unprofitable in recent years losses. (Figure 6.5). Sales revenue is entirely absorbed by wages and other production costs, which add Figure 6.5: Percentage of Unprofitable up to 140% of sales. In other words, farms are Fare 6.5 losing on average almost 40% on each ruble of sales revenue (Figure 6.6). Farm operations do 100 percent of farm enterprises not generate net income that can be used to repay debt, however small. 80 , Declining profits (and increasing losses) appear to be the major determinant of debt 60 -_ __ _ accumulation in CIS farms. The level of debt increases in inverse proportion to the level of 40-_ -____ - _ profits: as profits decline and losses grow, the real level of farm debt increases. This result is 20 - observed both for the entire farm sector over time and across thousands of farms in one year (1998). 1 *199019119193191951919798 So the debt problem is clearly attributable to lack of profitability. Figure 6.6: Profit-to-Sales Ratio: CIS-5 To explain debt accumulation, we thus need to understand the decline in farm profits. There 04 are two broad groups of reasons for the growing losses in CIS farms: internal farm-level reasons, and external policy-related reasons. 0.2 The internalfarm-level reasons are all related to the traditional collective farm structure, which 0 basically has not changed during the decade of farm reorganization in the CIS: 02 * The farm enterprises have not reduced their size to more manageable dimensions. -0.4 1990 1991 1992 1993 1994 1995 1996 1997 1998 Chapter 6. The Problem and a Solution Framework 47 All these internal reasons are obstacles to External Factors Affecting Profitability: The improving the cost-efficiency of farms, and Impact of Government Policies necessarily lead to suboptimal profits. As long as CIS farms continue their strategy of formal In the past, the farms in Leningrad and reorganization, avoiding radical internal Novgorod, two typical non-chemozem zone restructuring prescribed by market principles, they oblasts, were quite profitable. And yet Figure 6.7 will not be able to improve their efficiency and shows that past profitability was merely an profitability. illusion. In the past, the government traditionally injected massive subsidies into farm enterprises, A rough breakeven analysis of farms in two which compensated them for low product prices Russian oblasts - Leningrad and Novgorod - has and relatively high costs. Without subsidies, led to instructive results regarding cost efficiency Novgorod farms were losing all through the early and profitability. In Leningrad farms variable 1990s, and their reported profitability was costs are less than prices received, each unit of sustained entirely by subsidies. Subsidization of sales makes a positive contribution, and the farms agriculture was a serious burden on the state can switch from losses to profits if they increase budget, but this burden was deemed necessary to the sales volume by a factor of 1.8. In Novgorod ensure low food prices for the population. In farms, on the other hand, variable costs (per unit recent years, however, the economic and political of sales) are greater than the price received for environment has changed, the subsidies have all products sold. This means that the more Novgorod but disappeared, and without their masking effect farms produce and sell, the more money they lose. the proportion of farms with losses has increased Each unit sold generates an incremental loss. dramatically. The farms are facing an entirely Before attempting to increase their sales, different set of external factors linked with Novgorod farms should look hard at their cost government policies, which have a very strong structure and change radically the composition of impact on profitability. Without subsidies, farms variable costs to ensure that they become less than are not profitable given the current production the prices received. structure and management strategy. Although Leningrad farms in principle can Figure 6.7: Novgorod: Impact of Subsidies on Profit achieve profitability by increasing sales, the target of almost doubling the sales volume is not easy to meet in a generally contracting environment. To 600 1990 rubles (thousands) be realistically profitable, Leningrad farms should also work to reduce their production costs instead - of counting on sales growth. Thus, potential profitability of farms in these two oblasts 20 essentially depends on their ability to become 2 __ Reported profit more cost-efficient. Leningrad and Novgorod are -Without subsidy probably quite representative of CIS farms in \0\E general. The required changes in cost structure of /0 CIS farms are impossible in the traditional -200 ----- collective environment. To change the cost structure with the purpose of improving 85 86 87 88 89 90 91 92 93 94 95 96 profitability, the farms must undergo deep internal restructuring and switch to accepted market principles of operations and management. This We are not advocating the reinstatement of should include, among other things, willingness to subsidies. There are many other budgetary adjust the labor force in response to changing injections into agriculture (such as periodic debt production requirements and operation with writeoffs) that also need to be eliminated. On the strong orientation toward cost efficiency and contrary, we are arguing that farms must actively resource productivity. respond to reduction in government support by 48 Farm Debt in the CIS changing their objectives, by restructuring their continue to suffer from the squeezing effect of the operations, by reorganizing and realigning with "price scissors," even if the government stops its market principles to achieve greater cost intervention in food prices. efficiency and eventually return to profitability. Although state orders and procurement quotas With the elimination of producer subsidies, have been virtually eliminated in the CIS (with the the main external policy-related factor that has a notable exception of Belarus), the central detrimental effect on farm profits in CIS is the government and local authorities continue to government policy to continue maintaining low intervene in the sales and marketing decisions of food prices for the population. While prices for producers through a variety of export restrictions. manufactured commodities, including farm inputs Many products classified as "strategic" (grain, and machinery, have been liberalized and are now livestock) are subject to complex export licensing at or near world market levels, the prices received requirements. Not only exports to foreign by farms were not allowed to rise to the full extent countries are restricted: local governments often of the gap left by the elimination of producer erect administrative barriers to domestic trade subsidies. This is reflected in the so-called "price flows across provincial borders, arguing that the scissors," which correspond to the notion of food needs of the local population must be deteriorating terms of trade for agriculture. In satisfied before farm products are allowed to be CIS-4 the terms of trade had dropped by 1998 to exported to other regions of the country. Trade 0.2 of the 1990 level (Figure 6.8). This means restrictions of this kind severely constrain the that the cost of farm inputs between 1990-98 ability of producers to generate revenue and increased five times more than the prices received profits from operations. by farms for their products. External factors related to government policies - elimination of direct producer support, Figure 6.8: Terms of Trade in Agriculture: Ratio of Prices col of fd ric exacerbating rth Received by Producers to Prices Paid for Farm Inputs control of food prices exacerbating the deterioration of terms of trade for agriculture, 12 forCIS4, 199=1 restrictions on trade in agricultural commodities - certainly have a negative impact on farm profitability and thus lead accumulation of debt. 0.8 These policy distortions should be corrected to GA create a liberal market environment in which 0.6 \ producers can operate freely with the goal of 0.4 maximizing their profits and controlling their debt burden. Yet the ultimate solution to improving 0.2 profits and thus reducing the burden of debt is o l l l l l l l basically internal. In response to changes in the t990 199t t992 t993 1994 t995 1996 1997 t998 economic and political environment, the farms must reorganize and restructure for greater cost Deteriorating terms of trade are a universal efficiency and higher productivity. This is what phenomenon observed in all market economies. In Western farms do to remain profitable in a CIS, the "price scissors" effect is aggravated by changing world. government intervention in setting food prices. Elimination of government intervention in food Soft Budget Constraints are a Disincentive to prices will somewhat relieve the problem, but the Restructuring general trend of deterioration in terns of trend will persist. Farms in market economies respond In market economies, the allowable level of to deteriorating terms of trade by reducing their debt is limited by the risk of bankruptcy. Farms, costs and increasing the output, i.e., improving as all business enterprises, operate under hard their productivity and efficiency. As long as CIS budget constraints: if they are unable to generate farms fail to improve their productivity, they will Chapter 6. The Problem and a Solution Framework 49 sufficient profits to repay their financial budget constraints, they will take the path of least obligations, they go out of business. In socialist resistance - continue accumulating debt - instead economies, on the other hand, farms operated of making the hard and painful choices that under soft budget constraints: they always relied restructuring involves. on flows of funds from the state to cover their losses and repay their debts. Who Are the Farms' Main Creditors? Janos Kornai, in his classical work on the All through the I990s, about half the farm socialist economic system, characterizes the debt came from the government and banks and the softness of budget constraints by the commitment other half from supplier credit and wage arrears of the bureaucracy (i.e., the government in our (Figure 6.9). The exact role of the banks in the terminology) not to tolerate persistent loss-making early years of the decade is unclear: some of the (see, e.g., The Socialist System: The Polittcal eryyaso h eael nla oeo h (see, e.g., The Socialist System:.Uiersity debt recorded as bank loans (especially long-term Economy of Communism, Princeton Unversty loans) may in fact have been govement debt Press, 1992). Soft budget constraints prevail when channeled through state controlled agricultural economic agents believe that they can negotiate banks. During the recent years, when the division various benefits after the fact in case of adverse between commercial banks and the goverment outcomes (lack of profitability). The feasibility of became much sharper and clearer than in the past, this vertical negotiation process stems from the the share of bank lending in farm debt shrank to a paternalistic attitude of the government toward the minimum, and debt to the government became a farm enterprises, which according to Kornai is akin to the attitude that parents show toward domiant component. financial difficulties of their children, regardless of age. In this conceptual setting, soft budget Figure6.9: SourcesofDebt CIS-4 constraints are not limited to actual allocation of subsidized credits or debt write-offs. They often 100% include an implicit component that arises when the government's does not insist with all strictness 80% on collecting tax arrears or, even more indirectly, signals suppliers or banks not to press too hard for 60% Other collection of overdue obligations from farms. \Wages \ ~~~~~~~OoGvt The mentality of soft budget constraints 40%oBanks continues to persist in CIS countries during transition. Unprofitable farms with steadily rising 20% levels of debt do not go bankrupt. There are no self-limiting risk mechanisms on the amount of 0% 1990t91191931919519197t8 accumulated debt. Loss-making farms are able to continue borrowing from suppliers, from the state, and sometimes even from commercial banks, Another clear feature in the development of presumably because everybody - the borrowers farm debt over the last decade is the substantial and the lenders - believe that the goverment will increase in the share of suppliers' credit, which not let the large farm enterprises go bankrupt and nearly doubled from about 20% of total debt in will continue to arrange for periodic bailouts, the early 1990s to 40% in recent years (Table While lack of profitability makes debt 6.2). This may be interpreted as a clear sign of accumulation necessary, it is the persistence of progress toward commercial normalization of soft budget constraints that makes debt financial transactions in agriculture. Wage arrears accumulation possible. As long as farm are not and have never been a significant enterprises are allowed to operate under soft component of sources of farm credit. 50 Farm Debt in the CIS Table 6.2: Sources of Farm Debt: CIS-4 different groups of creditors. Thus, we should be 1990 1994 1998 able to repay suppliers by selling the inventories, and the banks by converting the liquid assets into actual cash (i.e., collecting accounts receivable, Commercial banks 39 19 7 selling off securities and investments, etc.). If Government 18 27 43 these two categories of relatively saleable current Wage arrears 21 22 16 assets do not leave surplus cash for further debt Supplier credit 22 33 35 reduction, the government can be offered to take over the social fixed assets in repayment of its debt and the workers, as a last resort, can be Overall, farm debt in CIS originates primarily offered ownership of enterprise housing - another from "passive" or "spontaneous" credit sources, component of fixed assets - in payment of their which grow simply because farms do not pay their wage arrears. This will not really compensate the obligations. These sources include all levels of workers for their lost wages, because they anyhow government (central, provincial, and district), have secure tenant rights in enterprise housing and trade credit from suppliers, and to a certain extent there is no active market in apartments in rural also farm workers, who extend involuntary credit areas to cash in on their new property. Yet, in a to farms through wage arrears. "Active sources" - pinch, privatization of housing against wage commercial banks - are of marginal importance arrears may be better than nothing for workers. accounting for less than 7% of total debt. Table 6.3 shows that in the CIS countries all Is Farm Debt Secure? the main categories of farm debt are securely covered by assets in the matching categories. Farms in the CIS have had no profits in recent Thus, the value of inventories exceeds the years, and they do not generate net cash flows that amounts owed to suppliers by a factor of 2. Liquid can be used to repay their debt. If farm debt assets exceed outstanding bank credit by about a cannot be repaid from operational earnings, it has factor of 5. This essentially means that liquid to be repaid by liquidation or sale of assets. assets cover the entire debt to commercial banks Overall, the total farm assets are more than and even part of the debt to suppliers. Social sufficient to cover the debt. Even the current assets are more than sufficient to cover the assets exceed the farm debt (see Table 1). Yet, as obligations to both workers and the government. we know, the value of assets is highly uncertain Although at present farms do not generate cash to when a firm declares liquidation, and it is repay any of their loans, they are not bankrupt in desirable to see to what extent farm debt can be the sense that their current assets (augmented by covered with minimum reliance on the fixed the non-productive component of fixed assets) are assets. sufficient to cover all outstanding debt with a comfortable margin. Farm debt can be recovered A certain natural matching may be suggested if the assets are saleable or will be accepted in between different categories of farm assets and exchange for outstanding debt. Table 6.3: Coverage of Debt by Assets in CIS-4 Russia Ukraine Moldova Belarus Average CIS-4 Inventories/suppliers credit 2.3 2.5 1.3 4.5 2.6 Liquid assets/bank credit 6.9 13.9 4.5 1.8 6.8 Social assets/wages + government debt 2.3 1.1 1.3 2.6 1.8 Enterprise-owned housing/wage arrears 1.3 3.0 NA NA NA Other social assets/government debt 0.9 2.0 NA NA NA Chapter 6. The Problem and a Solution Framework 51 We have to repeat the same caveat as before: and the state budgets in CIS cannot continue to these are sector averages, and they do not reflect deal with this problem according to traditional the situation in extreme cases. In some farms, prescriptions of rescheduling and forgiveness. current assets may not be sufficient to cover debt, and combined with lack of profitability this is a Lessons from Central and Eastern Europe' sign of severe financial distress, or insolvency. Yet the percentage of such farms is not very high, The experience in Central and Eastern Europe and on the whole farms can cover their debt with (GEE) provides two lessons for CIS. First, their current assets, which are much more liquid relatively straightforward but radical solutions and saleable than buildings and machinery. . a Drasic dbt sttleentprocdure maybe mplemented at the early stage of the reform Drasic dbt ettlmentproedurs ma be process helped to create a financially viable necessary for a relatively small number of farms, ressr helped to reatera inaci vabe restructured agricultural sector, which made and the mainfocus should be on enablingfarms to commercial lending to the sector feasible and regain profitability by market mechanisms. even attractive in some cases. Second, consistent application of bankruptcy procedures to privatized The Burden on the Economy farms in the later period, combined with a number of supportive government policy measures and the The traditiona way.inCISofdea with creation of a relatively undistorted incentive The traditional way In CIS of dealing th framework for agriculture, helped these countries accumulation of farm debt has been through periodic rescheduling and forgiveness of overdue avoid the accumulation of farm debt above the obligations. Since the state budget ultimately level acceptable in market economies. bears the cost associated with debt write-offs, this The large-scale farming structures inherited policy is tenable only as long as the level of debt from the pre-reform period carried significant is relatively low. This is no longer the case in CIS amounts of debt in the early 1990s. A relatively countries, where farm debt has risen to levels that high percentage of these farms were technically are not negligible compared with budget revenue bankrupt. In the Baltic states, the hyperinflation and even GDP. helped to create debt-free privatized farms. In Central Europe, with the exception of the Czech Figure 6.10: Farm debt as % of GDP Republic, insolvent farms (a relatively small proportion of the total number of farm enterprises) 40 tercont were liquidated and only the land and the assets remaining after bankruptcy sales were distributed 30 _- | among the former workers and members. In the farm debtUbudget revenue Czech Republic, the historical debt has been 20 carried over since the beginning of the reform period, and debt settlement attempts are just beginning (also mainly through bankruptcy). 10 . _ . farm debt/GDP The current debt situation in CEE is not o alarming. As Figure 6.11 shows, the real debt in 1994 1995 1996 1997 1 998 CEE agriculture is generally not rising. In Estonia and Hungary the real debt level remained relatively stable between 1993-98, whereas in the Fibudgutreve.10 plots theDratio ofIt farm dheb Czech Republic and for Polish corporate farms it period 1994-9g . Outstanding farm debt in CIS-4 actually declined over time. The level of real debt pnreriod 19-8 outsadn of dget in Ci increased significantly only for individual private increased from about 25%/ of budget revenues In 1994 to nearly 40% in 1998. It exceeded 10% of GDP in 1998. Farm debt today constitutes a 'This section is based on a review of farm debt in CEE significant burden on the economy as a whole, prepared by Mariusz Safin. 52 Farm Debt in the CIS farms in Poland and Lithuania (not shown in the in recent years to compensate for the losses figure). However, the initial debt levels for private suffered by the farms due to falling commodity farms in these two countries were near zero in the prices on international agricultural markets. early 1990s, and the increase from a very low initial level did not affect the overall indebtedness Figure 6.13: Liabilities to Current Assets Ratio in CEE - 1998 of the farm sector. Figure 6.11: Real Farm Debt in CEE 0.8…_ 2.5 0.6 0.4 1S ---7 ----- ------- > ==:= ......................,j:.::......... iE 05~~~~~~~~~~~~~~~~~~~ S0 , , ,,,,.,.................. '''''''''''''''''''''' Czech Rep. Estonia Lithuania Poland Hungary X33 U94 1195 898 197 aS3 C _ehorprt -Czachidiiual iA i I-HullgarI - Pd-d-rpke ISustainable profitability of the sector is the most important condition for maintaining financial solvency of farms. This requires a transparent macroeconomic framework, Figure 6.12: liabIlities to Assets Ratio in CEE distortion-free markets, and a restructured agricultural sector that can attract capital and has 0.7 -------.--------.--.