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Competitiveness and Private Sector Development: Ukraine 2011

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This review of competitiveness and private sector development in the Ukraine  provides a solid base for policy analysis and gives recommendations with immediate relevance and applicability. It includes diagnosis and policy actions for policy makers and advisors, offering policy responses to underpin economic diversification, enhanced competitiveness and private sector development. Finally, the book applies an innovative framework to identify barriers that hinder the development of selected sectors. It offers the design and suggests ways to implement specific policies to remove those barriers, including the selection and business analysis of Ukraine's most attractive sectors in terms of competitiveness and FDI appeal.  

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									Competitiveness and Private Sector
Development

UKRAINE
SECTOR COMPETITIVENESS STRATEGY
    Competitiveness and
Private Sector Development:
        Ukraine 2011

   SECTOR COMPETITIVENESS STRATEGY
This work is published on the responsibility of the Secretary-General of the OECD. The
opinions expressed and arguments employed herein do not necessarily reflect the official
views of the Organisation or of the governments of its member countries.

This document and any map included herein are without prejudice to the status of or
sovereignty over any territory, to the delimitation of international frontiers and boundaries
and to the name of any territory, city or area.

This document has been financed by the Swedish International Development Cooperation
Agency, Sida. Sida does not necessarily share the views expressed in this material.
Responsibility for its contents rests entirely with the author.


  Please cite this publication as:
  OECD (2012), Competitiveness and Private Sector Development: Ukraine 2011: Sector Competitiveness
  Strategy, OECD Publishing.
  http://dx.doi.org/10.1787/9789264128798-en



ISBN 978-92-64-12878-1 (print)
ISBN 978-92-64-12879-8 (PDF)




Series: Competitiveness and Private Sector Development
ISSN 2076-5754 (print)
ISSN 2076-5762 (online)




The statistical data for Israel are supplied by and under the responsibility of the relevant Israeli authorities. The use
of such data by the OECD is without prejudice to the status of the Golan Heights, East Jerusalem and Israeli
settlements in the West Bank under the terms of international law.




Corrigenda to OECD publications may be found on line at: www.oecd.org/publishing/corrigenda.
© OECD 2012

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                                                                                                           FOREWORD




                                                        Foreword
         S  ince 2009, the OECD Eurasia Competitiveness Programme has supported the Government of
         Ukraine in advancing national economic reform through its Sector Competitiveness Review project.
         This report contains the conclusions of the first phase of the project, the “Sector Competitiveness
         Strategy”. It provides an assessment and recommendations to guide investment policy reform and
         support the development of high-potential sectors such as agribusiness, machinery manufacturing
         and alternative sources of energy. These recommendations aim to promote competitiveness, attract
         investment to the country and strengthen the public-private dialogue.
              The second phase of the Sector Competitiveness Review of Ukraine was launched in November 2011,
         and focuses on supporting the Government of Ukraine in the implementation of selected sector-
         specific policy recommendations contained in the Strategy. This phase will result in a second report
         to be released in 2012-13.
             The project is conducted in collaboration with the Government of Ukraine and financially
         supported by the Swedish International Development Agency (SIDA) and the Government of Poland.




COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012                                         3
                                                                                           ACKNOWLEDGEMENTS