---___ ____access to risk management tools. Government intervention in CEE tends to be limited, generally 05 * focusing on various grant schemes. Credits and OA credit guarantees are mainly provided on a 0 . - - -commercial basis, supported by an appropriate 02 legal framework for recovering liabilities in case 02 . . of default. CEE governments, unlike their CIS 01 . counterparts, do not engage in debt writeoffs and O Q l! S4 1 97 m5 debt rescheduling for farms. While some of these Chorporats -C:;z_4hinmu E-,I countries do have direct credit subsidies, these are usually provided in the form of tax rebates to minimize the distortions. Similar conclusions can be drawn from the comparison of liabilities and assets (Figure 6.12), What Can be Done to Resolve the Farm Debt and the repayment capacity measured as the ratio Problem? of liabilities to current assets (Figure 6.13). The history of farm debt in the CIS countries A relatively straightforward application of provides many examples of attempts to resolve bankruptcy procedures is one of the key reasons the problem of farm debt. These include debt for this success in CEE. One must add, however, write-offs, moratoria, debt rescheduling and that governments in each country support farm restructuring. It is clear that these attempts have financing in various forms, including grants, not been successful. They have not stopped the interest rate subsidies, credit guarantees, tax accumulation of debt because they have been refunds, etc. The amount of support has increased treating symptoms, and not the true causes of the problem. The traditional measures have not Chapter 6. The Problem and a Solution Framework 53 changed the macroeconomic and incentive procedures may not offer a desired solution given framework around the farms, and they have left the specific circumstances in the CIS. First, a very the inherited farming and ownership structures large number of farms (in some countries more intact. The key to the solution of the farm debt than 50%) are technically bankrupt in the sense problem is improvement of the incentive that they report losses and cannot repay any debt framework combined with genuine restructuring from current cashflows. A strict approach to and privatization of farms. It is only in the context bankruptcy would require initiating court of these external and internal institutional proceedings in a volume that is simply not measures that a targeted resolution of farm debt is practicable given the fragile administrative and likely to succeed. judicial structures in CIS. There are no effective bankruptcy courts, and very few bankruptcy cases Accumulation of farm debt is caused by two have actually been tried to completion in any of sets of factors: external factors related to the CIS countries. government policies that produce a non-conducive economic environment for farm operation, and Second, the experience in the few farm internal factors related to farm organization and bankruptcy cases launched in CIS indicates that structure that lead to low productivity and the lack of potential buyers for farm assets is growing losses. Effective resolution of farm debt another obstacle to formal court-driven requires governments to address both sets of procedures. In CEE, subsidized credit schemes factors before they can decide to invoke were offered by the governments to support the bankruptcy, which is the standard market tool for purchase of farm assets in the process of dealing with highly indebted insolvent farms. liquidation. Such schemes do not exist in CIS, and the rural population suffers from a severe shortage Why Not Traditional Court-Driven Bankruptcy of capital. The absence of potential buyers would Proceedings? be a significant constraint in a mass bankruptcy and liquidation of insolvent farm enterprises. In market economies, unprofitable farms that are unable to repay their liabilities are declared Third, mass bankruptcy and liquidation of bankrupt by a court of law and go into liquidation. farm enterprises will affect the very large rural Perhaps the most obvious option for resolving population in CIS, which is basically dependent farm debt would be to follow the practice of for its livelihood on these farm enterprises, market economies and the experiences of some however unprofitable. By satisfying the claims of countries in Central Eastern Europe. Insolvent the creditors, the traditional bankruptcy farms would be declared bankrupt and go into procedures are likely to cause irreparable social liquidation, clearing the stage through debt damage to the rural population, thus producing a restructuring for the creation of new financially politically untenable situation in the transition viable units. This is how insolvent farms are countries, which still have no alternative treated in mature market economies, and how the employment opportunities for their farmers and more successful transition countries, such as peasants. This danger is particularly acute because Hungary, have dealt with the resolution of farm of the unclear standing of collectively shared land debt problems since the beginning of transition. in bankruptcy proceedings: courts may decide to Indeed, many experts recommend following this auction off not only buildings, tractors, and path in the CIS countries as well. All CIS livestock, but also farmland, leaving the rural countries have bankruptcy laws that in principle families without any sources of income. can impose liquidation of insolvent farms with the objective of satisfying the creditors' claims (at On balance, when politicians, social scientists, least partially). and even economists have to weigh the interests of creditors - businesses or government - against However, the present study and certain the interests of a large rural population, the experiences in other parts of the world suggest balance would naturally tilt in favor of the rural that the traditional court-driven bankruptcy population. After all, it could be argued that the 54 Farm Debt in the CIS creditors were lending to the farm enterprises in basic ownership and management problems, the expectation of making a profit, and if they including the development of realistic business have miscalculated, they should bear at least part plans, debt-restructuring programs have very little of the responsibility. The rural population, on the value. We recommend starting the process of other hand, had no say in the debt decisions and restructuring with the allocation of physically should not be penalized. Since courts would not identified land parcels with ownership titles to necessarily be guided by such considerations, this individuals. The new owners then should be is another argument against imposing traditional allowed to choose freely the actual farm bankruptcy proceedings on CIS farms. organization in which they prefer to continue using their land and other resources. General Principles for Resolution of Farm Debt Problem Implementable Framework for Out-of-Court Debt Settlement and Farm Restructuring Given the actual conditions in CIS, the optimal approach to resolving the farm debt Instead of invoking blanket bankruptcy problem should include a set of actions that procedures, we recommend an approach that address both macro- and micro-level factors. implements a one-time comprehensive out-of- court debt settlement linked with farm * Creation of an incentive system and a macro- restructuring and introduction of hard budget policy framework for agriculture that allows constraints. Such a process has been recently efficient agricultural producers to make implemented in Moldova. It is still too early to profits and to invest. judge the long-term impacts of the process, but it * A one-time process of expedited debt has certainly met with initial success: the .sAoettlment condiones on genuineintem deb outstanding farm debt has been practically settlement conditioned on genuine interna liquidated within one year, the rural population restructuring and privatizaton of the farms has not been deprived of its rights in land, livestock, and farm machinery, and the former * Creation of necessary economic conditions for collective farms were restructured into new debt- the recovery of the restructured farms free entities based on private ownership of land emerging from the debt-settlement procedure. and assets. * Introduction of hard budget constraints The Moldovan experience is an example of an forcing the farms to operate under strict integrated approach to managed out-of-court financial discipline, settlement of farm debt. The more general features * Implementation of a working bankruptcy of this approach could be applied also in other system that will prevent accumulation of new countries in the region. Following is a brief debt in farms created through the process of characterization of these general features. restructuring and debt settlement. * The major objective of the one-time managed The unique feature of this general program is intervention is to create new farm entities that the integration of debt resolution (handled as an are free of past debt burden and have the out-of-court managed process) with internal potential to become economically viable. The restructuring of farms and a shift to hard budget goal is not reorganization of existing constraints. Experience shows that if debt is enterprises, but actual creation of new entities written off while the farm organization remains compatible with market principles of unchanged, the result has never prevented re- operation. accumulation of new debt. In parallel with treating the outstanding debt, it is essential to implement a 0 The decision to launch the debt-settlement genuine restructuring of the farms based on process in each farm enterprise and the choice market principles with the goal of improving of the form of the new entity is left to farm productivity and profitability. Without addressing members. The decision-making process is Chapter 6. The Problem and a Solution Framework 55 supported by sufficient information outlining in detail all implications and alternatives, * The process ends with the full liquidation of informing the members of the basic market the old entity, without any legal successor, principles of farm organization and and registration of new entities by the former management. farm members. * The debt-settlement process is managed by a The process should have a definite completion debt-settlement committee, which is date for each farm (four-five months duration), appointed by a national body and consists of and the overall time frame for the entire project local and outside experts. The committee nationally also should be set in advance. A core announces the start of the process and collects group of experts should be assembled to work on the claims from the creditors. the preparation of detailed procedures and manuals, and to travel across the country with the * The outstanding debt is settled primarily from objective of training local forces and supervising the assets oi the farm enterprise. Land the implementation. remains outside the debt settlement procedure. The non-land assets are divided into three Pre-Conditionsfor Success of Debt-Settlement groups: (a) machinery and livestock, which Program are earmarked for distribution to farm members and are exempt from the debt- Certain conditions are essential for successful settlement process; (b) inventories, cash, implementation of such a framework: receivables, other current assets, and all production fixed assets (i.e., storage, farm * Legal framework for land ownership and buildings, processing facilities, etc., excluding titling is in place; housing and social infrastructure), which are Procedures for farm privatization have been used for settling the debt of commercial creditors; (c) social assets and non-privatized adopted; housing, which are used for settling the debt * There is political consensus for a complete to the government and to payroll. and comprehensive approach to farm privatization and farm debt settlement; * The full settlement of debt to commercial suppliers is an integral part of the process. All Thnical Implemanagea ble (e.g., assets under lien are automatically transferred technicaldiplementatio is feaible (. to the entitled creditor. The residual farav assets, excluding the portion distributed to farm members and used for settlement of * * * wage arrears and government debt, are offered to the creditors up to the limit of the debt. The unsettled debt, if any, is taken over by the The specific implementation of the debt- budget and used as a future tax credit for the settlement program will naturally vary from suppliers or in the form of long-term bonds. country to country, but the general principles adopted in Moldova appear to be valid and * The debt settlement process is implemented workable for all CIS countries. The larger with the full support of the government, and countries, such as Russia and Ukraine, may the budget acts as a last resort to reach a full prefer to adopt a regional approach, first settlement of all residual amounts remaining implementing the debt-settlement program in the after the farm assets are exhausted. This is not most progressive regions. The experiences of this a serious constraint, as in most cases farm approached can be extended to a national assets are more than sufficient to satisfy all program at a later stage. obligations. 56 Farm Debt in the CIS The most obvious indicator of success in farm criteria. Third, a working bankruptcy system restructuring and debt settlement is the future needs to be put in place immediately after financial performance of the new restructured restructuring and debt settlement. Bankruptcy farms. The efforts to resolve the debt problem are procedures need to be consistently and not finished with the formal elimination of debt. impartially enforced to avoid accumulation of First, the macroeconomic incentive framework new debt and to facilitate further restructuring and the internal farm organization should both be toward greater productivity and efficiency in the conducive to potential profitability and viability farning sector. It is only through a combination of farms. Second, soft lending must be abolished of such strict organizational and policy measures and hard budget constraints must be introduced that the farm sector will be start evolving along a for better financial discipline at the farm level. path that excludes the vicious circle of debt Future borrowing must be based on strict restructuring followed by new debt accumulation economic and business principles that use risk followed by more debt restructuring. and creditworthiness as the main decision Appendix A Annex Tables from the Main Text Annex to Chapter 2: Consumer Price Index and Exchange Rate by Country 1994-1998 Table A2.1. CPI used in the calculations (1994=1) 1995 1996 1997 1998 Belarus 8.1 12.4 20.3 35.0 Kazakhstan 2.8 3.8 4.5 4.8 Moldova 1.1 1.4 1.5 1.6 Russia 3.0 4.4 5.0 6.4 Ukraine 4.8 8.6 10.0 11.0 Source: IMF and own calculations Table A2.2 Exchange rates - US$ per unit of national currency (yearly average) Currency 1994 1995 1996 1997 1998 Belarus Ruble 3666 11533 13292 26191 46386 Kazakhstan Tenge 36 61 68 76 79 Moldova Lei 4.1 4.5 4.6 4.6 5.4 Russia Ruble 2400 4005 5010 5.8 13.3 Ukraine Hryvna 317.0 147.3 1.8 1.9 2.5 Source: IMF 57 58 Farm Debt in the CIS Annex to Chapter 4: Results of Farm Case Studies in CIS Countries Table A4.1: Farm Case Studies in Belarus Farm name Gory Goretsky Pogodina Debt burden Low Medium High Accounts payable as % of sales 5 20 73 Farm has arrears to social fund No Yes Yes Arrears to social fund increased in recent years No Yes Yes Barter is used for making payments to social fund No No No Farm has wage arrears No No Yes (3months) Change in wage arrears in recent years None None Increased Percent of wages paid in kind All cash 5% 20% Percent of farm output transferred to workers as wage payments None 5% 15% Percent of farm's output sold to workers 10% 2% None Change in farm employment in the near future None Decline by 25% None Source: Belarus Institute of Agricultural Economics. Unpublished results of interviews with the managers Table A4.2: Farm Case Studies in Kazakhstan Farm type Production Limited liability Production Production Production cooperative partnership cooperative cooperative cooperative Farm name Stepnoye Namys Tzelinny Temirlan Badam Farm location North North North South South Assets/debt 2 1.39 0.76 0.63 0.36 Current assets/current liabilities 1.57 1.0 0.69 0.60 1.16 Debt burden Low Medium High High High Farm has arrears to social fund Yes Yes Yes Yes Yes Change in arrears to social fund in Decreased Increased Increased Increased Increased recent years Barter used for payments to social Yes Yes Yes Yes Yes funds Farm has wage arrears None Yes Yes Yes Yes (6 months) (5 months) Change in wage arrears in recent Decreased Increased Increased Increased Increased years Average wage ('000 tenge, 1998) 70 59 62 9 17 Percent of wages paid in kind 15 58 40 28 40 Percent of farm output transferred 15 8 16 30 10 to workers as wage payments Percent of farm output sold to 10 5 9 0 15 workers Change in farm employment in the Increase 10% Increase 15% Increase 10% Increase 15% Increase 25% near future Source: Kazakhstan Institute of Agricultural Economics. Unpublished results of interviews with the managers. Appendix A 59 Table A4.3: Farm Case Studies in Russia Farm type Production Full liability Full liability Joint stock Joint stock Production cooperative partnership partnership company company cooperative Farm name Dzerzhinsky Iskra Selivaniha Borisovo Margarito Mir vsk Farm location (oblast) Rostov Orel Moscow Moscow Rostov Orel Debt/sales 0.06 0.14 1.05 1.77 2.01 2.40 Current assets/current 18.5 4.65 1.22 0.89 0.68 0.22 liabilities Debt burden Low Low Medium High High High Farm has arrears to n.a. n.a. Yes Yes Yes Yes social fund Share of arrears to n.a. n.a. 65% n.a. 28% 53% social fund in debt Farm has wage arrears None None Yes Yes Yes Yes Percent of wages paid n.a. n.a. n.a. n.a. 100% 90% in kind Change in farm Decrease by Decrease by Decrease by n.a. n.a. n.a. employment in 5 years 50% 50% 50% Source: Russian Agrarian Institute. Unpublished results of interviews with the managers 60 Farm Debt in the CIS Annex to Chapter 5: Overview of Policy Instruments Used for Farm Debt Resolution by CIS Countries 1992-2000 The policy instruments listed in the following The policy instruments are classified as tables are based in part on economic criteria (price "major" and "not major" according to the support, subsidized credit, bankruptcy) and in part importance of their use in each country for each on the actual practices observed in CIS (barter, year between 1992 and 2000. The classification commodity credit, inter-enterprise settlements, by importance is based on the agricultural policy etc.). The instruments are divided into four matrices available on the World Bank's web site groups: I) policies that affect revenue-generating (http://wblnOO I8.worldbank.orgleca/eca.nsf). opportunities for producers by emphasizing prices and marketing arrangements; II) policies that Country reports prepared by the five affect the ability of producers to reduce costs; III) counterpart teams participating in this study also policies that provide debt relief; and IV) policies provided a rich source of information about aimed at a long-term solution of the farm debt changing patterns of use of various policy problem (farm restructuring, bankruptcy). instruments over time. Appendix A 61 Table A5.1: Belarus Legend: + in shaded cells denotes major instrument, - not a major instrument in a particular year Policy goals and instruments 1992 11993 11994 11995 1996 11997 1998 |1999 2000 1. Creation of domestic and external marketing opportunities a) State procurement orders + + + + + + + + + b) Price support + + + + + + + + + c) Import tariffs and quotas + + + + + + + + + d) Exchange rate policy _ 7 _ _ _ _ _ _ _ e) Barter agreements with foreign + + + + + + + + governLments _+ 1., Measures to reduce production costs a)Inputsubsidies + + + + + I+ + + + b) Direct subsidies for farms that are + + + + + + + + + producing in unfavorable natural conditions__ _ __ c) Subsidized government credits + + + + + + + + d)Commodity credit - _ - + + + + + + e) Tax privileges + + + + + -+ + + + III. Debt relief a)Write-off and forgiveness of principal + _ _ _ _ _ b) Rescheduling and deferment _ - _ _ + + _ + c) Mutual settlements + + + + + + + + + d) Revaluation of current assets - _ _ _ _ + + - - e) Write-off of penalties for overdue debt _- + + + payments f) Tradable debt financial instruments - _ _ _ _ (bonds, promissory notes) IV. Farm enterprise restructuring ____X_ __ a) Merger and reorganization + + + + + + + + + b) Financial rehabilitation _ - - 1 1- - - - + c) Outside management - - 1- - _- +- l- + d) Bankruptcy and liquidation I . - 1- - - - + 62 Farm Debt in the CIS Table A5.2: Kazakhstan Legend: + in shaded cells denotes major instrument, - not a major instrument in a particular year Policy goals and instruments 1992 1993 11994 1995 1996 11997 1998 |1999 12000 I. Creation of domestic and external marketin opportunities a) State procurement orders + + + + + + - + + b)Pricesupport + + + + - - - c) Import tariffs and quotas + + + + d) Exchange rate policy + + + e) Barter agreements with foreign + + + + + + + + governments II. Measures to reduce production costs a) Input subsidies + + + b) Direct subsidies for farms that are + + + + producing in unfavorable natural conditions c) Subsidized government credits : + + + + + + + d) Commodity credit -+ + + + .+ e) Tax privileges : Ill. Debt relief a)Write-off and forgiveness of principal + + + + + b) Rescheduling and deferment + + + + c) Mutual settlements + + : + + + + + + d) Revaluation of current assets - - X e) Write-off of penalties for overdue debt - payments f) Tradable debt financial instruments (bonds, promissory notes) _ IV. Farm enterprise restructuring X a) Merger and reorganization _ I+ _ I+ I+ I I- b) Financial rehabilitation - | | | -+ _+ - c) Outside management - |- __|-_|+ |+ |+ d) Bankruptcy and liquidation - - _ _ _ _ ___|+ _ + |+ Appendix A 63 Table A5.3: Moldova Legend: + in shaded cells denotes major instrument, - not a major instrument in a particular year Policy goals and instruments 1992 1993 1994 1995 1996 1997 1998 |1999 2000 I. Creation of domestic and external market ng opportunities a) State procurement orders + + + + + + - - b) Price support + + + + c) Import tariffs and quotas + + + + + . d) Exchange rate policy + + + e) Barter agreements with foreign + + + + + + + + + governments __ __ 11. Measures to reduce production costs a) Input subsidies + + + + b) Direct subsidies for farms that are + producing in unfavorable natural conditions c) Subsidized government credits + + d) Commodity credit J - - 1 - - - - - e) Tax privileges + + + + + + + + + 111. Debt relief _ _____ a) Write-off and forgiveness of principal + + + + b) Rescheduling and deferment + + + c) Mutual settlements + + + + + + + + + d) Revaluation of current assets e) Write-off of penalties for overdue debt - payments __ f) Tradable debt financial instruments + + (bonds, promissory notes) _ _ _ IV. Farm enterprise restructuring a) Merger and reorganization + + l+ l+ l+ l+ __ __ __ b) Financial rehabilitation - _ _ ______+ |+ |+ |+ c) Outside management - - 1- 1-_ -_+ 1+ 1+ 1+ d) Bankruptcy and liquidation - - _ _ _____+ _ T+ I+ 64 Farm Debt in the CIS Table A5.4: Russia Legend: + in shaded cells denotes major instrument, - not a major instrument in a particular year Policy goals and instruments 1992 1993 1994 1995 1996 1997 1998 1999 2000 1. Creation of domestic and external marketing opportunities a) State procurement orders + + - b) Price support c) Import tariffs and quotas + d) Exchange rate policy _ + + + e) Barter agreements with foreign + + + + + + + + + governments I __ II. Measures to reduce production costs a) Input subsidies + + + - b) Direct subsidies for farms that are + + + l producing in unfavorable natural conditions c) Subsidized government credits + + + + + + + + d) Commodity credit l- l- + + - l- - e) Tax privileges + + + + + - 1- 1- Ill. Debt relief a) Write-off and forgiveness of principal + + - + - - b) Rescheduling and deferment - - + + + + + + + c) Mutual settlements - - + + + + + + + d) Revaluation of current assets - - - l e) Write-off of penalties for overdue debt - - - - - - - + - payments l l_l_l f) Tradable debt financial instruments - - - - -- - (bonds, promissory notes) _= _ _ _____ IV. Farm enterprise restructuring a) Merger and reorganization + + + + + + + ++ b) Financial rehabilitation - T 1 - - 1- I+ + 1+ c) Outside management r- T- 1 - - 1- 1- 1+ 1+ d) Bankruptcy and liquidation Appendix A 65 Table A5.5: Ukraine Legend: + in shaded cells denotes major instrument, - not a major instrument in a particular year Policy goals and instruments 1992 1993 11994 11995 11996 1997 1998 11999 2000 1. Creation of domestic and external marketi opprtunities a) State procurement orders + + + +_ b) Price support + + + c) Import tariffs and quotas + + + + + d) Exchange rate policy = _ + e) Barter agreements with foreign + + + + + + + + + governments 11. Measures to reduce production costs a) Input subsidies + + + + b) Direct subsidies for farms that are + + + + + poducing in unfavorable natural conditions c) Subsidized government credits + + + + + + + _ d) Commodity credit - + J+ + + + + + + e) Tax privileges + + + + + + + + + [11. Debt relief a) Write-off and forgiveness of principal + .+ . + + b) Rescheduling and deferment + . - + + + + + c) Mutual settlements + + + + + d) Revaluation of current assets + e) Write-off of penalties for overdue debt - + + + + + payments 1) Tradable debt financial instruments + _ (bonds, promissory notes) __ __ IV. Farm enterprise restructuring a) Merger and reorganization + + + + + + 1+ + + b) Financial rehabilitation - - - - - + c) Outside management - - - _- _- V_ __ - - d) Bankruptcy and liquidation - - - 1- ______ 1- 1- - Appendix B Statistical Tables with Debt-Related Data by Country 1994 and 1998 67 68 Table Bi: Structure of the consolidated farm balance sheet and structure of accounts paya ble by country (in percent) 1994 1998 Belarus Kazakhstan Moldova Russia Ukraine Belarus Kazakhstan Moldova Russia Ukraine Assets._ 1. Fixed assets 91 74 82 77 31 65 53 83 70 85 II. Current assets 8 20 17 20 69 29 30 17 14 15 11.I Inventories 7 15 11 15 43 26 17 10 11 12 11.2 Financial current assets 1 6 6 4 26 3 12 7 3 3 11.2.1 Accounts receivable 1 5 6 3 22 2 12 7 2 2 III. Other assets 1 6 1 3 0 5 17 0 16 0 Total assets 100 100 100 100 100 100 100 100 100 100 Equity and liabilities ______. IV. Equity 97 56 85 82 60 87 36 76 83 84 V. Long-term liabilities 0 0 0 5 0 2 6 4 2 3 V.1 long-term bank loans 0 0 0 1 0 2 2 1 0 0 VI. Current liabilities 2 44 16 14 39 11 59 37 15 13 VI. i short-term bank loans 1 6 1 4 3 1 1 1 0 0 VI.2 Accounts payable 2 19 13 8 25 9 57 17 13 12 VI.2.1 goods and services I 1.1 5 4 10 6 27 7 5 5 VI.2.2 payroll 0 2 2 1 3 1 6 2 1 2 VI.2.3 social funds 0 2 2 1 3 0 11 3 5 2 VI.2.4 taxes 0 2 2 1 4 1 8 5 2 2 VI.2.5 other payables 1 1 2 1 6 1 5 1 1 2 Accounts payable Total accounts payable 100 100 100 100 100 100 100 100 100 100 Goods and services 48 57 42 48 38 65 47 41 35 39 Payroll 14 11 12 16 13 8 10 10 8 17 Social funds 5 13 15 15 10 5 20 18 40 17 Taxes 3 12 14 9 14 11 15 27 12 13 Other payables 30 7 18 12 24 11 9 4 5 14 Table B2: Changes in maor balance sheet components by country (per-farm data, in US$ '000) 1994 1998 Belarus Kazakhstan Moldova Russia Ukraine Belarus Kazakhstan Moldova Russia Ukraine Total assets 4155 3288 1924 1382 549 2620 798 2302 2444 2914 Current assets 352 664 330 272 379 763 236 393 345 428 Inventories 16 71 59 17 27 33 31 63 15 25 Financial current assets 49 183 117 62 142 69 99 168 74 77 Accounts receivables 39 179 III 44 121 55 97 156 50 64 Total liabilities 4155 3288 1947 1382 549 2620 798 2688 2444 2914 Long-termn liabilities 5 14 4 64 2 46 46 93 45 86 Long-term bank loans 5 14 1 11 2 46 19 16 3 1 Current liabilities 104 1436 301 189 215 298 468 420 376 379 Accounts payable 73 638 247 II 139 239 454 400 327 357 For goods and services 35 364 103 54 54 154 213 163 116 140 Payroll 10 70 29 18 18 19 44 41 25 60 Social fund 80 37 17 15 89 71 130 62 Taxes 2 77 35 10 20 26 66 108 40 46 Table B3: Summary of changes in major per-farm indicators 1994-1998 (ratio 1998/1994 based on per-farm data in US$) Belarus Kazakhstan Moldova Russia Ukraine Number of enterprises 0.93 1.19 0.93 0.99 0.89 Agricultural land per farm 1.05 0.56 1.07 0.93 1.07 Arable land per farm 1.04 0.57 1.10 0.89 1.08 Total number of employed per farm 0.84 0.36 0.73 0.68 0.76 Employed in agriculture per farm 0.83 0.35 0.75 0.69 0.80 Value of production 2.77 0.85 1.49 0.74 0.84 Value of sales 2.69 0.39 0.90 0.82 0.67 Production costs 2.85 0.35 0.90 0.73 1.38 Total assets 0.63 0.24 1.20 1.77 5.31 Current assets 2.17 0.35 1.19 1.27 1.13 Inventories 2.29 0.28 1.06 1.28 1.48 Financial current assets 1.43 0.54 1.43 1.19 0.54 Accounts receivables 1.43 0.54 1.41 1.14 0.53 Total liabilities 0.63 0.24 1.38 1.77 5.31 Long-term liabilities 9.47 3.21 23.44 0.71 36.53 Long-term bank loans 9.47 1.31 11.47 0.31 0.50 Current liabilities 2.88 0.33 2.83 1.99 1.76 Short-term bank loans 1.25 0.04 0.72 0.13 0.20 Accounts payable 3.27 0.71 1.62 2.94 2.56 For goods and services 4.42 0.58 1.58 2.15 2.62 Payroll 1.85 0.63 1.39 1.39 3.40 Social funds 3.51 1.11 1.91 7.75 4.24 Taxes 10.30 0.86 3.13 4.09 2.34 Total debt (long-term liabilities plus current liabilities) 3.18 0.35 3.10 1.66 2.14 Total net liabilities (total debt minus financial current 4.61 0.33 4.13 1.82 5.14 assets) Total net liabilities adjusted for social assets (total net 0.27 0.34 2.16 -5.11 0.75 liabilities minus value of social assets) I I I Table B4: Structure of consolidated farm profit and loss statement, structure of production costs, and farm product mix by country (in percent) - 1994 1998 Belarus |Kazakhstan |Moldova Russia Ukraine Belarus Kazakhstan Moldova Russia Ukraine I. Structure of profit and loss statement I Total sales revenue 100 100 100 100 100 100 100 100 100 100 Cost of sold commodities, services etc. 90 108 89 113 54 97 153 119 136 125 Profit from sales of commodities, services 10 -8 11 -13 31 3 -53 -36 -37 -37 etc. I _I Total Profit 11 -12 16 -2 34 3 -58 -47 -39 -50 Profit tax 1 1 I I I 0 1 0 0 0 Net profit 10 -12 15 -2 33 3 -59 -48 -50 -66 II. Structure of production costs Total production costs 100 100 100 100 100 100 100 100 100 100 Wages 16 21 34 25 30 18 22 26 18 20 Material inputs 79 51 63 49 59 73 59 62 60 61 seeds and seedlings 3 2 4 2 5 4 12 7 6 6 animal feed 28 11 13 19 17 30 14 12 23 19 intermediate farm-produced inputs 2 1 1 2 2 2 1 1 1 6 fertilizer 7 1 1 1 3 7 1 2 2 4 fuel and oil products 12 13 14 6 13 6 12 11 7 9 electricity 5 7 5 4 4 4 4 3 3 3 spare parts 8 5 4 5 7 7 7 4 6 6 payments for custom services 5 10 3 8 8 3 4 2 9 8 Depreciation 5 3 1 13 1 9 12 11 14 12 III. Product mix Share of livestock costs in total production 0.57 0.41 0.35 0.60 0.53 0.60 0.38 0.27 0.58 0.52 costs I_I I Table B5: Structure of major sources of investment in agriculture by country (in percent) 1994 1998 Belarus Kazakhstan Russia Ukraine Belarus Kazakhstan Russia Ukraine Total investment (mln. US$) 122 149 2493 873 375 12 1997 820 Total investment 100 100 100 100 100 100 100 100 Own financial resources, total 64 93 65 65 55 98 94 76 depreciation 33 27 52 9 42 52 62 69 Borrowed capital, total 36 7 35 35 45 1 6 24 bank credits 0 0 0 0 0 0 0 0 other enterprises debt 9 0 14 1 28 0 1 0 non-budgetary funds 20 0 19 22 8 0 3 21 Other 4 0 1 0 2 0 0 0 Table B6: Structure of taxes and social contributions assessed for farm enterprises (in percent of total amount assessed) 1994 1998 Belarus Kazakhstan Moldova Russia Ukraine Belarus Kazakhstan Moldova Russia Ukraine Social contributions assessed, total 59.8 23.2 48.4 19.2 26.8 60.7 44.8 31.5 n.a. 40.6 Social security fund 58.7 22.0 0.7 15.2 23.5 59.8 34.9 0.2 n.a. 34.3 Unemployment fund 1.1 0.5 40.7 1.4 0.0 0.9 3.1 28.2 n.a. 2.0 Medical insurance fund n.a. 0.7 7.0 2.6 3.3 n.a. 4.5 3.1 n.a. 4.3 Taxes assessed, total 40.2 76.8 51.6 80.8 73.2 39.3 55.2 68.5 n.a. 59.4 VAT 6.6 67.0 18.2 75.9 37.1 15.5 35.0 16.4 n.a. 34.0 Excise tax 2.6 1.3 8.1 0.6 1.4 4.8 0.8 7.2 n.a. 0.7 Profit tax 5.5 7.3 14.5 1.4 3.3 2.6 2.4 8.7 n.a. n.a. Land tax 3.3 1.0 4.7 1.5 1.0 8.2 2.4 16.8 n.a. n.a. Real estate tax 1.5 0.1 1.1 0.0 1.2 1.8 4.8 0.2 n.a. 9.0 Other taxes 20.8 0.1 5.0 1.4 33.5 6.4 9.7 19.2 n.a. 15.7 Total taxes and social contributions 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 n.a. 100.0 Additional summary information on contributions/taxes Social contributions as % of sales 5.7 3.9 13.0 12.3 9.7 6.9 17.9 11.2 n.a. 13.7 Taxes as % of sales 3.8 12.7 13.9 51.7 26.5 4.5 22.1 24.3 n.a. 20.0 Total social + taxes as % of sales 9.5 16.6 26.9 64.0 36.2 11.4 40.0 35.5 n.a. 33.7 Table B7: Effectiveness of collection of taxes and social contributions in farm enterprises (ratio of collected to assessed taxes, in percent) 1994 _ _ 1998 Belarus Kazakhstan Moldova Russia Ukraine Belarus Kazakhstan Moldova Russia Ukraine Social contributions, total 81 50 32 65 62 91 17 94 30 39 Social security fuid 81 50 21 67 65 91 16 100 27 42 Unemployment fund 81 0 27 60 82 66 13 94 48 17 Medical insurance fund _ 50 59 59 45 19 93 37 17 Taxes, total 83 48 36 99 79 91 53 84 n.a. 54 VAT 81 45 49 100 86 97 47 116 n.a. 63 Excise tax 83 59 22 79 82 95 77 68 n.a. 81 Profit tax 84 61 32 84 88 87 96 90 n.a. n.a. Land tax 100 87 36 79 97 77 62 51 n.a. n.a. Real estate tax 68 50 38 66 96 84 59 143 n.a. 48 Othertaxes 81 14 29 66 70 95 54 88 n.a. 35 Total social contributions and taxes 82 48 34 92 74 91 37 87 29 47 Table B8: Financial ratios by country 1994 1998 Belarus Kazakhstan Moldova Russia Ukraine Belarus Kazakhstan Moldova Russia Ukraine Current liabilities/Total assets 0.02 0.44 0.16 0.14 0.39 0.11 0.59 0.37 0.15 0.13 Total liabilities/Current assets 11.81 4.95 5.90 5.08 1.45 3.43 3.38 6.83 7.09 6.80 Current liabilities/Current assets 0.29 2.16 0.91 0.70 0.57 0.39 1.98 2.16 1.09 0.89 Current liabilities/(Current assets minus 2.13 7.84 2.57 3.06 1.52 4.30 4.74 5.07 4.90 4.91 Inventories) I Accounts payable/Accounts receivable 1.89 3.56 2.22 2.51 1.15 4.33 4.68 2.56 6.49 5.60 (Total liabilities - Current assets)/Total 0.92 0.80 0.83 0.80 0.31 0.71 0.70 0.85 0.86 0.85 liabilities _ (Total liabilities - Current assets- Social 0.80 0.74 0.82 0.69 0.28 0.56 0.65 0.69 0.65 0.73 assets)/Total liabilities l _ (Profit + Annual depreciation)/Total 0.01 -0.01 0.03 0.06 0.25 0.05 -0.11 -0.04 -0.02 -0.03 liabilities I _ _ Total liabilities/Sales 13.55 5.88 5.78 4.44 1.38 3.17 3.69 8.81 9.59 10.98 Current liabilities/Sales 0.34 2.57 0.89 0.61 0.54 0.36 2.16 2.79 1.47 1.43 Sales/Total assets 0.07 0.17 0.18 0.23 0.73 0.32 0.27 0.13 0.10 0.09 Sales/Current assets 0.87 0.84 1.02 1.14 1.05 1.08 0.92 0.78 0.74 0.62 Profit/Sales 0.10 -0.12 0.15 -0.02 0.33 0.03 -0.59 -0.48 -0.50 -0.66 Table B9: Basic indicators of agricultural sector by country (per farm data, US$ '000) 1994 1998 Belarus Kazakhstan Moldova Russia Ukraine Belarus Kazakhstan Moldova Russia Ukraine Value of agricultural output 424 1534 379 679 591 1176 1311 566 501 499 Value of sales 307 559 337 311 398 826 216 305 255 266 Production costs 407 956 435 685 457 1161 334 391 502 632 Total assets 4155 3288 1924 1382 549 2620 796 2302 2444 2914 Current assets 352 664 330 272 379 763 235 393 345 428 Current material assets 303 481 213 210 237 694 137 226 268 351 Financial current assets 49 183 117 62 142 69 98 168 74 77 Accounts receivables 39 179 I11 44 121 55 97 156 50 64 Total liabilities 4155 3288 1947 1382 549 2620 796 2688 2444 2914 Long-term liabilities 5 14 4 64 2 46 46 93 45 86 Long-term bank loans 5 14 1 11 2 46 19 16 3 1 Current liabilities 104 1436 301 189 215 298 467 850 376 379 Short-term bank loans 30 189 24 54 15 38 7 18 7 3 Accounts payable 73 638 247 III 139 239 453 400 327 357 For goods and services 35 364 103 54 54 154 213 163 116 140 Payroll 10 70 29 18 18 19 44 41 25 60 Social funds 4 80 37 17 15 13 89 71 130 62 Taxes 2 77 35 10 20 26 66 108 40 46 Net profit 32 -70 50 -7 131 22 -128 -145 -127 -174 Total debt 108 1450 305 253 218 345 513 943 421 465 Total net liabilities 60 1267 188 191 75 275 414 776 347 388 Total net liabilities adjusted -416 1090 160 31 59 -114 374 346 -157 44 for social assets (total net liabilities minus value of social assets) Table B1O: Basic productivity and indebtedness indicators per hectare by country (US$/ha) 1994 1998 Belarus Kazakhstan Moldova Russia Ukraine Belarus Kazakhstan Moldova Russia Ukraine Per hectare of agricultural land Value of agricultural output 164 171 154 116 254 431 260 214 92 200 Value of sales 118 62 137 53 171 303 43 115 47 106 Net profit 12 -8 20 -1 56 8 -25 -55 -23 -70 Total debt (long-term liabilities plus current 42 162 124 43 93 126 102 356 78 187 liabilities) Total net liabilities (total debt minus 23 141 76 33 32 101 82 293 64 156 financial current assets) Total net liabilities adjusted for social -161 122 65 5 25 -42 74 131 -29 18 assets (total net liabilities minus value of social assets) . Table Bll: Basic productivity and indebtedness indicators per worker by country (US$/worker) 1994 1998 Belarus Kazakhstan Moldova Russia Ukraine Belarus Kazakhstan Moldova Russia Ukraine Per agricultural worker Value of agricultural output (in current 1464 2341 737 2505 2022 4843 5628 1503 2707 2241 prices) Value of sales (current prices) 1058 854 655 1148 1362 3404 926 810 1376 1191 Net profit (current prices) 109 -107 98 -27 448 89 -549 -385 -685 -782 Total debt (long-term liabilities plus 374 2213 592 933 744 1420 2200 2506 2273 2088 current liabilities) ___ Total net liabilities (total debt minus 206 1934 365 705 258 1134 1777 2061 1875 1741 financial current assets) I I_I Total net liabilities adjusted for social -1437 1663 311 113 202 -468 1606 918 -847 198 assets (total net liabilities minus value of social assets) . Table B12: Major indicators of government credit use and debt restructuring _ Belarus | 1990 1991 1992 1993 1994 1995 1996 1997 1998 Use of government credits (million ruble) Owed to the government at the beginning of the year 3205 1348 2051 21000 265000 375000 1130000 1937000 3550000 Amount of government credits during the year 1293 1435 34603 488000 612000 1829000 2088000 4412000 12374000 Amount of credits paid back during the year 530 732 15668 244000 502000 1074000 1281000 2799000 5265000 Amount of credits written off 2620- Owed to the government at the end ofthe year 348 2051 20986 265000 375000 1130000 1937000 3550000 10659000 Overdue credits owed to the government 2 13 1000 2000 44000 35000 275000 177000 Share of overdue credits to the government in total 0 0 0 1 4 2 8 2 Exchange rate 19 59 193 2696 3666 11533 13292 26191 46386 Use of government credits (million dollars) I Owed to the government at the beginning of the year 169 23 11 8 72 33 85 74 77 Amount,of government credits during the year 68 24 179 181 167 159 157 168 267 Amount of credits paid back during the year 28 12 81 91 137 93 96 107 114 Amount of credits written off 138 1 Owed to the govemment at the end of the year 18 35 109 98 102 98 146 136 230 Overdue credits owed to the government 0 _0 0 1 4 3 10 4 Kazakhstan 1992 1993 1994 1995 1996 1997 1998 Use of government credits (million tenge) _ _ Amount of government credits during the year 2525 4540.9 1114 1184.6 40 0 Amount of credits paid back during the year 0 0 735 1075.2 119.4 40 Restructured until 2004 1221 Overdue credits owed to the overnment 379 119.4 . Exchange rate 36 61 68 76 79 Use of government credits (million dollars) ___ _ _ Amount of government credits during the year 125 18 17 1 0 Amount of credits paid back during the year 0 12 16 2 1 Restructured until 2004 34 0 0 0 0 Overdue credits owed to the governnent 0 6 2 0 0 Moldova 1992 1993 1994 1995 1996 1997 1998 Use of government credits (1000 lei) Owed to the government at the beginning of the year Amount of government credits during the year 15576 4666.8 16077.3 2074.2 975.7 213.1 Amount of credit paid back during the year 19949.7 4101.9 16595.3 0 183.7 85.3 Amount of credit written off 10780.2 963.4 12310.9 28.8 Credits owed to the government at the end of the year 2249.8 689.8 9916.2 4146.6 1301.6 301.1 Overdue credit owed to the government 2249.8 689.8 9916.2 4146.6 1188.5 301.1 Share of overdue credit to the government in total 100 100 100 100 Exchange rate 219 1.644 4.06 4.49 4.6 4.62 5.37 Use of government credits (million dollars)I Amount of government credits during the year 0.071 2.839 3.960 0.462 0.211 0.040 Amount of credit paid back during the year 0.091 2.495 4.088 0.040 0.016 Amount of credit written off 0.049 0.586 3.032 l _ 0.005 Credits owed to the government at the end of the year 0.0 10 0.420 2.442_ 0.924a 0.282 0.056 Overdue credit owed to the government 0.010 0.420 2.442 0.924 _ 0.257 0.056 Russia 1992 1993 1994 1995 1996 1997 1998 1999 Use of government credits (billion rubles) Amount of government credits during the year(s) 274.6 1806 8341.5 7200 10 I Ioo Amount of credit Paid back during the year Amount of credit written off 23 (1990) Amount of debt rescheduled 5600 25000 5100 5.7 3.5 Owed to the government at the end of the year Overdue credit owed to the government Total for credits denominated in dollars in 1992-97 i Exchange rate 223 932 2400 4005 5010 5.76 13.305 20 Use of government credits (million dollars) Amount of government credits during the year(s) 1231 1938 3476 1798 2216 0 0 0 Amount of credit paid back during the year 0 0 0 0 0 0 0 0 Amount of credit written off 0 0 0 0 0 0 0 0 Amount of debt rescheduled 0 0 2333 6242 1018 0 428 175 Owed to the government at the end of the year 0 0 o 0 o 0 0 0 Ukraine 1992 1993 1994 1995 1996 1997 1998 1999 Use of government credits (million rubles) Amount of government credits during the year(s) 335 211 581 764 1159 1148 Amount of credit paid back during the year 372 Amount of credit written off 1800 _xxx xxx 741 Amount of debt rescheduled Owed to the government at the end of the year Overdue credit owed to the government Exchange rate 319 9584 147.307 1.829 1.862 2.453 3.7265 Use of government credits (million dollars) _ Amount of government credits during the year(s) 1.06 1.43 317.7 410.3 472.5 308.1 Amount of credit paid back during the year 199.8 Amount of credit written off 198.8 Amount of debt rescheduled Owed to the government at the end of the year Appendix C The Moldova Farm Debt Restructuring Program - A Unique Approach1 PART I: OVERVIEW * reorganization of the collective farm into other legal forms sanctioned by Moldovan The first land privatization efforts were legislation. sanctioned with approval of the Land Code in 1992 and more than 1.2 million people were CPBR Moldovan technicians developed a empowered to own agricultural land. However, methodology and appropriate legal framework there was no significant organized land reform and successfully privatized all 72 farms by the program until 1996 when the Government of spring of 1998, when the National Land Program Moldova requested - and USAID approved - (NLP) started on all collectively farmed East-West Management Institute (known in agricultural enterprises throughout Moldova. Moldova as the Center for Private Business Reform - CPBR) to privatize a collective farm Early expectations that the successor known as Mayak in Nisporeni. As a result, 1,345 enterprises (collective shell) would sell assets left individual land titles were distributed to eligible during privatization to pay-off debts, or would farm members. The privatization of the Mayak settle debts by generating profits from mills, oil farm and the legalization of private land presses or other potentially lucrative businesses ownership was a historic step that completely and left in the "shell" did not materialize. In most irrevocably separated the agricultural sector of cases the "shell" continued to accumulate debts Moldova from its Soviet past. and remained "alive" as a legal entity, providing ample opportunities for tax evasion and other Following completion of the Mayak types of fraud. privatization, the Government of the Republic of Moldova with the support of the US Agency for It became clearer during the Pilot Project that International Development, implemented the the issue of unsettled debts of the collective farms "Land" Pilot Project in 72 former collective farms would likely slow down the privatization and in 31 rayons throughout Moldova starting in 1997. reorganization in the entire agricultural sector. The methodology applied on these farms was Within a relatively short time after starting the entirely based on the existing Moldovan NLP, this problem became critical and resulted in legislation and included: several negative impacts: * actual distribution of all land farmed by the * complete restructuring and distribution of collective farm to entitled farm workers; property was being delayed; * actual distribution of the collective farm's * assets of privatized farms reserved to repay debt-free assets to entitled farm workers; and debts were idle and without adequate security, hence their depreciation was accelerating; This summary is based on the Moldova country study prepared by D. Dumbraveanu, R. Flick, A. Muravschi, S. Shapa, and C. Tanase (see ECSSD Working Paper 27 for the full version). It is intended as a descriptive record of the debt settlement procedure implemented in Moldova and does not necessarily reflect the views and opinions of the World Bank and of the authors of the present report. 