                                              Acknowledgements
         T  his report is the outcome of work conducted by the OECD Eurasia Competitiveness
         Programme under the authority of the Eastern Europe and South Caucasus Initiative
         Steering Committee (referred to in this publication as the “OECD Secretariat” when policy
         recommendations are suggested), in consultation with the Government of Ukraine and
         participation of the private sector in Ukraine.
               Representatives of the administration of the President of Ukraine, the Verkhovna Rada
         of Ukraine, several Ministries, government agencies, and private sector associations in
         Ukraine contributed to this report. These include:
         ●   Iryna Akimova, First Deputy Head of the Administration of the President of Ukraine;
             Borys Tarasyuk, Chairman of the Committee on European Integration of the Parliament
             of Ukraine; Andriy Klyuyev, First Deputy Prime Minister; Sergiy Tigipko, Deputy Prime
             Minister; Hryhoriy Nemyrya, former Deputy Prime Minister; the Cabinet of Ministries of
             Ukraine (Yuryi Savchenko, Head of Department on Foreign Economic Policy and
             International Co-operation; Mariia Nikitova, former Deputy Chief of Office of the DPM of
             Ukraine; Yuriy Malich, Foreign Economic Policy Bureau).
         ●   The Ministry of Economic Development and Trade (Vasyl Tsushko, Antimonopoly
             Committee Chairman and former Minister; Bohdan Danylyshyn, former Minister;
             Anatoliy Maksyuta, former Deputy Minister; Volodymyr Pavlenko, Deputy Minister;
             Iryna Kriuchkova, former Deputy Minister; Oleksandr Sukhomlyn, former Deputy
             Minister; Viktor Panteleyenko, former Deputy Minister; Mykhailo Rusynskyi, former
             Deputy Minister; Olena Kucherenko, Head of Department on International Technical
             Assistance and Relations with International Financial Organisations; Volodymyr Panchenko,
             Head of Investment and Innovation Policy Department; Yuliya Khvesyk, former Head of
             Department on Investment and Innovation Policy; Volodymyr Zhovtukha, Head of
             Department for Regulatory Policy; Tetyana Zinchenko, Head of Unit, Department on
             International Technical Assistance and Relations with International Financial
             Organisations; Svitlana Kovalivska, Head of Investment Policy Unit, Investment and
             Innovation Policy Department; Svitlana Yatsenko, Head of Unit on Methodology of
             Market Analysis, Department for Development of Economic Sectors; Maksym Duda,
             Head of Unit, Department of Macroeconomics; Vitaliy Troyan, Chief Consultant;
             Lyudmyla Musina, Consultant).
         ●   The Ministry of Agrarian Policy and Food (Maksym Melnychuk, former Deputy Minister;
             Valentina Zavalevska, former Deputy Minister; Yaroslav Hadzalo, former Deputy Minister;
             Serhiy Ivashchuk, former Head of Department for Foreign Economic Co-operation;
             Oleksandr Kuts, Head of Department on Economy and Management of State Property).
         ●   The Ministry of Finance (Andriy Kravets, Deputy Minister; Oleksandr Savchenko, former
             Deputy Minister).


COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012                                 5
ACKNOWLEDGEMENTS



      ●   The Ministry of Foreign Affairs (Victor Mayko, Deputy Minister; Pavlo Sultansky, former
          Head of the Department on Economic Co-operation).
      ●   The Ministry of Justice (Valeriya Lutkovska, former Deputy Minister).
      ●   The Ministry of Fuel and Energy (Volodymyr Makukha, Deputy Minister; Serhiy Pavlusha,
          former Deputy Minister).
      ●   The Ministry of Transportation and Communications (Volodymyr Korniyenko, First
          Deputy Minister; Borys Shyyanov, Deputy Minister).
      ●   The State Agency on Management of Corporate Rights and Property – formerly Ministry
          of Industrial Policy (Serhiy Syrotyuk, former First Deputy Minister; Sergiy Grishchenko,
          former Deputy Minister; Sergii Bilenkyi, former Deputy Minister; Volodymyr Nikitenko,
          Aircraft Industry Department; Alex Shubin, former Deputy Director; Platon Popkov,
          Foreign Economic Relations Department; Valeriy Ivanov, Head of Aircraft Industry
          Department; Yuriy Petrovskiy, Head of Department for foreign economic relations;
          Oleksandr Kiva, Vice-President of Antonov; Volodymyr Vlasyuk, Director of the State
          Company “Ukrpromzovnishekspertyza”; Oleksandr Nahrobovyi, Head of Department for
          Development of Entrepreneurship; Larysa Komarova, former Head of Department for
          Implementation of Strategic Investment Projects).
      ●   The State Committee on Statistics (Vadym Pishcheyko, First Deputy Head;
          Tetyana Tyshchuk, Deputy Director, Department on Production Statistics); the State
          Agency of Ukraine on Investments and Management of National Projects (Igor Zhovkva,
          Head of Department for National Projects and former Chief of Staff of the Deputy Prime
          Minister); the former State Agency of Ukraine on Investment and Innovation
          (Lyudmyla Suprun, Head; Serhiy Moskvin, Deputy Head; Rostyslav Lukach, Head of
          Investment Department); the former National Agency on Foreign Investment and
          Development (Serhiy Taran, Head; Vasyl Feduk, Head of Department for Attracting
          Foreign Investment and Creating a Positive Investment Image); the State Agency on
          Energy Efficiency and Energy Saving – formerly NAER (Sergiy Dubovyk, Vice-Chairman;
          Vitalii Grygorovskyi, First Deputy Chairman; Mykola Kurinko, former Vice-Chairman;
          Oleksandr Semchenko, Deputy Head of Technical Policy Department; Oleksandr Tron,
          Head of Economic Policy Department; Oleksandr Grytsyk, Head of International
          Cooperation Division); the former National Commission of Ukraine for Regulation of
          Electroenergy Market (Serhiy Dunaylo, Member).
      ●   The European Business Association (Anna Derevyanko, Executive Director; Olga Valchuk,
          Deputy Director); the American Chamber of Commerce in Ukraine (Jorge Zukoski,
          President; Oksana Panchuk, former Deputy Director); ICC Ukraine (Volodymyr Schelkunov,
          Chairman; Vladimir Mikhailov, First Deputy Chairman; Volodymyr Nikolaiev, Deputy Head
          Department on Communications; Sergiy Babak, Deputy Secretary General; Darya Revina,
          Head of Commission on green investments, alternative and renewable sources of energy;
          Olga Revina, Director of the EU Ukraine Business Council); ICPS (Olga Shumylo-Tapiola,
          Visiting Scholar of Carnegie Europe and former Director); the Ukrainian Chamber of
          Commerce and Industry (Victor Yanovsky, First Vice-President, Secretary General;
          Valeryi Korol, Director, International Economic Relations Department).
      ●   The Co-Chairs of the OECD Eastern Europe and South Caucasus Initiative, Sweden (His
          Excellency Stefan Gullgren, Ambassador of Sweden to Ukraine; Mirja Peterson,
          Counsellor and SIDA Country Director for Ukraine; Olga Tymoshenko, Programme
          Officer, SIDA) and Poland (His Excellency Pawel Wojciechowski, Ambassador and