81 82 Farm Debt in the CIS new private farms created during the on their books. For this reason, and in full privatization process were not functioning conformity with the law, inactive collective farm normally as over 35 thousand dissatisfied shells continued to accrue debts and penalties for collective farm creditors were refusing to the delay in repayment of debts. According to deliver supplies and services and in some projections based on the amount of debt and cases were using informal methods to attempt fiscal legislation, each month of the post tender debt collection. period the unsettled debts would increase a total of 16 million lei in debts, penalties, etc. Two At the same time there were other emerging thirds of the debt increase would be penalties issues requiring solution: accrued by the Social Fund for nonpayment of the * the national budget continued to be faced with debts, accumulated in the past. the constant and uncontrolled losses of collective farms and which might continue Based on survey data it was projected that the without complete and final liquidation; property of all collective farms would diminish * social and community infrastructure was by 0.8 billion lei, or 6 percent during one year abandoned and continued rapid deterioration; due to depreciation, theft, sales of seized assets, * significant assets remained on old collective uncontrolled distributions, or other unaccounted shells which potentially could be used to settle for losses. Therefore while debts increased debts or be distributed in a second and final exponentially - even though there was little or no property tender if a way could be found to economic activity on many collectives - the value settle the debts; of their assets which might eventually be used to e old collective shells containing frozen assets repay these debts depreciated or declined. Clearly and debts created potential opportunities for something had to be done. fraud. After much discussion and debate it was Therefore in 1998 CPBR launched an decided that special legislation would be exhaustive debt study throughout the country on a necessary to resolve the debt situation on sample of 562 collective farms. This debt study, collective farms participating in the National Land involving a statistically significant number of Program. But there was fear of the potential farms, resulted in national projections concerning budget impact and concern for the ability to pass farm debt and crystallized resolve to initiate a comprehensive legislation which would: national debt resolution program fully integrated stimulate the process of creating new enterprises into the NLP. The study on 562 farms able to work in market conditions based on private documented that 48 percent (589,679,000 lei) of land and property; be a one-time process, not to be the total farm debt (1,216,434,000) was owed to repeated; be applied only to farms participating in government and 52 percent (626,755,000 lei) was the National Land Program; reasonably defend the owed to private creditors. Eighty one (81) percent interests of the private creditors; and have a of all the debt corresponded to debt principle "reasonable" burden on the country's budget. while 19 percent was attributed to penalties and interest. During the development of the Debt Law the following main principles were applied: it had to But the analysis of the data of 562 farms be a systems approach; it must use of out-of-court documented a continual and rapid increase in liquidation procedures; it must be voluntary; debts - from 1,217,300,000 lei to 1,498,700,000 responsibility must be decentralized and lei or 23 percent increase in 1998 alone with no distributed to various parties during debt indications that this would cease in subsequent settlement; procedures should be as simple as years. In fact, after holding land and property possible and they must be easy to understand. In tenders, the old collective farms, with rare addition to the Debt Law, it was decided to amend exception, ceased their economic activities, but several other laws which would strengthen the they continue existing de jure with all the debts Debt Law and facilitate development of the regulations to the law. The amendments were Appendix C: The Moldova Farm Debt Restructuring Program - A Unique Approach 83 included in a separate law, which was examined Commissions on the one hand, and the expert and approved together with the Debt Law. Such a team and state agencies on the other. The expert comprehensive approach was more convenient team, composed of economists, lawyers, and than separate presentation and approval of the two accountants, and support staff provides technical laws. It spared time and avoided problems - it was assistance to the government, and represent the not necessary to awaken the "parliament tiger" farms' interests during the sittings of the twice. Republican Commission - the official body approving acceptance by the government of The debt settlement procedure begins with a historical debt and other critical approvals during general farm meeting to decide whether to the debt resolution process. One vital role of this participate in the Debt Program, which must expert team was to assist different government include debt settlement and liquidation. Once this agencies (mainly the Tax Office and the Ministry is published by the Property Commission in the of Finance, the Social Fund, Registration Official Monitor, the process formally begins. Chamber by the Ministry of Justice, the State Publishing the farm liquidation intent notifies Archive, the Department of Privatization, the creditors and obliges them to file claims or have National Securities Commission, and others) draft their debts written off; starts a process where any internal regulations and issue circular letters debts owed to the farm are considered aiming at adjusting existing working procedures immediately due; and initiates a period when farm to the provisions of the Debt Law, providing clear property cannot be written off, seized or instructions to local authorities and government collateralized in any way. Following the official representatives on the implementation of the Debt notification, the debt settlement proceeds Law, as well as training them in all aspects of the according to the following steps: 1) Settlement of program. debts to priority creditors and employees; 2) Historic debt settlement; 3) Settlement of current A critical initial task was to assist the Ministry debts; 4) Settlement by the state of transferred of Finance and the Main Tax Office draft the debts; 5) Privatization of property, remaining after regulations to the Debt Law. The regulations were debt settlement; 6) Farm liquidation and removal designed to provide detailed procedures for debt from the State Commercial Registry. resolution, completion of privatization and liquidation of collective farms. The regulations After the Debt Law was passed by the also contained the necessary forms for the entire Moldovan Parliament on 13 May 1999, the CPBR process. Direct participation of our staff in decided to form a new unit (Debt Resolution Unit developing the regulations and the forms excluded - DRU) to provide assistance to all Government the need for training staff after these regulations agencies involved in debt resolution and were adopted by the government, and, to a certain liquidation of collective farms under the degree, simplified the process since the co-authors provisions of the Debt Law. This was approved of the forms were the future implementers. This and additional financing was provided by USAID. aspect was critical and only hindsight has confirmed this. Following the existing CPBR internal structure, new teams of 3 accountants each were Seminars were organized in all regions and formed within each of the eight CPBR field the capital of the country (10 in total). Officials, offices. New staff was also hired to form two as well as farms' main creditors, heads of Chisinau based teams: the core team and the Property Commissions and accountants of farms expert team and the decision was made to add a subject to debt resolution and liquidation senior expatriate advisor. The local teams assist participated at these seminars. Speeches given by the Property Commissions of the farms in former collective farm managers who had already preparing legal and accounting documents, and benefited from the program (those were primarily provide consultations on different issues. The core from the first 18 farms liquidated) were teams ensure the flow of information and provide particularly popular. the link between local teams and Property 84 Farm Debt in the CIS Mass farm debt settlement has no precedents * 539 farms finalized privatization and were in Moldova, and because of this, delays were liquidated. experienced. The practice of resolving delays of farm debt settlement showed that the main reasons For these farms: for these delays were problems of settling current * 1,021,865,000 lei (US$1.00 = lei 12.5 debts, historic debts to banks and transfer offarm approximately) in debt was settled; portfolio shares. But these issues were settled, not a 818,630,000 lei in social assets were without tension and disagreement between the transferred to the local government; Ministry of Finance, the Social Fund and the Main * 624,971,000 lei in historical debt was offset State Tax Office and the NLP executives. In the with assets; end, it was necessary to develop and pass an * 35,265,000 lei in historical debt was written- amendment to the Debt Law as well as the off as remaining historical state debt. corresponding government regulations, promulgated through Government Decisions. The The average time .required for a collective amendments to the Debt Law became effective on farm to completely settle its debt, distribute its June 8, 2000 and since the NLP specialists had property and liquidate was 122 days, ranging from already prepared the requisite regulations to this 32 to 300 days. The efficiency of the debt law, these will be immediately promulgated by component of the National Land Program was Government Decision. constantly growing, and reached by the end of May 2000 a daily average of: The process to amend the Debt Law started in . 2.3 farm liquidations; October 1999 with informal discussions between * 4.3 million lei ($345,000) in debts settled. the NLP and the Republican Commission, the Main State Tax Office, and other GOM officials * * * and ministries. It wasn't until April 2000 until the Government accepted the wording of the As of June 2000, the Debt Program in amendment and it was officially introduced into Moldova is in its final stage. The main goals of Parliament. the National Land Program, including its debt resolution component will be attained by the end NoPexeutwithstandi their abovediscus stiareon, the of August 2000, thus finalizing the first phase of NsLP executives and their advisors still are Of the agricultural reforms in Moldova - complete opinion that the amendment to the Debt Law was rivatizat and in of a coletean unnecessary, if the bureaucracy would have qprvatization and liqudation of all collective and respectedthe intent and spirit of the original law. state farms, and creation of new, privately owned respected the intent and spirit of the original law. farms, free from debt. According to the CPBR work plan approved After a five year stagnation period between by the USAID, 888 collective farms should the appearance of the first applicable Moldovan complete all debt resolution stages and be legislation and the implementation of a completely privatized and liquidated by August comprehensive land reform program, completion 31, 2000. A snapshot view of the debt component of the NLP objectives in a relatively short period of the National Land Program shows the of time was an ambitious project. Sporadic, ad hoc following results, as of the end of May 2000: and superficial privatization was replaced by mass * 765 collective farms published liquidation empowerment of people through real privatization notices; of land and property, secured by land and property * 694 farms' documents were approved by the titles. Although the Law on critical property Republican Commission (decisions on allowed significant advances in 1999, the transfer to the state of historical debt and indebtedness of collective farms was still a serious writing-off of remaining unsettled historical impediment for completion of privatization. debt, if necessary); Solutions were sought to solve the debt problem * 564 farms repaid all debts (including debts to through an intensive analysis of the financial priority creditors, historic and current debts); Appendix C: The Moldova Farm Debt Restructuring Program - A Unique Approach 85 situation of farms, the reasons and dynamics of constantly refining its methodology. Many debt accumulation, as well as by testing and elements of internal methodology became later analyzing existing procedures for debt settlement. parts of laws and regulations providing more opportunities for farms and farmers. The hands- CPBR did not compromise its basic principles on experience gained by the CPBR specialists was while approaching the farm debt issue. It was an invaluable assets when participating in drafting decided that farm debt resolution would be carried legal acts. The popularity of the program grew, a out within a program, farms would join the fact witnessed by vivid interest and large program on a volunteer basis, the program would participation. The popularity was built on trust, be entirely based on Moldovan legislation, and early beneficiaries of the program saw its would have strong built-in incentives. evolution, and believed in increasing opportunities Government support was considered a vital offered by the program in the future. Trust was element and the key to success of the program. also built through the transparency of the The program is the tool for implementing processes and intense information campaigns - legislation that also allows democratic and which were inherent parts of the National Land transparent participation of farms, based on Program and special concerns of CPBR. The contracts signed with the program. Contracts information campaigns aimed at providing a clear stipulate the responsibility of all parties involved, understanding of everyone's rights and legal describe the process in concrete steps and contain options, deep insight into the benefits offered by deadlines for each. The role of the CPBR the program. The program had pure social and specialists was to provide technical assistance to economic reform objectives and managed to avoid the government at all levels. The National Land any political implications. Program enjoyed strong government support and paid great attention to relations with the President, The current stage of the implementation of the Parliament and the Government, which the collective farm debt resolution program allows broadly advertised its objectives within official to infer that the legal framework provided by the circles and mass media. Four Governments were Debt Law proved to be workable. The procedures changed during the implementation of the NLP for debt resolution under that law proved to be without affecting its progress. applicable and succeeded in offering solutions to the great amount of issues and special cases Attractive incentives inserted along the encountered during the settlement of collective process stimulated a great number of farms to farms' debts. More than 800 collective farms will participate, making the program indeed a national be liquidated during one year of implementation program. Only farms that decided by democratic of the debt resolution program in Moldova. The voting to participate in the program and honored success of that work resides in two major groups their contractual obligations, could fully benefit of reasons - those related to the legal procedures from all facilities/advantages provided by the themselves for debt resolution, and those related program. The incentives included: free land titles, to the way these procedures were implemented by full technical support to farms along the the National Land Program. processes, defense of farmer's rights and representing their interests at different instances The major principles of the Debt Law are the by well qualified CPBR professionals, the following: moratorium on accruing penalties and sanctions, * Debt resolution combined with complete an advantageous debt resolution and the privatization and liquidation of collective possibility to start new businesses without farms - a complex one-time event offered to burdensome debts. All these were offered as part participants in a government program on a of one process, a one time-event with clearly volunteer basis. specified limitations in time. * Relatively simple and inexpensive liquidation As the program evolved from a pilot project which allowed rapid completion. on one collective farm to a national program, . State acceptance of farm debts to private comprising the vast majority of farms, it was creditors and the possibility of settling farm 86 Farm Debt in the CIS debts to the state by offsetting with social profit firms unwilling to make contributions assets. for the benefit of the program. * The impact on the budget was not a * The CPBR staff actively participated in significant burden. drafting the Law and the Regulations, with an * Very decentralized process - most decisions understandable tendency to simplify their are made at the local level. future work - actual implementation. * The most important decisions are made by a * The internal CPBR infrastructure provided special government body - the Republican significant local presence of the CPBR staff in Commission, formed by representatives of the field. Regional offices were staffed with various Ministries, thus dispersing professionals, and were well equipped and responsibility. supported. * Provision of incentives fostering large and * The project was carried out over a relatively active participation of farms. short period. * The entire effort was carefully planned and To a great extent the success of the program is monitored. The system of concrete monthly due to the way it was actually implemented. targets for regional offices allowed firm and Several important aspects of the implementation steady work progress throughout the country. are presented below: * The CPBR staff actually did most of the work, Although the program is not finished yet it i.e., CPBR implemented the program, not has already brought some results. By liquidating simply advised government. the collective farms it has produced a huge * Highly professional staff assisted central and cleansing of bad debts in the agricultural sector. local government wherever and whenever The tax offices are recording greater tax possible (cooperation with Government at all collections - private farmers proved to be more levels). disciplined tax-payers. Banks also registered a * Strong Government support and political will decrease in delinquent loans as a result of the made the implementation of the program a disappearance of the collective farms. The combined effort between CPBRIUSAID and program created the necessary premises for the the Moldova Government. development of land markets and land * East West Management Institute (EWMI), a consolidation, the creation of rural credit private, non-profit, non-governmental associations, and other post-privatization organization actually contributed significant activities. amounts of its own money to ensure maximum flexibility and success. Compare this with other contracts implemented by for- Appendix C: The Moldova Farm Debt Restructuring Program - A Unique Approach 87 PART II: THE SOLUTION the process of developing the respective legislative framework. This section describes the political and financial discussions, based on which the concept The first approach. All the insolvent farms of the Law on restructuring of farms undergoing had to initiate bankruptcy procedures, in privatization (hereinafter - Debt Law) was compliance with the Law on bankruptcy. This developed, as well as the main principles of this position was supported mainly by the experts of law and the reasons for introducing the respective the World Bank and the Agency for Restructuring amendments in other laws, as well as the of Agricultural Enterprises. Their main arguments normative procedure for farm debt settlement. for this approach were: * in the agricultural sector there are farms The Debate: Political Situation and Budget functioning effectively and having no debts; Impact general debt forgiveness would put these farms in a unfavorable situation, discouraging them to function effectively; After the pilot-project became the National . bankruptcy procedures would allow the "Land" Program, including most farms, it became situation in each and every farm to be studied clear that the main economic barrier in quick in detail; implementation of the program was the debt * all creditors have the possibility to defend problem. By the beginning of 1999, the total their rights in a court of law; amount of farm debts to various creditors, thirgtsnacotoflw amoun of frm dbts t varius ceditos, 0the bankruptcy procedure will be stimulated, including the state, was over 2 billion lei and and this is important for continuous growing. The transfer of those debts to the new red is resorces fom continuo enterprises, based on private ownership (peasant effective to farms, limited liability companies, joint-stock effectve enterprises. companies, etc.), would have put them in difficult Each of the above mentioned arguments seem conditions from the very beginning. This would logical, however, generally the approach could not have made development of private enterprises in be accepted based on the following reasons: the agricultural sector difficult, if not impossible. * according to the Moldovan legislation, the As a result, the agricultural reform would have bankruptcy procedure requires a lot of time been completely discredited, as it would have not for analysis - approximately one year or reached the final objective, longer for each entity; Thus, the necessity to develop and adopt a * it is important to enforce bankruptcy on new legal framework and to develop concrete almost all farms simultaneously, which is procedures for settling the farm debt problem was practically impossible due to lack of judges raised. with expertise in this sphere; * a large number of creditors, that form the The political situation in the country, at the agricultural infrastructure, supplying it, beginning of 1999, generally favored the providing machinery services and processing successful settlement of the debt problem. There agricultural products would have gone was a parliament majority (the Alliance for bankrupt de facto, since the enterprises have Democracy and Reform) that strongly supported no liquid assets; the implementation of the agricultural reform. The * the provision of credit to the agricultural government backed the idea and was ready to sector would likely have stopped for a long enforce all the measures for the agricultural period of time; reform, in accord with the Memorandum singed * creation and functioning of new viable with the World Bank. farming enterprises would not have been ensured as much of the tools, implements and However, several contradictory approaches to machinery would have been stripped from the solving the agricultural debt problem emerged in 88 Farm Debt in the CIS farms, leaving the newly created private farms creditors. This approach would have complicated without possibilities to work. and prolonged the debt settlement process. The second approach. The debt problem As a result, after long and arduous discussions must be settled for all farms, with no exceptions, within government, with the executives