6                                              COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012
                                                                                               ACKNOWLEDGEMENTS



            Permanent Representative of the Republic of Poland to the OECD) were donors to the
            project and provided important guidance and support.
             The report was written under the guidance of Carolyn Ervin, Director of the
         Directorate for Financial and Enterprise Affairs (DAF); Anthony O’Sullivan, Head of the
         Private Sector Development Division, DAF; and Fadi Farra, Head of the Eurasia
         Competitiveness Programme, DAF.
               Antonio Somma, Economist, led and supervised the study. The individual chapters were
         prepared by a core team of policy analysts and consultants: Gregory Lecomte, Policy Analyst
         and Project Coordinator (grain and dairy sector, production of energy and heat based on
         biomass, methodology), with input from Ales Triska, General Manager of CinemArt;
         Dusan Triska, Professor at Prague University of Economics and former Deputy Minister of
         Finance of Czech Republic; Eduardo Negrete, Legal Advisor of the Investment Promotion
         Agency in Peru (land reform); and Jens Holm-Nielsen, Associate Professor, Head of Center for
         Bioenergy and Green Engineering of Aalborg University (production of energy and heat based
         on biomass); Gabriela Skulova, Policy Analyst (methodology); Annamaria de Crescenzio,
         Policy Analyst (methodology, economic overview); Clément Brenot, Policy Analyst; and
         Edgardo Valencia Cruickshank, Policy Analyst (machinery manufacturing), with input from
         Evgeny Bogdanov, Principal of A.T. Kearney; Denis Verret, Senior International Advisor and
         Massi Begous, Partner Stratorg (civilian aircraft manufacturing); Sergiy Rusnak, Consultant
         (agribusiness); Blanka Kalinova, Senior Economist (Chapter on Investment Policy Review of
         Ukraine, based on the OECD publication “OECD Investment Policy Reviews – Ukraine”);
         Wojciech Paczynski, Consultant of the Center for Social and Economic Research in Poland,
         held a workshop on renewable energy in the early stages of the project.
             The Country Capability Survey developed by the Programme was carried with the
         support of GfK Ukraine. The Business and Industry Advisory Committee to the OECD (BIAC)
         provided support for the OECD Foreign Investor Survey.
               The report underwent a quality review by a panel consisting of OECD experts,
         academic peers, and external country specialists affiliated with the OECD. The quality
         review focused on:
         1. Methodology. Dr. Richard Pomfret, Professor of Economics at the University of Adelaide,
            reviewed the publication in its entirety. Alan Paic, Economist, and Ania Thiemann,
            Economist at the OECD, participated in review discussions.
         2. Geographic specificities. William Tompson, Head of the Regional and Rural Development
            Unit of the Public Governance and Territorial Development Directorate, revised the
            entire publication in light of his expertise on former Soviet Union economies.
         3. Sectors. Olga Melyukhina, Agriculture Policy Analyst in the Policies in Trade and Agriculture
            Division of the Trade and Agriculture Directorate, led the review of the agriculture content of
            the publication. Pavel Vavra, Policy Analyst in the Agro-food trade and markets Division of
            the Trade and Agriculture Directorate led the review of the content on dairy. Adam Brown,
            Senior Energy Analyst of the International Energy Agency, led the review of the content on
            production of energy and heat based on biomass. Andrea Goldstein, Head of Global
            Relations at the Investment Division within DAF, and Claire Jolly, Policy Analyst in the
            International Futures Programme Division of the Science Technology and Industry
            Directorate led the review of the content on aircraft manufacturing.
             In addition, the publication was reviewed in Ukraine by the Ministry of Economic
         Development and Trade.

COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012                                      7
ACKNOWLEDGEMENTS



          The final report was edited and prepared for publication by Fadi Farra,
      Antonio Somma, Blanka Kalinova, Grégory Lecomte, Clément Brenot, Annamaria
      de Crescenzio, Daniel McArthur, Sergiy Rusnak, Michael Sykes, Vanessa Vallée,
      Emma Beer and Ed Smiley.
          Local research and support in Ukraine was provided by Dmytro Kotlyar, Consultant of
      the OECD and former Vice-Minister of Justice of Ukraine, and by Oksana Shulyar,
      Consultant of the OECD and former Adviser to the Head of the Parliamentary Committee of
      Ukraine on European Integration.
          Valuable administrative support was provided by Anna Chahtahtinsky, Orla Halliday,
      Renata Helliot-Tavares, Zara Kuruneri, Elisabetta Da Prati and Lynn Whitney.




8                                           COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012
                                                                                                                                                  TABLE OF CONTENTS




                                                             Table of Contents
         Acronyms and abbreviations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                       15

         Executive summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                17

         Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .       23


                                                                            PART I
                                                                         Methodology

         Chapter 1. Approach and methodology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                              27
             The definition of competitiveness . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                            28
             Identifying sectors for intervention . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                           31
             A prioritisation framework to select policy recommendations 
             for the implementation phase . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                         38
                Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .   39
                Bibliography . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .        39


                                                    PART II
                     Economic overview and findings of the Investment Policy Review of Ukraine

         Chapter 2. Economic overview. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                      43
             A country with abundant natural resources and a well qualified labour force . . . .                                                            44
             After struggling immediately following independence, the Ukrainian economy 
             enjoyed a period of robust growth. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                           45
             The global financial crisis highlighted existing weaknesses. . . . . . . . . . . . . . . . . . . .                                             46
             Economic activity relied mainly on agriculture and highly energy intensive 
             industries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .         47
                Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .   51
                Bibliography . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .        51

         Chapter 3. 2011 OECD Investment Policy Review of Ukraine – Key findings . . . . . . . . . . . .                                                    53
             General investment policy recommendations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                       57
             Suggested measures to improve the investment climate . . . . . . . . . . . . . . . . . . . . . .                                               58


                                                                        PART III
                                                                Sector-specific analysis

         Chapter 4. Agribusiness . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                61
             Summary. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .           62
             Sector definition and segmentation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                             63


COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012                                                                                         9
TABLE OF CONTENTS



              Global trends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .      64
              The role of foreign investors along the agribusiness value-chain . . . . . . . . . . . . . . .                                           70
              Ukraine agribusiness sector at a glance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                        71
              Why focus on the grain and dairy sub-sectors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                               77
              Stakeholder consultations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                78
              Bibliography . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .     79

       Chapter 5. Focus on the grain value chain. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                          81
           Summary. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .        82
           Sub-sector definition and segmentation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                              83
           Global trends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .         86
           Sources of competitiveness . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                    89
           The role of foreign investors in the grain value chain . . . . . . . . . . . . . . . . . . . . . . . . .                                    92
           Key issues and policy barriers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                    94
           Policy recommendations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                   99
              Notes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 102
              Bibliography . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 102