of the regardless of the legal form, including the farms National Land Program, within Parliament and its not joining the National Land Program. This members, and with donors, the following basic approach was supported mainly by left-wing principles were established: parliament representatives. The main arguments * Debt settlement must stimulate the process of were: creating new enterprises able to work in * debt settlement only for farms included in the market conditions and based on privatized National Land Program is a method of forced land and privatized property. destruction of collective farms, which * Mass debt settlement is a one-time process, contravenes with the principle of equality for which will not be repeated. Upon its all legal forms. completion, the newly created private enterprises will solve the problems of newly However, the adoption of such an approach gained debts independently, without state meant reducing efforts to accelerate farm assistance, including through court procedures privatization since it would remove a strong and the application of bankruptcy procedures. incentive for privatization. Furthermore, the NLP * Settlement of debts will be applied only to is a voluntary program, entered through a farms participating in the National Land democratic process and the second approach was Program, which will form the basis for a top-down anti-democratic imposition from intensive and quick reform of the agricultural central government. By adopting the second sector and will further stimulate the approach, the system of ineffective kolkhoz- participation in the program. sovkhoz production would have been kept, and * The interests of the private creditors must be the process of adapting the farm to market reasonably defended. conditions would have slowed down. In the * The burden on the country's budget connected meantime, the state must show political will to with settlement of farm debts must not be implement the agricultural reform and stimulate excessive. farms that take this path. There were very important budget questions, The third approach. This approach had few which were constantly raised during the analysis supporters and meant the following. It is of all three approaches: what is the real amount of necessary to solve the problem of farm debts to all farm debts and their structure? What losses the state only. Farm debts to private creditors will the budget bear as a result of debt settlement must be: to private creditors? i) fully liquidated and attributed to the business risk losses of creditors, or Because the detailed analysis of the financial ii) settled based on separate court actions, situation of farms through field work on 562 filed by each private creditor. farms throughout the country , only the forecast of the budget burdens as part of the state assumed The first approach is completely impractical - responsibility to settle farm debts to private it cannot be legally decreed, as it would be a creditors will be discussed in the following crime against ownership. Voluntary and mass paragraphs. cancellation by creditors of the farm debts is financially unreal and has no precedents. Farm debt to private creditors could be resolved and the farm liquidated if this private The second approach assumed the enforcement debt was ceded to the state and offset against debt of the previously analyzed bankruptcy procedure, the creditors might have with the state. Creditor but only with the participation of selected private Appendix C: The Moldova Farm Debt Restructuring Program - A Unique Approach 89 debt or payables to the state budget arise to settle Furthermore, the 290 - 365 million lei excise tax, customs duties, value added taxes, land projections did not consider that many farms taxes and payments to the Social Fund, to mention would transfer "excess" social assets when several. But this mechanism would only work if compared with the amount of their actual debts to the farm debt to private creditors was equal to or the state. Likewise, other farms without sufficient less than the private creditor's debt to the state. social assets would also transfer separate What would happen if the private creditor did not agricultural processing facilities, shares received owe the state sufficient funds to cover the farm's through the earlier mass privatization of state debt to the private creditor? How would this owned processing industries, and accounts difference be settled and what impact would this receivables, some of which could be sold, leased have on the consolidated national budget if the or managed to produce future revenue streams for state would settle these amounts? the state. The following forecast (Figure A.1, Table It should also be mentioned, that experience A.1) was compiled based on the main principles in Moldova has demonstrated that private and procedures being discussed for inclusion in enterprises work more efficiently than collective the law. farms (which is the actual purpose of the National Land Program), and honor their liabilities to the Based on the survey of 562 farms discussed budget in a more disciplined manner. Further, it earlier, it was projected that this "overage" or was clear that this qualitative renewal of the tax overhang for all potential farms eligible for base in agriculture will make the budget losses joining the National Land Program might amount due to the Debt Program insignificant. to between 290 million lei and 365 million lei, or between 58 and 73 million lei per year over a five With these projections, it soon became year period. Amortizing this estimated "overage" evident that the aggregate or "net" burden on the or overhang during a five year period would result consolidated budget would in fact be considerably in a two to three percent budget burden each year, less than the 58 - 73 million yearly projections which was judged to be acceptable both politically mentioned above. and financially for the Government and Parliament. Figure A.1: The Estimated Dynamics of the Budget Impact Gross load U Collections and losses *Net load m Le 70 60 59 60 --- H& 50 40 l 40 30 28 20 10 I year 11 year III year IV year V year Appendix C: The Moldova Farm Debt Restructuring Program - A Unique Approach 90 Table A.l: The Estimated Dynamics of the Impact on the Budget A. Budget loadforecast (mln. lei) Index Year Total IILI IV V Realistic forecast 1. Repayment of treasury notes ........... 65 65 65 65 65 325 2. Collections ...................... 50 32 20 1 0 103 3. Losses of private creditors .5 5 5 5 5 25 4. Net load (1-2-3) 10 28 1 40 59 60 197 Optimistic forecast 1. Repayment of treasury notes ........... 58 58 58 58 58 290 2. Collections ...................... 60 40 27 1 0 128 3. Losses of private creditors .............. 8 8 8 8 8 40 4. Net load (1-2-3) -10 0 23 49 50 122 Pessimistic forecast 1. Repayment of treasury notes ........... 73 73 73 73 73 365 2. Collections ...................... 40 25 12 1 0 78 3. Losses of private creditors .............. 2 2 2 2 2 10 4. Net load (1-2-3) 31 46 59 70 71 277 B. Collectionsforecast Assets sheet, mln. lei sales price Total, mE. lei Realistic forecast 1. Industrial units .270 75 35 70 2. Receivables .80 35 95 27 3. Stocks .40 95 15 6 Total 390 x x 103 Optimistic forecast 1. Industrial units .270 80 40 86 2. Receivables .80 40 100 32 3. Stocks .40 100 25 10 Total 390 x x 128 Pessimistic forecast 1. Industrial units .270 65 30 52 2. Receivables .80 30 90 22 3. Stocks .40 90 10 4 TotalT 390 1 x J x 78 Therefore a system of issuing treasury notes the designated year(s), not to exceed five years. (tax vouchers) to offset the "overage" or overhang The forecast of losses to be absorbed by private was thought to resolve this issue, and without creditors as a result of the restrictions mentioned significant budget impact. above is presented in Table A.1. Further discussions and bargaining between The forecasts of the budget impact of the Parliament, the Government and National Land selected option of settling farm debts, as well as Program officials decided that these treasury notes supporting materials for these forecasts, were should not be negotiable, should be used to pay presented to the Government and the Parliament. any obligation by a private creditor to the This eliminated unnecessary debates with the consolidated budget, and would be valid only in opponents and eased defending the Debt Law. Appendix C: The Moldova Farm Debt Restructuring Program - A Unique Approach 91 Major Principles and Rationale of the Debt (ii) description of the elements of the Law methodology of the National Land Program, which were not reflected in other legislative During the development of the Debt Law, the acts (for example, signing agreements with debt settlement concept described in the previous the National Land Program, particularities of section, and the following main principles were finalizing property privatization). taken into consideration: * system approach; Due to these additions, the draft Debt Law * usage of out-of-court liquidation procedures; strengthened all the main elements in the * voluntary restructuring; methodology of the National Land Program. The * responsibility distributed to various parties whole process conducted by this program was during debt settlement; named "restructuring". The stages of this process, * simplification of procedures to the extent including the three main objectives of the possible and their detailed description in easy National Land Program reflected in it are to understand regulations. presented in Figure A.2. The legal reflection of this process is included in Art. 2 of the Debt Law. System approach. The systematic character of the Debt Law is firstly emphasized by the fact The farm restructuring process cannot be that it is oriented towards the achievement of the reduced only to privatization, or debt settlement, final objectives of the National Land Program, or farm restructuring, or only to the creation of which are: private enterprises. This is the uniqueness and (I) land privatization, main thrust of the Debt Law and its accompanying (2) property privatization, and regulations. (3) creation of private enterprises free-of-debt. The systematic character of the Debt Law is However, the first versions of the Debt Law reflected also in the fact that it regulates a focused especially on settling farm debts as the complex series of financial, organizational, and most difficult problem. But when this problem legal issues related to farm debt settlement. was solved, it became clear that this law must also include: The method of settling farm debts was most (i) coordination of debt settlement with the difficult, as the farms are insolvent, and the respective privatization processes (for interests of the main restructuring participants example, debt settlement may begin only (peasants, state budget, local budget and private after land and critical property privatization, creditors) are rather contradictory. Thus, the and final property privatization may only be search for a unique and simple schematic for all finished after the settlement of all farm types of farms to all categories of creditors was debts); not, and could not be successful, i.e., some parties Figure A.2: Stages of Farm Restructuring .......I.......................... ......................................... ......................... .............................................................. ....................................................... ................................................. Preparation [ (3) Creation of private enterprises (1) Land privatization (2) Property (2) privatization Debt Liquidation settlement 92 Farm Debt in the CIS are satisfied some of the time, but it is impossible deceased employees killed as a result of a work- to satisfy all parties, always. In order to establish a related accident). Debts to priority creditors and balance of interests for the main farm farm employees (wage arrears) are settled only on restructuring participants, their debts and creditors the farm's expense, i.e. in a regular manner. were categorized in classes (Figure A.3). The schematic of settling historic farm debts Debts, incurred before I January 1999 were to the state and private creditors consists in the considered historic, and debts incurred after that following. Because farns are insolvent, their date were considered current (Art. 2 of the Law). historic debts to private creditors are transferred to This debt classification allowed the development the state, of course, with the state's consent (the of a compromise between the budgetary interests main purpose of the Republican Commission for of the state and financial interests of other farm Settling Farm Debt - see later). After this restructuring participants. The essence of this dramatic procedure is finished, the state becomes compromise is the following. the debtor of the farm's private creditors only to the extent the private creditor is not a debtor to the According to the currently functioning budget state. methodology, historic debts are not considered during the development of the budget for the The state, becoming debtor of private coming year, in our case - the budget for 1999. creditors, settles its debts by tax credits. With this Thus, historic debts can be settled according to a view, the state issues treasury notes (tax preference scheme. On the contrary, contributions vouchers), a kind of loan certificate from the of 100% current debt settlement are taken into Ministry of Finance valid for a 5-year period. As consideration. Thus, current farm debts to the these certificates are not securities, they cannot be state must be settled fully. This was the most the traded on the securities market. The idea of Ministry of Finance and the Main State Tax issuing tradable treasury notes (securities), i.e. Office would agree to, as their main objective is to cash payments from the budget, was rejected from ensure real collection of contributions to the the very beginning. This is explained simply with budget. the fact that it is absolutely unreal to receive cash from the country's budget in order to pay off the Priority creditors are banks or others whose state treasury notes in conditions of chronic and loans were guaranteed by collateral, as well as acute budget deficit. beneficiaries (individuals to whom the farm is liable for health detriments or families of Figure A.3: Classification of Farm Debts and Creditors ........................................................... .................... ........................................... .................... .................... .... ............................. .............. . ............................................. Farm dbs| Historic Current Priority creditors State - main Private creditors and employees creditor ........... .............. ..............................................................................-............................................ ....................................................................................................................... Appendix C: The Moldova Farm Debt Restructuring Program - A Unique Approach 93 The farm settles its historic debts to the state, their privatization and debt settlement issues on including historic debts to private creditors their own. After the approval of this law, the transferred to the state. It was decided that this number of farms joining the National Land settlement would be done through the same Program increased substantially. untraditional process - by transferring property to the state, at its book value, in the following order Upon completion of the development of the (Art. 15, Debt Law): Debt Law, the question of its position in the a) public assets (schools, hospitals, cultural Moldovan legislation system emerged. The centers, roads, and other communication problem was that this draft law included a series means) - into the ownership of mayors' of new regulations, which were either not offices or local maintenance organizations, in stipulated by the current legislation, or order to maintain the village social contradicted it. In similar situations in the infrastructure; Republic of Moldova, as well as in some other b) mills and oil mills - into the ownership of countries, such a law describes the norms when it mayors' offices, with the view to create has priority to other laws in the same domain. municipal enterprises that would satisfy the However, in its Decision No. 56 of 26 October needs of villagers and contribute to the local 1999, the Constitutional Court of the Republic of budgets; Moldova ruled that such priority norms are c) agricultural or crop processing facilities - into unconstitutional. The Debt Law was being mayors' offices administration for their developed during the same period. Therefore, in privatization against cash proceeds; order to exclude difficulties in passing and d) portfolio stocks - to the Department of enforcing the Debt Law, amendments for 6 Privatization for their sale against cash complementary laws were developed (Table A.2). proceeds; These amendments were short and simple, but e) accounts receivable - to local tax offices for they created good legal defense for the Debt Law. forcible collection, in conformity with the Indeed, by harmonizing this law with the current respective tax legislation. legislation, these amendments deprived the opponents of any formal grounds to attack the The given list of property is exhaustive. If Law during its development and approval. the listed property is not enough to settle historic farm debts to the state, it was decided that any All these amendments were included in a debts remained would be cancelled. separate law, which was examined and approved together with the Debt Law. Such a The main facilities offered to farms by the comprehensive approach was more convenient state are: acceptance by the state of historic farm than separate presentation and approval of the two debts to private creditors, transfer to the state of laws. It spared time and avoided problems - it was limited non-cash property as historic debt offset, not necessary to wake twice the "parliament transfer of this property at its book (not market) tiger." value, cancellation of the amount of historic debts remaining unsettled, and exemption of these Furthermore, in order to estimate future transaction from taxation. problems with some other laws, the Debt Law was given organic law status. Respectively, if there For organizational purposes, the following are contradictions between this law and ordinary principle was adopted: the sooner the prepared laws, the Debt Law has priority. Such a priority is reform is conducted, the higher chances to success in absolute compliance with the Moldovan it has. Thus, the enforcement period of the Debt Constitution, which stipulates three types of laws, Law was limited to 1 July 2001. All farms that do based on their priority - constitutional, organic, not manage by this time will be forced to solve and ordinary. Appendix C: The Moldova Farm Debt Restructuring Program - A Unique Approach 94 Table A.2: Short Characteristic of the Amendments to Laws Related to the Debt Law Amended law Idea of the amendment Objective of the amendment * Civil Code The court has no right to arrest farm Defend farm critical property from critical property aggressive creditors * Law on entrepreneurship and Particularities of agricultural farm Exclude contradictions (the first Law enterprises liquidation are regulated by the Debt did not stipulate out-of-court Law liquidation procedures) * Law on enterprise restructuring Idem Idem * Law on State Tax Office Tax offices must participate in farm Prevent a boycott of tax offices debt settlement * Law on budget for 1999 The Debt Law determines the Exclude contradictions (Law on particularities of farm relations with budget for 1999 does not stipulate a the budget special procedure of settling farm debts to the state) * Law on budget of state social Idem Idem insurance for 1999 Out-of-court farm liquidation procedure. The Debt Law regulates both settlement of all Fifth, kolkhozes and sovkhozes have been an farm debts and the farm liquidation itself. The illegal enterprise form for seven years already. following circumstances engender the necessity of The Law on entrepreneurship and enterprises liquidating collective farms. (adopted in 1992) included a limited list of enterprise legal forms in Moldova. Kolkhozes and First of all, kolkhozes (collectives) and sovkhozes are not included in this list. sovkhozes (state farms) are economically ineffective in market conditions - 70%-80% of Based on professional arguments, any of the them are actually absolutely bankrupt, i.e. the reasons given above would be sufficient to market value of their assets is smaller than the reinforce the necessity of collective farm amount of all debts (see chapter 2). This is why liquidation. However, all these reasons were privatization of the agricultural sector of the considered because kolkhoz and sovkhoz national economy is absolutely necessary. liquidation stirred up criticism from the anti- Second, after land and critical property reform opposition. privatization, kolkhozes and sovkhozes do not have enough resources to continue agricultural The next question was - how quickly can the production. mass farm liquidation procedure be conducted? Court farm liquidation procedure is rather long, Third, aggressive creditors are trying to expensive and not always predictable. Besides, the transfer the burden of kolkhoz and sovkhoz debts potential of the Moldovan court system was to the newly created private enterprises. Leaders absolutely inadequate to cover mass farm of private enterprises, however, sometimes try to liquidations (see also chapter 2.3). refer their enterprises' taxes and expenses to the kolkhozes and sovkhozes. It is clear that both A normal reaction to the insufficiency of the actions bare a negative character and contradict classical liquidation procedure for insolvent farms the tasks of agricultural sector restructuring. was the idea of out-of-court liquidation. The main advantages of this procedure is its relative Fourth, only when the farm is being simplicity. Calendar calculations demonstrated liquidated, is it possible to force its creditors to that by using out-of-court procedures the final quickly settle the debt problem, using quite objectives of the National Land Program could be favorable methods, and stop the possibility of achieved within reasonable timeframes. continued fraud and tax evasion. Appendix C: The Moldova Farm Debt Restructuring Program - A Unique Approach 95 The Debt Law does not include the out-of- The reason is clear, this procedure is more court procedure for liquidating insolvent farms as advantageous for private creditors. an imperative, but as a possible alternative to the court procedure. This can be explained by the fact Voluntary restructuring. Another principle that according to the general norms of civil of the Debt Law is that, according to this Law, the legislation, an insolvent enterprise has only the general meeting of farm members makes the right to decide on its liquidation, whereas the decision on farm liquidation. This refers not only liquidation method - court or out-of-court - is to farm liquidation, but also to land and critical determined exclusively by the creditors. A property privatization. different approach would have rudely infringed the creditors' right to ownership. Voluntary participation in restructuring is expressed not only by participants' free Creditors exercise their priority right within communication of their opinions at the farm one month after the farm decides to resolve debt general meeting, but also in the fact that relations and liquidate and this decision is published in the between the National Land Program and the farms Official Monitor of the Republic of Moldova. are being included in agreements signed with the Within this timeframe, just like in other National Land Program. The basic agreement with liquidation procedures, creditors file their claims the NLP is signed for land and critical property against the farm. In these claims, besides privatization, and for creation of new private including the amount of farm debts, creditors must enterprises. Only after complete fulfillment of mention which farm liquidation procedure they these steps, the additional agreement with the choose - court (bankruptcy procedure) or out-of- National Land Program for debt settlement, final court (Art. 8, Debt Law). property privatization and farm liquidation is signed. However, it is important to take into account that the state, as a creditor, in accord with Art. 8, Thus, the system of "two agreements," Debt Law, always chooses the out-of-court farm although a little intricate, allows farm participants liquidation procedure. Assuming that to decide on farm liquidation, even after all the approximately 60% of all liquidated farm debts land and critical property is distributed, and are debts to the state, it becomes clear that the agricultural activity on the old collective is choice of out-of-court farm liquidation is terminated. Experience shows that this choice predetermined. once again strengthens the signing of the main agreement with the National Land Program, Experience of enforcing this law has shown stimulates its fulfillment and creates equal the following. For three out of four farms, private agreement-based relations between the farm and creditors voted unanimously for out-of-court the Debt Program. (Of course, under ideal liquidation procedure. On average, for every farm, circumstances, it should be enough to sign one only one out of four creditors chooses court agreement for the whole restructuring process.) liquidation procedure. In the end, the court liquidation procedure did not get many votes as The experience of implementing the Debt none of the farms that published liquidation Law also proved that approximately 1%-2% of all notices, in accord with the Debt Law, were farms, which had already conducted land and obliged by creditors to follow regular bankruptcy critical property privatization within the National procedures. Land Program, did not wish to settle their debts and liquidate, in accord with the Debt Law. These Thus, the results of mass voting of private farms did not sign additional agreements with the creditors, combined in the same document with Program on continuation of restructuring. For the classical procedure of forwarding claims to the example, agricultural production cooperative farms, prove that the overwhelming majority have "Aroma" (Cobusca Noua village, Anenii Noi voted for the out-of-court liquidation procedure. raion) chose this path. This cooperative refused to liquidate, because its products have earned 96 Farm Debt in the CIS appreciation abroad, and cooperative liquidation ministries and departments involved. The would have immediately slowed down the Republican Commission's authority is enough to process. The National Land Program respects the settle issues with ministries and departments, free choice of such enterprises. representatives of which were not included into its membership. This hypothesis was proved in the For Moldova's conditions, the voluntary course of activity. Moreover, when in the principle had and still has political meaning as beginning of 2000 the crisis on settling current well. It took away the opponents' favorite farn debts arouse, a second Republican argument about forced kolkhoz and sovkhoz Commission was created. However, the main liquidation. drawbacks of this commission is the fact that its members are reluctant to -undertake Responsibility distribution. According to responsibilities for unusual issues not fully the forecasted data, within a limited period of time regulated by the existent legislation. (two years), 1.4 billion lei historic farm debts were to be settled in the restructuring process. The principle of delegation of responsibilities Moreover, settlement must also be conducted in is also used at the farm's level during liquidation, an untraditional manner. That is why, a critical which is conducted by the Property Commission. question was raised: who would make decisions This commission is chaired usually by the farm on settling these debts on behalf of the state. From manager. Farm's chief-accountant, representatives various discussed variants (Parliament, of the territorial office of the Department of Government, judet commissions, etc.) of such a Privatization and State Property Administration, body, a Republican Commission was empowered and of the Ministry of Agriculture and Processing to settle farm debts to the state (Art. 11, Debt industry, are also members of the Property Law). Commission. The Republican Commission for Settling Critical property privatization proved that Farm Debt includes representatives of various these commissions are most efficient. Why? ministries and departments, participating in the Because their responsibilities are divided among a debt settlement process. The main ones are the large group of people, and the commissions are Ministry of Finance, the Main State Tax Office temporary. and the Social Fund. Simplification of procedures and their The Republican Commission, as opposed to detailed description. Out-of-court farm the Government or the Parliament, can conduct liquidation is not being organized by the court, but technical work and quickly make decisions. At the by the Liquidation Commission. In order not to same time, several ministries and departments are complicate the administration of this procedure, responsible for making decisions on settling debts functions of the Liquidation Commission have to the state. The Law stipulates two measures of been transferred to the current farm Property control over the activity of the Republican Commissions (Art. 9, Debt Law). Commission by the Parliament and the Government: The Law describes in most details the debt (i) the Republican Commission publishes settlement procedures. This was necessary monthly in the Official Monitor the main because financial tools (cancellation of debts with content of its decisions, and expired maturity term, debt transfer, debt (ii) the Republican Commission submits settlement using non-cash proceeds, treasury tax quarterly reports on its activity to the vouchers, etc.), included in the Debt Law, were Government, and the Government submits not widely used in the country. Besides, any yearly reports to the Parliament. ambiguities in the procedures presenting the least risk for budgetary means, may be used by state The Republican Commission may also settle officials to slow down the process. Such delays current issues with the representatives of are usually the result of long coordination of Appendix C: The Moldova Farm Debt Restructuring Program - A Unique Approach 97 Government decisions and administrative 2. Beginning of the farm liquidation circulars of ministries and departments relating to procedure the implementation of the law, in which officials try to distort the meaning and objectives of the Approval of Farm Liquidation Decision. law. These bureaucratic and anti-reform forces The farm liquidation procedure begins when the cause frustration, but so far they have been unable respective decision is made by the general to stop this reform process. meeting of shareholders, associate members or cooperative members. The Property Commission Thus, the main principles of the Debt Law are publishes a notice on farm liquidation in the a response to concrete problems set for the Official Monitor, in accord with the Debt Law. National Land Program in the beginning of 1999. The farm liquidation notice states that creditors At the same time, these principles are rather can file their claims to the farms within one month general. In our view, this may facilitate their from the publishing of the notice, and must adoption in other countries facing similar indicate which farm liquidation procedure (court problems under similar macroeconomic and or out-of-court) they choose. The amount of state- political situations. claimed debts is determined based on the extracts from the personal account of the taxpaying farm; all these claims are chosen to be settled through Farm Restructuring Steps Under the Debt Law out-of-court procedures. Priority creditors and farm employees are not obligated to file claims to 1. Steps preceding farm liquidation the farm; also, they cannot vote for any of the two liquidation procedures. The liquidation procedure In-kind Property Share Allocation. The (based on the law on bankruptcy or the Debt Law) critical property is allocated by the Property is chosen on the basis of claims of those creditors, Commission to privatization participants, debts to whom are more than 50% of the total of regardless of the farm financial situation and its all submitted claims. Claims not filed, or filed debts. The property share can be received in-kind after 30 days are written-off as unsolicited claims, by the privatization participant himself or by his and their deduction from the farm's balance sheet proxy representative. In-kind allocation of is authorized in the law. Expired debts are production facilities and neighboring lots is being cancelled in the same manner (over three years done based on the necessity of compact from the date the debt became overdue). organization of the production process. Farm Restructuring upon the Local Foundation of Private Enterprises. The Council Decision. If it is impossible to hold a private enterprise is being founded by persons farm general meeting because it stopped its who were allocated in-kind land shares and production activity or due to other reasons, the property shares from the critical property, or only farm restructuring and liquidation decision may be the land share - within 3 months from the date of made by the local village council, in accord with receipt of the respective title certificates. The Law 392-XIV of 13 May 1999. private enterprise can be a peasant farmn or another legal form. These enterprises may use, until all Creation of a New Property Commission. If debts are settled, based on an agreement, property the privatization commission ceased its activity or of the farm undergoing privatization, only if this the farm does not conduct any activity, the local property is not seized. If the land share holder has council can create a new Property Commission, alienated or leased out the land, s/he is obligated which is delegated the rights and obligations of to submit the respective documents to the mayor's the original Property Commission. office. Consequences of Publishing the Farm Liquidation Notice are the following: a) creditors consider that they are being informed and are obligated to file claims; 98 Farm Debt in the CIS b) debts are considered redeemable, and the Commissions are also published in the Official claims are being settled by means of a unique Monitor. procedure; c) farm property cannot be written off, seized or Offsetting Farm's Historic Debts to the collateralized in any other way. State. Historic farm debts to the state, formed from primary debt (actual farm debt to the state) 3. Settlement of debts to priority creditors and secondary debt (formed as a result of state and employees receipt of historic farm debts to private creditors), are offset with certain categories of property the Debts to Beneficiaries are settled first, by ownership of which has been ceded to the state in transferring the compensation payments to the a strict succession in accord with the law. creditor, stipulated by law, directly or by capitalizing Social Fund payments. Settlement Property Used for Debt Settlement, directly to beneficiaries is done by using cash Stipulated by Law: proceeds or other farm property accepted by the a) public assets - into the ownership of local creditor. government; b) mills and oil mills - into the ownership of Collateralized Debts are settled, using local government; collateralized property, and if this is not enough, c) agricultural processing facilities - into the the remained debt is settled according to the administration of local government; general procedure. d) portfolio shares - to the Department of Privatization for further privatization; Debts to Farm Employees for wage arrears e) accounts receivable - to local tax offices for are settled according to the method of settling forcible collection. current debts. Each latter category of property may be used 4. Historic debt settlement only upon complete transfer of previous categories, i.e. if the previous category is not Compilation of the Creditors' Registry. sufficient. The debt offset using property is Based on creditor's claims, the registry of carried out by the territorial tax office, within 5 creditors' claims, signed by the chair of the days from the submission of the transfer bills. Property Commission and mayor, is compiled; the registry also indicates liquidation method chosen Writing-off of the Historic Debts to the by each creditor. Reconciliation statements are State Remained Unsettled is done only in compiled by the Property Commission within one instances when some part of historical farm debt month from the date of publishing the farm remains unsettled (unsettled historical debt liquidation notice, and are submitted to the tax balance) after transfer to the state of all the farm office. The tax office verifies the documents and property defined for that purpose. The respective forwards them to the Republican Commission for request is submitted by the chair of the farm examining and decision making. Property Commission to the territorial tax office, which forwards it to the Republican Commission The Republican Commission for Settling for the respective decision. Farm Debt takes decisions on state acceptance of farm's historic debts to private creditors which 5. Settlement of current debts have not been either time barred or excluded because the creditor failed to respond to the The Sequence of Current Farm Debt liquidation announcement in the Off cial Monitor. Settlement: Based on this decision, the Tax Office register the a) debts to beneficiaries; state receipt of historic farm debts to other b) debts to employees, which include all unpaid creditors in the personal accounts of both the farm wages; and its creditors. The decisions of the Republican c) debts to the state; Appendix C: The Moldova Farm Debt Restructuring Program - A Unique Approach 99 d) debts to other creditors. value of the assets transferred, and the transaction is approved by both the creditor Property Used for Current Debt and the local council of government (village Settlement, After the Settlement of Priority council). Debts: a) cash proceeds; 6. Settlement by the state of b) agricultural products; transferred debts c) other property, except for seized property or property destined for historic debt settlement. Method of Settling Private Debts Transferred to the State. The state offsets the The Procedure of Current Debt Offset transferred farm debts to a private creditor within with Property. The property is transferred to the limits of the creditor's debt to the State. creditors, according to the scheme of preferences mentioned above by: (a) direct negotiation; (b) Treasury Notes (tax vouchers). If the amount auction organized among creditors of the same of a creditor's debt to the State is less, the level. The creditor is offered a written proposal by difference in favor of the creditor is settled by the the Property Commission, to which a list of Ministry of Finance in equal installments over a 5- property destined for current farm debt settlement year period through tax credits. The state is attached. Within 20 days, the creditor must give obligations are confirmed by Ministry of Finance its agreement to receive the offered property and treasury notes, in form of annotations in the consider the debt settled or to reject it and cancel personal accounts of the enterprise in the Treasury the debt. Lack of creditor's answer is considered Notes Registry. The Main State Tax Office rejection. The property is proposed at the includes the respective annotation on the transfer estimated appraised value established by the of historic farm debts to the state, within one Property Commission. In case of differences month from the date the Republican Commission regarding the value of the proposed property made the decision. Ministry of Finance treasury between creditors and the farm undergoing the notes cannot be alienated or transferred to third liquidation process, the respective property parties, they can only be transferred to the evaluation can be conducted by a licensed creditor's legal successor. appraiser. Terms and Manner of Debt Offset Through Settlement by Transfer of Farm Debts: Tax Credits. The historical farm's debts to a) Upon consent of the creditors (frequently privaie creditors relinquished to the state are farm employees -unpaid wages, farm input repaid by the Ministry of Finance in equal suppliers or banks), one or more private installments over a five year period through enterprises created during the privatization offsetting of all types of payments (taxes and process may accept current debt provided other levies) to the state and local budgets accrued that the collective undergoing debt settlement on each creditor (tax credit). Tax credit is applied and liquidation also transfers an equivalent starting the calendar year following the year of amount/value of property - at estimate or debt transfer. If a creditor's tax payments to the market value - to the new private farm state and local budgets accrued over a five-year willing to accept current debt. period proved to be less than the amount of b) Part of the current debts, including debts to historical farm debts relinquished by it to the beneficiaries (priority creditors) can be state, the validity period of the treasury notes is transferred to the enterprise created by local not prolonged. government to own and operate property transferred to the local government (mills, oil 7. Privatization of property remaining after presses, agricultural crop processing debt settlement facilities) in settlement of historic debt, provided that the amount of these debts Calculation of Property Shares. The farm transferred does not exceed 10 percent of the Property Commission calculates the property 100 Farm Debt in the CIS shares of each privatization participant in the general meeting, the balance sheet is approved by remaining assets on the list of remained property, the local government. The final liquidation and ensures its allocation through a second and balance sheet, together with other foundation final property tender. documents, is sent to the territorial tax office, which approves it within 5 days, and returns it to Transfer of Property Unclaimed by the Property Commission. Privatization Participants. Property, in calculated property shares, unclaimed at the end Removal of the Farm from the State of farm liquidation, is transferred into the Commercial Registry. Within 5 days from the economic administration of local government. receipt of all required documents: This procedure is necessary only when a a) the request on farm's removal from the State participant or his/her proxy is not present at the Commercial Registry; final property tender. This property is allocated to b) farm's registration certificate (the original); its owners within 30 days from the receipt of their c) statement confirming complete settlement of requests. The final deadline for submitting debts to the consolidated state budget, issued requests to receive property is I July 2001, after by the territorial state tax office; this date, the respective property goes into the d) statement confirming that the farm closed its ownership of local government. Unsolicited land bank account(s), issued by the servicing lots remain under the local governments' bank(s); administration until they are solicited by the e) foundation documents (original); privatization participants. There is no time limit in f) certificate confirming that the farm's stamps the applicable legislation. and seals were destroyed, issued by the local police office; 8. Termination of farm liquidation g) copy of the farm liquidation notice published in the Official Monitor of the Republic of Compilation and Authorization of the Moldova; the State Registration Chamber Liquidation Balance Sheet. Within 10 days from within the Ministry of Justice removes the the settlement of all farm debts, the Property farm from the State Commercial Registry, and Commission prepares the farm's final liquidation issues a copy from the registry to the Property balance sheet and submits it for approval to the Commission of the collective farm. general meeting; and if it is impossible to hold a Appendix C: The Moldova Farm Debt Restructuring Program - A Unique Approach 101 PART III: IMPLEMENTATION and others) in drafting internal regulations and issuing circular letters aiming at adjusting existing Internal Structure and Methodology working procedures to the provisions of the Debt Law, providing clear instructions to local After the Law on Restructuring of Farms authorities and Government representatives on the Undergoing Privatization was passed by the implementation of the Law, as well as training Moldovan Parliament on 13 May 1999, the CPBR them through a series of seminars organized decided to form a new unit (Debt Resolution Unit during the first 2-3 months of our activity. Thus, - DRU) to provide assistance