       Chapter 6. Focus on the dairy value chain. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                        105
           Summary. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .      106
           Sub-sector definition and segmentation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                            107
           Global trends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .       108
           Sources of competitiveness . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                  110
           The role of foreign investors in the dairy sector . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                             114
           Key issues and policy barriers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                  116
           Policy recommendations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                 122
              Bibliography . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 127

       Chapter 7. Energy-efficiency and renewable technologies: Focus on production 
                  of energy based on biomass . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                       131
           Summary. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .      132
           Why focus on production of energy based on biomass . . . . . . . . . . . . . . . . . . . . . . . .                                        133
           Sector definition and segmentation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                        137
           Global trends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .       138
           Sources of competitiveness . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                  141
           The role of foreign investors in the biomass value chain . . . . . . . . . . . . . . . . . . . . . .                                      145
           Key issues and policy barriers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                  147
           Policy recommendations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                 151
              Bibliography . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 155

       Chapter 8. Machinery and transport equipment: Focus on civilian 
                  aircraft manufacturing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 157
           Summary. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 158
           Why focus on civilian aircraft manufacturing. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 160
              Sector definition and segmentation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                     161
              Global trends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .    165
              Sources of competitiveness . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .               171
              The role of foreign investors in the civilian aircraft value chain . . . . . . . . . . . . . . . .                                     173
              Key issues and policy barriers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .               176

10                                                                      COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012
                                                                                                                                           TABLE OF CONTENTS



                Policy recommendations. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 182
                Bibliography . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 185

         Conclusion and roadmap for implementation phase . . . . . . . . . . . . . . . . . . . . . . . . . . . . 187
            A roadmap for creating a favourable business environment 
                and attracting investment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 188
                Targeted interventions are recommended to build long-term capabilities 
                in promising sectors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 189
                Bibliography . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 191

         Tables
          1.1. Sample size of the survey questionnaire . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                            37
          4.1. How are domestic agro-climatic conditions favourable to more intensive 
               crop growing? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .        79
          5.1. World grain production and harvest area, 2009 . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                83
          5.2. Black Sea ports have a cost advantage for grain exports to middle-eastern 
               countries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .    91
          5.3. Foreign companies are sizeable grain exports . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                               93
          6.1. Turnover of the largest global dairy processing companies, 2009 . . . . . . . . . . . . . .                                           115
          6.2. Quality standards for raw cow milk for food production in Ukraine 
               and the EU . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .    120
          7.1. The distribution of Ukraine’s coal mines . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                          135
          7.2. Energy uses of biomass . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .              139
          7.3. Straw, wood, husk and manure as primary biomass sources are promising 
               in Ukraine . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .    142
          8.1. Aircraft industry was selected as it presents specific technology 
               and capabilities in Ukraine and high government priority . . . . . . . . . . . . . . . . . . .                                        161
          8.2. Segmentation of civilian aircrafts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                    163
          8.3. Distribution of selected aircraft by segments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                            164
          8.4. Active fleet by carrier, Airbus vs. Boeing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                      171
          8.5. Total accidents/Total aircraft production % of key aircraft competitors . . . . . . . .                                               172
          8.6. Active fleet by country, selected countries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                         176
          8.7. Investment in the Boeing 787 programme by Japanese risk-sharing partners . . .                                                        179

         Figures
           1.1. Ukraine needs to move from a factor-led economy to an efficiency-led economy . .                                                     30
           1.2. Sector Prioritisation Framework methodology . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                32
           1.3. Sector Prioritisation Framework, analysis for Ukraine . . . . . . . . . . . . . . . . . . . . . . .                                  33
           1.4. Results of consultations with private and public sector representatives . . . . . . .                                                34
           1.5. Agribusiness example: Comparison of production costs for wheat 
                (USD per metric tonne), 2009 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                  35
           1.6. Civilian aircraft industry example: Areas for potential FDI 
                along the supply-chain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .              36
           1.7. Dairy sub-sector example: Difficult access to finance is partly due 
                to the weak links between farmers and processors . . . . . . . . . . . . . . . . . . . . . . . . .                                    37
           1.8. A framework to prioritise among policy recommendations for Phase II based 
                on the country’s strategic advantage and the areas of intervention . . . . . . . . . . .                                              38
           2.1. Ukraine’s labour force has a high level of tertiary education . . . . . . . . . . . . . . . . .                                       44
           2.2. Female labour participation in Ukraine is high compared to regional peers . . . .                                                     45