to all Government more than 170 official documents were prepared agencies involved in debt resolution and on behalf of different Government agencies in the liquidation of collective farms under the form of letters, circulars, orders, Government provisions of the Debt Law, as an integrated part regulations, amendments to laws, etc. of the National Land Program. The new staff for the Debt Resolution Unit Following the existing CPBR internal teams was hired in June 1999. It was also decided structure, new teams of 3 accountants each were to add a senior expatriate advisor to the CPBR formed within each of the eight Farm staff to provide advice and council to the DRU Privatization and Restructuring Centers (FPRCs). and accept responsibility for meeting the targets. New staff was also hired to form two Chisinau This person arrived in September 1999. The based teams: the core team and the expert team. members of the DRU teams were intensively The local teams assist the Property Commissions trained by CPBR specialists, explaining the Debt of the farms in preparing legal and accounting Law and other legal issues involved, announcing documents, provide consultations on different the timeframe and the goals of the project, and issues. The core team is mainly formed by eight how to achieve these goals under the Debt Law accountants-coordinators assigned to each FPRC. provisions. The work methodology was These coordinators are responsible for the developed: the entire process of debt resolution organization of the debt resolution work and and liquidation of farms was divided in discrete liquidation of collective farms within their regions and sequential stages, and the key players in each in compliance with respective legal procedures stage, as well as the flow and sequence of and according to internal monthly targets. The documents to be prepared through the process, core team members ensure the flow of were identified and clarified. It was decided that information and provide the link between local the work progress, stage by stage, on each farm, teams and Property Commissions on the one hand, within each region, would be assessed and and the expert team and state agencies on the monitored by DRU management on a weekly other. The expert team composed of economists, basis to prevent any inconsistencies, possible lawyers and accountants provides technical delays and failures to meet monthly targets. assistance to the Republican Commission, and represent the farms' interests during the sittings of After the Law on Restructuring of Farms the Republican Commission. The expert team Undergoing Privatization was promulgated by the members also provide consultations to President and enacted on July 15, 1999, it became coordinators and local teams, check the possible to plan the activity of DRU in detail. The correctness of all documents prepared in the field plan was based on the assumptions that: it takes a before they are presented to the Main State Tax farm about 5 months to complete the whole Office, Ministry of Finance, and the Republican process; between 800-900 farms would join the Commission. As work started, another activity of program; one year would be sufficient to finish the expert team became vital: assisting different the work on all farms. Thus, monthly work plans Government agencies (mainly the Tax Office and for one year were elaborated for each FPRC. The the Ministry of Finance, the Social Fund, work plans contained 10 consequent stages a farm Registration Chamber by the Ministry of Justice, should go through to completely settle its debt and the State Archive, the Department of liquidate, and numbers of farms that should Privatization, the National Securities Commission, complete each stage at the end of each month. In 102 Farm Debt in the CIS such a way each local team had sets of tasks to accomplish during each month. The first several dozen farms liquidated during the first months of the DRU activity The work plan was the main tool for proved that the Law on Restructuring of Farms monitoring and controlling the whole process with Undergoing Privatization was workable, and that the overall objective - completion of privatization the methodology developed and applied by the and liquidation of 888 farms in compliance with National Land Program based on the existing Moldovan legislation by August 31 2000. legislation was applicable at national level with no reservations whatsoever. Attracting more farms into the process and getting the government at First Steps both central and local levels more involved was the next task for the National Land Program. Assisting the Ministry of Finance and the Main Tax Office in drafting the regulations to the Following this imperative, 10 seminars were Debt Law, i.e., the Government Decisions organized in all judets (Moldovan administrative- required by the Debt Law (Decision on territorial unit) and the capital of the country. Republican Commission for Resolution of Farm Judet officials (Prefects and Chairmen of Local Debt (No. 767, of August 9, 1999), and Decision Councils), Primars (heads of local administration), on State Support in Restructuring of Farms specialists of various government agencies of Undergoing Privatization (No. 854, of Sept. 17, central and territorial levels (Department of 1999)) was the first important activity of the Debt Privatization and State Property Administration, teams. These two Government Decisions (annex Ministry of Finance, Tax Office, Customs 4) were designed to provide detailed regulations Department, Social Fund, State Registration and mechanisms for debt resolution, completion Chamber, State Archives, Department of Statistics of privatization and liquidation of collective and Sociological Analyses, Office of Public farms. The regulations also contained the Prosecutor, law-courts), as well as farms' main necessary forms (documents to be filled in) for the creditors, heads of Property Commissions and entire process and that fact ensured the accountants of farms subject to debt resolution smoothness and regularity of the process and and liquidation participated at these seminars. excluded any misinterpretations and ambiguity, Speeches given by former collective farm also making possible later automation of the managers who had already benefited from the process. Direct participation of DRU staff in program (those were primarily from the first 18 developing the regulations and the forms excluded farms liquidated) were particularly popular. the need for training staff after these regulations During the seminars the NLP specialists explained were adopted by the Government, and, to a certain the procedures under the Debt Law, their degree, simplified the process since the co-authors sequence, the rights and responsibilities of all of the forms were the future implementers. This participants in the process at different stages, etc. aspect was critical and only hindsight has The seminars were of great interest to all parties confirmed this. involved judging by the number of questions asked at round tables concluding the seminars. The last regulation was enacted late in More than 2,500 people attended the seminars. September 1999, thus completing the legislative Sets of handouts that included brochures with base for the process of farm restructuring and texts of the Debt Law, Government Decisions and privatization of the agricultural sector of Ministry if Finance orders, specially prepared Moldova. By the end of that month 232 collective guidelines for Primars, Social Fund, State Archive farms published their liquidation announcements and Tax Office employees were distributed to in the Official Monitor in compliance with Law seminar participants. 392-XIV, whereas 18 farms from all the regions of Moldova settled their debts and distributed the For transparency reasons, extraordinary remaining property amongst the participants to sittings of the Republican Commission were held privatization, and were liquidated. in various judets at the beginning. These field Appendix C: The Moldova Farm Debt Restructuring Program - A Unique Approach 103 sittings of the Republican Commission (usually specialists assisted different Ministries and hosted by Judet Prefect - Government local Departments in drafting these instructions before representative) also aimed at getting a better they were officially disseminated to the local insight into the problems encountered through the government. This collaboration of the NLP and process of farm restructuring, speeding up the central government, especially the Ministry of process, attracting more farms, and solving Finance and the Social Fund, was seldom smooth. problems on the spot in the presence of more Conflicts were caused by the NLP tendency to parties involved. After the sittings, representatives simplify and expedite the process of debt of the Main State Tax Office, members of the settlement, whereas the Ministry of Finance and Republican Commission organized seminars for the Tax Office, for example, had the task to local Tax Office employees providing guidelines "defend" the budget and increase tax collections on the procedures of farm debt settlement, and in cash. Notwithstanding opposing interests, they also measured the work progress of the local compromises have been always found and the working groups against the provisions of the process has never been fully stopped. As a result, Government official schedule. more than 30 official letters and orders providing instructions on procedures for farm debt In accord with the Government Decision No. settlement and liquidation have been drafted with 854 On state support in restructuring of farms the NLP active participation and issued by the undergoing privatization the Ministry of central government during the first months. Agriculture and Food Processing Industry During that time government agencies were together with the Ministry of Economy and establishing internal procedures and were taking Reforms created judet working groups including certain positions under the provisions of the new representatives of their territorial divisions for the law. It was extremely important then for the debt purpose of timely changing the membership of team to be tuned to all decisions taken by all property commissions and taking ad hoc decisions government agencies which required vigilance on any other issues which appear during the and prudence. It was vital to react promptly to fulfillment of the quarterly schedule for transfer to make sure NLP principles were not misinterpreted the state of historical debts and their settlement by or distorted, and that the NLP goals and the time- farms participating in the NLP. In many judets schedule were not jeopardized. these groups manifested good cooperation with the NLP and understanding of the NLP principles and goals, and proved to be very helpful in Major Constraints to Farm Debt Settlement removing obstacles in farm restructuring and completion of privatization. Mass farm debt settlement has no precedents in Moldova, and because of this, delays were to be Another important and complicated mission expected. Besides, the debt settlement process of the DRU was to collaborate with various regulates contradictory interests of its many Government agencies in order to harmonize participants. Data indicates there are different working methodologies in use. Conflicts approximately 430 creditors per farm, including: of interests demanded a thorough understanding . 400 employees (usually unpaid wages); and cooperation from all parties involved, * 2 individual beneficiaries or families of especially when dealing with financial issues. Due deceased to whom the farm is liable for health to the complexity of debt settlement procedures, detriments; an impressive list of various participants * 2 state bodies (territorial tax office and belonging to different Government structures territorial representative of the Social Fund), were involved in the process. According to which represent the state-creditor; established traditions, and in response to the * 26 private enterprises - creditors. avalanche of questions asked by the local government, the central government had to issue The circle of public administration agencies official explanatory notes in form of circular that control this process is also large. The delays letters, instructions and orders. The Debt Program 104 Farm Debt in the CIS encountered are subdivided into delays at the local On the other hand, being ordinary creditors, level and delays at the central level, based on according to the Debt Law, these bodies are where they are regulated. The reason for such a obligated to receive from the farm real property as division is that, in the beginning, settlement of any debt offset to the state, which is not considered as delays is always initiated at the local level. If that a budget contribution. Thus, their second role fails, the issues are settled at the central level, in contradicts their first one. Moreover, this second hierarchical order (Figure A.4). role is unusual for them - often, in the beginning of the debt settlement process, these bodies did The practice of resolving delays of farm debt not submit their requests to the farms, wrongly settlement showed that the main reasons for these considering that they are regulated by the public delays were problems of settling current debts, law even during the farm liquidation process. historic debts to banks and transfer of farm portfolio shares. The National Land Program insisted that the state be an ordinary creditor with no The first two problems are conditioned by the privileges. As a result, in the course of settling contradiction of interests between the agricultural current debts, requirements in Art. 17 of the Debt reform and the national budget. This conflict of Law regulate the state as well. This means that the interest appears in the same state public state, like the other creditors, must choose administration bodies, which gives them duplicity property, within 20 days, from the list offered by and instability. the farm after historic debt settlement. Immediately after the receipt of this property, the The Current Debt Problem. This problem sate cancels current farrn debts at the total emerged because the Ministry of Finance, Main appraised value of the property, without waiting State Tax Office and the Social Fund are for its sale. If the state refuses to receive this traditionally the administrators of budgetary property, or does not answer within the inflows. As a result, these bodies are interested in established timeframes, current farm debts to the selling farm property to contribute cash to the state are canceled. budget. Figure A.4: The Order of Eliminating Delays Encountered During Farm Debt Settlement ........ ....... ....... ....... ....... ....... ........ ....... ....... ..................... ........ ....... ....... .............. ....... ............................... . . . . . . .. . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Delays ^ C~~~~~~~~~~~~~~~~enta level Local leve Government |Parliament * / \ ^ Mm~~~~~~~~Mistr es I Local bodies commission ....---------- .... ..... ................. ............. ............ .............................................................................. ............... ................ .............. ................... ................................ ...................... Appendix C: The Moldova Farm Debt Restructuring Program - A Unique Approach 105 At the end of 1999, after much hesitation, The The delays in settling current farm debts were Ministry of Finance, Main State Tax Office and solved by Government Decision on Completion of Social Fund took a firm position regarding the the Restructuring of Farms Undergoing process of settling current farm debts, according Privatization No. 173 of 25 February 2000. to which: * budgetary interests have priority as opposed This decision was based on Art. 17 of the to agricultural sector interests; Debt Law. At the same time, based on limited * tax bodies are not ordinary creditors and they possibilities of the tax office to sell the non-cash will not be "the division for agricultural property transferred to the state, this decision property sale." regulated the limited list of this property, which can be transferred to tax offices as current debt Based on that, the Ministry of Finance, in settlement. This list includes portfolio shares and accord with the Main State Tax Office, and the farm's accounts receivables. The other categories Social Fund, but without the agreement of the of non-cash property are transferred into the National Land Program, issued circular No. 10- mayor's offices ownership. 19-4512 of 20 December 1999 (issued in the last few days of the Sturza Government). This circular The existent Republican Commission could allowed settlement of current farm debts to the settle issues connected only to settlement of state, only using cash proceeds. This meant that historic debts to the state. Therefore, another current farm debts were settled only after the farm Republican Commission was created for sold its property and transferred the received cash settlement of current debts (hereinafter - second to the Tax Office and Social Fund accounts. This Republican Commission) chaired by the Vice procedure would be repeated until all current farm Prime Minister. debts to the state are settled completely. As a result of all these measures, the issue on By carrying out this circular, Territorial Tax settling current debts was solved and farm Offices and representatives of the Social Fund liquidation process accelerated considerably. blocked liquidation of a large number of farms, because usually farms do not have liquid property, The Problem of Debts to Banks. This and the market for used farm property was problem appeared because usually banks are practically non-existent at this time. priority creditors, as debts to them are secured by collateral. Such debts to banks are settled in a In order to illustrate the negative impact of separate manner, stipulated by the Law on this circular on the debt settlement process, the collateral, and thus, cannot be transferred to the National Land Program conducted a study of state. However, beginning with March 2000, the reasons for delay in this process (November- first Republican Commission began to reject state December 1999 sampling). The results of this receipt of historic farm debts to banks even in study are given in Table A.3. As the results show, cases when the object of collateral was sold or lost three of the four delays were caused by (creditor then becomes an ordinary creditor in government bodies. accord with the Law on collateral). Table A.3: Causes of Delays in Debt Resolution The main argument for refusal was the Groundless Delays in Debt Resolution Delays % following. If there is a collateral agreement, the 1. Caused by Government ....................... 68 76.4 bank is a priority creditor until the whole amount a. Caused by Tax offices .................. ... 46 51.7 of debts is settled. The budget is poor - the banks b. Caused by Social Fund .................... 8 9.0 c. Caused by Primarias ........................ 9 10.1 are rich. Banks write off bad debts and have d. Other (BTI, state archives, 5 5.6 reserves for such losses, therefore they should creditors) . . ................... write off these farm debts. 2. Caused by Farm under liquidation .......... 21 23.6 Total 89 100.0 The National Land Program standpoint was based on the Law on collateral. In compliance 106 Farm Debt in the CIS with Art. 32 and 34 of this Law, the bank stops kolkhoz and sovkhoz supplied agricultural raw being a priority creditor and becomes an ordinary materials. creditor, if (i) the object of collateral is sold, but not all debts to bank are settled, (ii) the collateral Delays in transfer of the respective shares to was lost, or (iii) the creditor and debtor dissolved the state or other creditors was caused, first of all, the collateral agreement. Thus, if historic farm by the fact that after receiving these shares, many debts to banks are not secured by collateral, such kolkhozes and sovkhozes reorganized by division debts must be transferred to the state, and the state into cooperatives, limited liability companies, or should issue tax vouchers to the banks in accord by merging into joint-stock companies or with the Debt Law. production cooperatives. In order to determine the situation on However, the Registry of Shareholders of settlement of farm debts to banks, the National processing enterprises was not officially informed Land Program conducted a study of the methods and did not include respective data on used for settling these debts. The results of this reorganization of shareholder-enterprises in their study as of April 2000 are included in Table A.4. database. The inevitable problem of registering As the data shows, the main method for settling the successor's ownership title of the shareholder- farm debts to banks is transfer of these debts to enterprises due to their reorganization in the private enterprises, created as a result of the privatization process appeared. Difficulties arose privatization process. However, it contradicts because a lot of time had passed since the shares directly one of the strategic objectives of the had been registered and certain documents program, which is to create debt-free new farming necessary for re-registration of the shares were enterprises. missing. This was also because several collectives had gone through reorganizations without This conflict of interests was also settled by correcting the share registry. the Government. Government Decision No. 529 (5 June 2000) included the list of documents to be For example, kolkhoz "AAA," possessing submitted by the property commission for portfolio shares, reorganized in 1995 into confirmation of the fact that debts to the bank are cooperative "BBB". The latter subdivided in 1998 not secured by collateral and can be transferred to into LLC "CCC" and LLC "DDD"; each of them the state. Thus, this constraint to farm debt were transferred portfolio shares. The problem is settlement was also solved. that portfolio shares, which are still registered under kolkhoz "AAA" in the Registry of Table A.4: Methods of Settlement of Bank Debt Shareholders, must be reregistered under Methods of settlement of farm Total, % cooperative "BBB," and then reregistered again debts to banks thou. lei under LLC "CCC" and LLC "DDD." This Write-off ..................... 3 082 19.4 reregistration must be conducted in 2000, when Repayment without sale of 704 4.4 cooperative "BBB" has already been liguidated, collateral cooperatv docu"ehas aready b iquidated Sale of collateral and repayment ...... 