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         2.3.    Annual inward FDI flows in the region . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                46
         2.4.    FDI per capita in Ukraine is lower than in its regional peers. . . . . . . . . . . . . . . . . .                             47
         2.5.    The share of services in GDP has expanded since independence. . . . . . . . . . . . . .                                      48
         2.6.    The current account deficit has widened . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                  48
         2.7.    The evolution of real GDP has been closely linked with steel prices . . . . . . . . . . .                                    49
         4.1. The agribusiness supply-chain. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .              64
         4.2. Consumption of crop and livestock products to increase more rapidly
              in non-OECD countries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .         65
         4.3. Agricultural production growth over the last decade was driven
              by non-OECD countries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .         66
         4.4. Agricultural production in non-OECD countries to grow at a faster pace
              than OECD countries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .       66
         4.5. Demand for high value added products in modern retail outlets
              grows as incomes rise . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .       67
         4.6. Price changes for selected commodities in 2005-10 . . . . . . . . . . . . . . . . . . . . . . . . .                             68
         4.7. Most commodity prices in real terms to remain above the last decade’s level. . .                                                69
         4.8. FDI stock in agriculture is rising in CIS countries and South-East Europe
              but it is much smaller than in Latin America and Africa . . . . . . . . . . . . . . . . . . . . .                               71
         4.9. Arable land in selected European countries, thousand square kilometres . . . . . .                                              72
        4.10. Production of agricultural commodities in Ukraine, millions of USD, 2008. . . . . .                                             72
        4.11. Ukraine: Share of agriculture sector in GDP, 1999-2009 . . . . . . . . . . . . . . . . . . . . . .                              73
        4.12. Export structure of Ukraine, 2008. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .              73
        4.13. Variation in production of selected commodities in Ukraine,
              2006-09, index 100 = 2005 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .         75
        4.14. Domestic consumption status and outlook for key agricultural products . . . . . . . . .                                         78
        4.15. Annual world imports of agricultural products, status in 2009
              vs. outlook in 2020 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .   79
         5.1. Example of the wheat value chain. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                 84
         5.2. Ukraine’s grain production has rebounded in recent years . . . . . . . . . . . . . . . . . . .                                  85
         5.3. Ukraine’s production of wheat and coarse grains . . . . . . . . . . . . . . . . . . . . . . . . . . .                           85
         5.4. Ukraine is amongst the top exporters of wheat and coarse grains. . . . . . . . . . . . .                                        86
         5.5. Growth of world grain consumption is projected to be higher
              in non-OECD countries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .         86
         5.6. Africa, Middle-East and East Asia will drive the additional
              grain imports over the coming decade . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                    87
         5.7. Grain production costs are competitive, while yield still offers opportunity
              to improve efficiency of production. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                90
         5.8. Ukraine could apply more fertiliser to increase yields . . . . . . . . . . . . . . . . . . . . . . .                            91
         5.9. Major importers of starch and gluten, millions of USD, 2007 . . . . . . . . . . . . . . . . .                                   93
        5.10. Percentage of farmers having difficulty in obtaining credit. . . . . . . . . . . . . . . . . . .                                94
        5.11. Limited access to long-term loans results in very low use
              of agricultural machinery . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .         95
        5.12. Cargo handling volume is near to maximum capacity of Ukrainian ports . . . . . .                                                97
         6.1. Cow’s milk dominates the global raw milk output . . . . . . . . . . . . . . . . . . . . . . . . . . 107
         6.2. The dairy value chain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 108
         6.3. World consumption growth of dairy products driven by non-OECD countries. . . 109




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                                                                                                                                              TABLE OF CONTENTS