415 2.6 and many documents are already missing on Transfer of collateral to banks ......... 1 579 9.9 kolkhoz AAA. Transfer of debt and collateral to 7 154 45.0 private farms ..................... Another issue related to determining the Transfer of historic debt to state ...... 2 952 18.6 appraised value of shares transferred to the state Total 15 886 100.0 and the accurate legal compilation of the bills of share transfer. These and other issues concerning Transfer of portfolio shares. The third the registration of new owners of portfolio shares main reason for delay is transfer of farm portfolio were solved by means of consultations provided shares for debt settlement. Farms received these by share registrars and by the National Securities shares in 1994 -1996 during the voucher Commission. A circular was issued and sent to privatization of canning, sugar, wine, dairy share registrars based on the consultations enterprises and other factories that processed provided by the National Securities Commission. Appendix C: The Moldova Farm Debt Restructuring Program - A Unique Approach 107 The Department of Privatization and State and cross verification of the collectives' debts. As Property Administration made a significant a result of these audits practiced in accord with contribution in solving these issues. A new team the Tax Code, inspectors would apply penalties, was created within the Debt Resolution Unit fines and assess taxes due to mistakes (or handling the transfer of portfolio shares. As a instances of discovered fraud) in old tax result, the issue of transferring portfolio shares declarations. against debt settlement was solved. As such there were recorded cases where a Research indicated that the three main reasons 50,000 lei current debt to the state would grow of delays in the debt settlement process were exponentially to hundreds of thousands of debt connected with contradictions in the respective after application of back taxes, fines and penalties legislation. They were solved at the level of the on the unpaid amounts as a result of the tax audits National Securities Commission, the Department after the official liquidation announcement had of Privatization and State Property Administration been published in the Monitorul O?fcial. The Debt and at the Government level. Team referred to this as "piling-on" and viewed this as a government "taking" of private property Legislation. In practice, it was demonstrated without proper compensation, i.e., a re- that complete high Government support is not nationalization of assets which heretofore had always sufficient to eliminate all delays. been owned by the rural people (viz., the farm). Therefore, it was necessary to amend the Debt Law. The amendments were prepared by the Even if the tax years audited were within the National Land Program in cooperation with the period classified as "historical debt" in the Debt Ministry of Finance and the Main State Tax Law, i.e., prior to January 1, 1999, tax inspectors Office. and Ministry of Finance officials insisted these fines and penalties, as well as the original tax Parliament approved the amendments on 27 amount, should be treated as current debt. April, 2000. These amendments were debated in Parliament at the beginning of 2000 in intensive While Debt Program executives and managers discussions. However, as a result of the successful never discovered the real reason for this action on implementation of the Debt Law from September- the part of tax inspectors and the Main State Tax December 1999, the amendments to the law were Office, speculation included ideas such as re- examined and approved in favorable conditions. nationalization of the non-land means of generating income in rural Moldova, stripping as The respective amendments can be divided much as possible from the farm for the benefit of into (i) amendments eliminating instances of the central and local government, punishing the artificial increase of current farm debt and (ii) new private farmers as through the "stripping" amendments aimed at simplifying the debt process any additional assets owned by the farm settlement procedure. would not be distributed in the second property tender, accruing assets to sell or allocate cheaply The first category of amendments were aimed to friends or families or other higher government at eliminating the artificial increase of current officials, or simply as a misguided effort to create debt. obstacles for the Debt Program so as to block liquidation of the collective shells - which for For example: some tax inspectors, in use of many individuals had provided an illicit livelihood their rights under the Tax Code, would decide to for decades. audit a farm's accounting records and tax declarations corresponding up to the statute of The amendment assisted resolution of the limitations after the announcement of liquidation above problems by moving the dates for historical had been made in the Monitorul Oficial but before and current debt from December 31, 1999 to (or even during) the NLP debt coordinators and December 31, 2000 as well as classifying fines, FPRC teams began the process of reconciliation penalties, unpaid back taxes discovered through 108 Farm Debt in the CIS this audit process as historic debts if the audits providing incentives for the creation and success were performed for years prior to December 31, of private business, quite the contrary, it drives 2000. Furthermore, the amendment instructed tax private business persons into the gray or shadow authorities that penalties, etc. discovered on farms economy. For this reason, new farmers created out after the announcement in the Monitorul Oficial of the NLP usually do not register their could NOT be charged. This section of the businesses. amendment effectively eliminated the practice of "piling-on" and reduced the current debts by at This lack of registration complicates matters least 33 percent. for the assessment and collection of taxes, e.g., land and Social Fund taxes, since tax officials are Another major problem that the amendment unaware of the existence of these new enterprises effectively eliminated regarded the frequent and private landowners. This has additional practice of falsely accounting income and repercussions in that taxes that should be assessed expenses of private farms (created through the against the newly created farmers continue to be privatization process but which had not officially wrongly assessed against the old collective shell. registered as a new economic entities) on the The effect is that unpaid tax and Social Fund accounting records of the old collective, as if the amounts engender fines, penalties, etc. This just collective had been carrying on this economic facilitates the "stripping" away by the tax officials activity. In this manner, the old collective of any remaining assets which could possibly be appeared for all practical purposes to be engaged distributed to eligible workers in the second and in economic activity, however the entrepreneurs final property tender prior to reaching a "nil" were undertaking the economic activity, not the balance sheet shortly before final liquidation. old collective. Tax officials, whether they genuinely didn't know or understand what was Therefore, there is a vicious circle which in happening, or whether they were just too lazy or the end prejudices the ordinary worker whose ill equipped to assess Land, Social Fund, VAT, rights are being violated (without their knowledge income tax, customs duties etc., on thousands of or consent in most cases) by leader farmers, new clients, continued to assess these taxes on the inefficient or corrupt tax officials, and old old collective, which of course never paid. These collective farm accountants and managers. The unpaid taxes, which really belonged to the newly amendment to the Debt Law tries to resolve some created private farms, were lumped together of these issues in favor of the second and final initially as either historic or current debt and property tender. written off, transferred to the state and offset with property or settled as current debt to the state Last, the amendment to the Debt Law also through transfer of mills, oil presses, etc., etc. fixes an anomaly regarding losses due to exchange rate fluctuations on credit agreements The amendment forced tax officials to assess between farms and parastatal suppliers of fuel, Land and Social Fund taxes on the new fertilizer and other imported chemicals. For landowners from the end of the month in which whatever reason, many of the agreements between the land was distributed at the land tender, and the farms and the parastatal corporations were made it easier for tax officials to assess other denominated in the national currency without taxes on these same private farmers. consideration of possible devaluation. But in 1998 and 1999, the national currency lost about 50 This discussion raises another issue, i.e., the percent of its value vis-a-vis the U.S. dollar. tax regime against agriculture and private Therefore during debt settlement proceedings, enterprise and the methods utilized by the tax many of these supply agreements were delinquent service to collect what they consider due to the and were classified as either historic of current state as a result of private economic activities. The debt, depending on the dates when the original current Moldovan tax system and collection deal was made. methodologies is so heavily weighted against the private business entrepreneur that instead of Appendix C- The Moldova Farm Debt Restructuring Program - A Unique Approach 109 The parastatal corporations had apparently specialists had already prepared the requisite borrowed in dollars from the Government of regulations to this law, these will be immediately Moldova to import the input supplies for resale to promulgated by Government decision shortly after farms. Therefore during debt settlement, these the amendment is published. corporations sought desperately to peg their credits to the US dollar-lei exchange rate, thereby The process to amend the Debt Law started in inflating the nominal value of the debts October 1999 with informal discussions between enormously. In order to accomplish this several of the NLP and the Republican Commission, the these corporations resorted to unofficial tactics Main State Tax Office, and other GOM officials such as threatening farm managers if they didn't and ministries. It wasn't until April 2000 until the amend the original agreement to include exchange Government accepted the wording of the rate differences. In other cases, contracts were amendment and it was officially introduced into falsified outright. Parliament. Thus a new stage in debt restructuring will commence on June 8th - and none too soon - The amendment to the Debt Law attempted to as the remaining farms are those which couldn't clean-up this issue by not allowing any exchange be liquidated earlier due to problems and more rate differences to be included as either current or difficult financial situations. historic debt unless they were mentioned in the original contract. It further stipulated that no Notwithstanding the above discussion, the exchange rate differences would be accepted NLP executives and their advisors still are of the unless these were filed and registered prior to the opinion that the amendment to the Debt Law was date liquidation was announced in the Monitorul unnecessary if the bureaucracy would have Oficial. respected the intent and spirit of the original law. The second category of amendments were aimed at simplifying the debt settlement Current Status procedure. For example: * it combined the two Republican Commissions According to the CPBR work plan approved (one for historic debt and another for current by the USAID, 888 collective farms should debt) into one, simplifying the decision complete all debt resolution stages and be making process and the document flow completely privatized and liquidated by August to/from this state body; 31, 2000. A snapshot view of the debt component * it suspended the execution of earlier court of the National Land Program shows following rulings concerning farm's property during the results, as of the end of May 2000: out-of-court liquidation of the farm, which * 765 collective farms published liquidation will greatly simplify the process of property notes in compliance with the Law on transfer for debt offset; Restructuring of Farms Undergoing * it obliged mayor's offices to accept assets Privatization (Debt Law); transferred to the state as current debt * 694 farms submitted documents, which were settlement, which will considerably eliminate approved by the Republican Commission the delays in the transfers of assets; and (there were adopted decisions on transfer to * it regulates the procedure of transferring the the State of historical debt and writing-off of documents of the liquidated farm to State remaining unsettled historical debt, if Archives and mayor's offices' archives, necessary); which will eliminate delays in completing the * 564 farms repaid all debts (including debts to final farm liquidation procedure, etc. priority creditors, historic and current debts); * 539 farms finalized privatization and were The amendments to the Debt Law became liquidated. effective on June 8, 2000 (Monitorul Oficial No. 24-26 or June 8, 2000) and since the NLP 110 Farm Debt in the CIS collectives as business counterparts, has changed Figure A.5: The Initial Structure of Debts significantly in 2000 when the majority of farms had distributed land and critical property, and stopped their main economic activities. lOther Employ Ocredit 5 State Debts that were written-off as debts with ! 28 ~ 25 expired statute of limitations (3 years), and unclaimed debts (debts to creditors that failed to forward their claims within one month after the announcement of liquidation) constituted almost 20% of the total amount of farms' debts. The percentage of debts to private creditors that were Ban_ written-off as unclaimed debts decreased from B?afl I _ 'l20% during first months after the Debt Law was Ministry Local enacted to 15% at the present. The percentage of Finan Social 13 current debt increased from 3% to 13% during 9 1 25 months, and more than 20% of current debt to the state was the result of back taxes, penalties and fines applied by tax inspectors during the process of liquidation. For these farms: * 1,021,865,000 lei in debt was settled; Historic debts of farms are composed by * 818,630,000 lei in social assets were primary (initial) historic debt to the state, and transferred to the local government; secondary historic debt (historic farms' debts to * 624,971,000 lei in historical debt was offset private creditors transferred to the state). The ratio with assets; of secondary historic debt to the state was 27%. e 35,265,000 lei in historical debt was written- Both primary and secondary debt to the state off as remaining historical state debt. amounted to 660 million lei at the end of May 2000. More than 839 million in lei at book value The average time required for a collective were transferred to the state, including social farn to completely settle its debt, distribute its assets (97.5%), mills, oil presses and other property and liquidate was 122 days, ranging from processing facilities (1%), portfolio shares (1.4%). 32 to 300 days. The efficiency of the debt Although, on aggregate, the book value of all component of the National Land Program was farms' assets was greater than the amount of their constantly growing, and reached by the end of historic debt to the state, 35 million lei in historic May 2000 a daily average of: debt to the state were written off as unsettled * 2.3 farm liquidations; remainder (Figure A.6) in cases when farms did * 4.3 million lei ($345,000) in debts settled. not have sufficient assets to transfer to the local government. An overage of social assets worth The structure of debts (as of the date of the more than 190 million at book value was announcement of liquidation) is shown in Figure voluntarily transferred gratis to the government. A.5. The farm debt structure registered in 1998 Current and priority debts were settled before distribution of land and critical property urrenta and prores deby the Det (Tabl inrae from 48% to 64 n etth usin various procedures provided by the Debt private sectorndcreased from 52to64%and t to 3. Law. The preferred method used by farms for Collective farms debts to the state increased settling these categories of debts was different for Collective farms debts tothestateidebts to the state and debts to private creditors mainly as a result of fines and penalties applied to (Table A.5). Three main procedures were used to the collectives that lost capacity to repay debts. At settle current debts and debts to priority creditors: the same time, private creditors preferred the newly created private farms to the semi-dead old * repayment by cash and/or other assets; Appendix C: The Moldova Farm Debt Restructuring Program - A Unique Approach 111 * writing off in case of refusals of creditors to electronic registry kept by the Main State Tax accept any assets or insufficiency of assets; Office. * debt transfer to private farms that volunteered to accept debts together with an equivalent Figure A.6: Offsetting Farm Historic Debt to the State amount of assets. with Assets Current debts to the state were preferably - - - repaid by cash and/or other assets (68.5%), while 901 (Million private debts were preferably taken over by the 80 newly created private farms, especially debts to the employees of the former collectives (49% and 80%, respectively). These preferences can be 60 l explained by the private farms desire to maintain 50 good relations with private creditors - their 40M present and future suppliers, some moral 301 l obligations to former employees, and last but not 20 least - the possibility of receiving additional 35 assets before the final distribution of property, 10 l35 Table A.6 summarizes the results of the Assets Debts Debts CPBR collaboration with government in creating a favorable legal environment for farm debt Thus, a larger amount (57.7%) of farms' debts settlement and farm restructuring, as well as to private creditors transferred to the state was expediting the process and ad hoc overcoming settled right after the transfer, and 42.3% was different specific issues. deferred for future repayments through tax credits. As a result, the impact on the consolidated budget The amount of farms' historic debt to private generated by debt settlement procedures in 1999, creditors transferred to the state totaled 65.5 amounted to 5.5 million lei for each budgetary million lei by the end of December 1999. Of this year tax credits were deferred for. The load on the amount of state debts to private creditors: 1999 budget was less than forecasted in the * 37.8 million lei were settled right after the projections made from the 1998 farm debt survey. debt transfer through offsetting of creditors' debts to the state and local budgets; By June 2000, the value of treasury notes * 27.7 million lei was deferred and will be extinguished by the Main State Tax Office repaid by the Ministry of Finance in equal through tax credits amounted to 1,968 thousand installments during 5 years, i.e., during 2000- lei, or 36% of the amount due for the current year. 2004. It can be concluded that the treasury notes, as a special financial tool, elaborated and implemented The deferred debt repayments were by the National Land Program proved workable documented by 233 treasury notes of the Ministry and functional, and the state honors its obligations of Finance. The treasury notes are documented for to private enterprises - former creditors of the each creditor following the principle "one creditor liquidated collective farms. - one treasury note" and are entered into an 112 Farm Debt in the CIS Table A.5: Methods of Settlement for Different Categories of Farm Debt Repaid written-off transferred thsd. lei % thsd. lei % thsd. lei % Current debt to the state ............................ 38 358 68.5% 4 346 7.8% 13 282 23.7% Current debt to private creditors ............... 13 371 29.3% 11 179 24.5% 21 145 46.3% Debt to employees ............................ 10525 18.5% 654 1.1% 45715 80.4% Debt to banks ............. ............... 7 370 41.4% 762 4.3% 9 682 54.4% Total 69 624 39.5% 16 941 9.6% 89 824 50.9% Table A.6: Legal Cooperation with the Government of Moldova Drafted and enacted Number Normative acts L Laws..7 * Government Decisions ..8 * Orders of various Ministries .. * Circular letters for local tax and Social Fund offices ..22 Subtotal 42 Non-normative acts • Letters to the local government ..15 * Letters to the General Prosecutor ..14 * Letters to various ministries and departments ..10 * Letters on releasing farm assets from seizure ..52 * Formal answers on behalf of the Republican Commission ..39 Subtotal 130 TOTAL 172 National Land Program Methodology 1. Initial steps in I. Farm preparation . I. Distribution of IV. Collective farm debt V. Complete privatization . land and critical plettlement * privatization .aproperty a nd final liquidation of *~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ g;;i. ollective , 1. Disseminate . 8. Settlement of debt to priority creditors information to farin * administration . , -. , * * 8 9. Settlement of historical debt Land tender~ ~ ~ ettement of Settlement of ** General Pparation for land and al6o(atn of .istorical debt to ||historical debt |i Distribution t n*fnnationnfoGen plva tiation f adS transferred to theo ning 4ht (Including ltdposo eann C - eapersons wh (withndd Transfe ing abanoned the reaato fo Tede for regisatione of hitria non Ilectirvtiatov*e*'sletiefam +:* mployees and 1/or~~- property)i n tne CL 7. 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"Reform and Market Adjustment of the Bulgarian Agricultural Sector," VIIth EAAE Congress, Stresa, Italy, Contributed Papers, Volume F: Agricultural Development and Transition, pp. 1-14. S. Wegren. 1995. "The development of market relations in agricultural land: the case of Kostroma Oblast," Post-Soviet Geography, 34(8): 496-512. S. Wegren, Ed. 1998. Land Reform in the Former Soviet Union and Eastern Europe, Routledge, London- New York. G. Wunderlich, ed. 1995. Agricultural Landownership in Transitional Economies, University Press of America, Lanham, MD. R. Zile. 1993. "The Development of Privatization in Latvian Agriculture," Report 93-BR 14, Center for Agricultural and Rural Development, Iowa State University. Distributors of World Bank Group Publications Prices and credt terms vary from CZECH REPUBLIC INDIA Eulyoo Publishing Co., Ltd. PERU SWEDEN count to countryConsultyour USIS. 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