           6.4. World dairy production value and structure, recent trends and forecasts, 
                2005-19 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .   109
           6.5. Key importers of selected dairy products globally. . . . . . . . . . . . . . . . . . . . . . . . . . .                                  110
           6.6. Annual dairy, food and meat price indices, 2002-04 = 100 . . . . . . . . . . . . . . . . . . . .                                        111
           6.7. Millions of cows producing milk in Ukraine, 1990-2006 . . . . . . . . . . . . . . . . . . . . . .                                       111
           6.8. Milk yield, tonnes of fluid milk per cow per year, 1990-2006 . . . . . . . . . . . . . . . . . .                                        112
           6.9. Cost of milk production in selected countries, US dollars per 100 kg, 2007 . . . . .                                                    113
          6.10. Domestic demand for processed dairy products is expected to increase 
                by 30% over the coming decade . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                       113
          6.11. The Ukrainian dairy industry exports significant volumes 
                of its production . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .         114
          6.12. CIS countries and Middle-East already key importers of Ukrainian 
                dairy products . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .        114
          6.13. Workforce skills are seen as an area for improvement where government 
                action is called on. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .          117
          6.14. Quality of state controls and regulation are debated . . . . . . . . . . . . . . . . . . . . . . . .                                    119
          6.15. Milk yields in Ukraine’s large dairy farms are half 
                of the European Union average . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                       120
          6.16. Lack of financing affects the level of investments and therefore productivity. . .                                                      121
          6.17. A summary of policy options to enhance initial and VET education . . . . . . . . . . .                                                  123
          6.18. Extension programmes are an example of a policy option 
                to develop producers’ skills. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                 124
          6.19. Credit guarantee schemes are a way to foster access to finance 
                for mid-size farmers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .              126
          6.20. Supply chain financing brings the financial means of large or foreign firms 
                to small-scale producers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                127
           7.1. Energy intensity, a cross country comparison . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                                134
           7.2. Opportunities to reduce energy-intensity and to develop alternative 
                sources of energy along the value chain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                           134
           7.3. Naftogaz (100% owned by the state) dominates the gas-value-chain 
                in Ukraine . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .      135
           7.4. State-owned Naftogaz dominates exploration and production, 
                as well as the main oil pipelines . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                     135
           7.5. State and private ownership of power transmission and distribution assets 
                until mid-2011. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .         136
           7.6. Biomass residue supply chain for energy production. . . . . . . . . . . . . . . . . . . . . . . .                                       138
           7.7. Structure of the global total primary energy supply, 2007 . . . . . . . . . . . . . . . . . . . .                                       139
           7.8. Structure of world renewable energy sources supply, 2007 . . . . . . . . . . . . . . . . . . .                                          140
           7.9. Key success factors for a bio-energy project . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                              141
          7.10. Economic potential of biomass sources in 2008, breakdown by type 
                of agricultural residue, millions of tonnes of coal equivalent . . . . . . . . . . . . . . . . .                                        142
          7.11. Production costs of heat by straw-based boilers are lower than 
                by gas-fired boilers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .          143
          7.12. Operating costs and profits of a hot water boiler based on wood biomass 
                for supply of a middle-size city, thousands EUR . . . . . . . . . . . . . . . . . . . . . . . . . . . . 144
          7.13. Net cash-flow plan in the five first years of the project, thousands EUR. . . . . . . . 144
          7.14. Fuel used for power and heat production in Ukraine, 2006 . . . . . . . . . . . . . . . . . . . 145


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        7.15. Price of natural gas for utilities in Ukraine, past trends according 
              to IMF requirements. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 146
        7.16. Potential opportunities for FDI along the value-chain . . . . . . . . . . . . . . . . . . . . . . . 146
        7.17. Lack of public support and awareness for the biomass industry 
              was pointed out . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 149
        7.18. Payment arrears also need to be solved to allow for investment . . . . . . . . . . . . . .                                        150
        7.19. The quick adoption of biomass in Poland has made it a key element 
              in the renewables landscape . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .               153
         8.1. Four sub-sectors were identified on the basis of their share in the national 
              domestic turnover . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .       160
         8.2. The aircraft manufacturing industry ranges from components 
              to after-sales services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .       162
         8.3. OEMs play a key role in designing, coordinating suppliers, and assembling 
              the final product . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .   162
         8.4. Number of deliveries of regional turboprops, 2002-10 . . . . . . . . . . . . . . . . . . . . . . .                                164
         8.5. Number of deliveries of regional jets, 2002-10 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                        165
         8.6. Number of deliveries of large or very large aircraft, 2002-10 . . . . . . . . . . . . . . . . . .                                 165
         8.7. Total expected demand for civilian aircraft by segment over 2011-30 . . . . . . . . . .                                           167
         8.8. Asia Pacific and other emerging economies will drive the growth of demand 
              for civilian aircraft . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .   167
         8.9. Example of Airbus A380 global supply-chain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .                          171
        8.10. Surveyed entrepreneurs assessed the skill gap in the aircraft segment . . . . . . . .                                             180
         9.1. Selected areas of interventions in the Agribusiness sector . . . . . . . . . . . . . . . . . . .                                  190
         9.2. Selected areas of interventions in the Energy production 
              from alternative sources sector . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .             190




14                                                                   COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012
                                                                                ACRONYMS AND ABBREVIATIONS




                                      Acronyms and abbreviations


         AF              Agrarian Fund
         CAGR            Compound Annual Growth Rate
         CCS             Country Capability Survey
         CET             Continuing Education and Training
         CHP             Combined Heat and Power
         CIS             Commonwealth of Independent States
         BIAC            Business and Industry Advisory Committee to the OECD
         DAF             Directorate for Financial and Enterprise Affairs
         EBRD            European Bank of Reconstruction and Development
         ECA             Export Credit Agencies
         EIU             Economist Intelligence Unit
         EU              European Union
         FAO             Food and Agriculture Organization of the United Nations
         FDI             Foreign Direct Investment
         FTA             Free Trade Agreement
         GCI             Global Competitiveness Index
         GDP             Gross Domestic Product
         GECAS           General Electric Commercial Aviation Services
         HO              Heckscher-Ohlin
         IAR             Industria Aeronautică Română
         IEA             International Energy Agency
         IEAv            Instituto de Estudos Avançados
         IFC             International Finance Corporation
         IFI             Instituto de Fomento e Coodernação Industrial
         IFPRI           International Food Policy Research Institute
         ILFC            International Lease Finance Corporation
         ILO             International Labour Organization
         IMF             International Monetary Fund
         INPE            Instituto Nacional de Pesquisas Espaciais
         ITA             Instituto Tecnológico de Aeronáutica
         MAPU            Ministry of Agricultural Policy of Ukraine
         MENRU           Ministry of Environment and Natural Resources of Ukraine
         MHCU            Ministry of Health Care of Ukraine
         MNE             Multinational Enterprise
         MRO             Maintenance, Repair and Overhaul
         MSPIS           Main State Phytosanitary Inspection Service
         OBM             Original Brand Manufacturer
         OEM             Original Equipment Manufacturer


COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012                               15
ACRONYMS AND ABBREVIATIONS



       PFI          Policy Framework for Investment
       PSE          Producer Support Estimate
       PPP          Public Private Partnership
       PPP          Purchasing Power Parity
       R&D          Research and Development
       SCUTRCP      State Committee of Ukraine on Technical Regulations and Consumer Policy
       SDVM         State Department of Veterinary Medicine
       SEIS         State Ecological Inspection Service
       SEZ          Special Economic Zone
       SES          State Epidemiological Service
       SIDA         Swedish International Development Cooperation Agency
       SME          Small-and medium-sized enterprise
       SNAI         Servicio Nacional de Aprendizaje Industrial
       SOE          State Owned Enterprise
       SPF          Sector Prioritisation Framework
       SSSU         State Statistics Service of Ukraine
       TCO          Total Cost of Ownership
       TFP          Total Factor Productivity
       UAC          United Aircraft Corporation
       USDA         United States Department of Agriculture
       UNCTAD       United Nations Conference on Trade and Development
       UNECE        United Nations Economic Commission for Europe
       UNIDO        United Nations Industrial Development Organization
       VAT          Value Added Tax
       VEB          VneshEkonomBank
       VET          Vocational and Educational Training
       WBD          Wimm-Bill-Dann
       WEF          World Economic Forum
       WTO          World Trade Organization




16                                           COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012
        Competitiveness and Private Sector Development: Ukraine 2011
        Sector Competitiveness Strategy
        © OECD 2012




                                        Executive summary

After a decade of sustained growth, the Ukrainian
economy has been impacted by the global crisis

        The Ukrainian economy experienced a decade of robust growth from 2000 onwards.
        During 2000-08, real GDP grew at an annual average rate of 7%, among the fastest in
        Europe. Foreign direct investment (FDI) inflows to the country increased at an annual
        average rate of 43.8% to reach USD 10.9 billion in 2008 in nominal terms. The economic
        growth of the country was supported by a more efficient use of resources which led to an
        increase in productivity, and by external factors, including an upsurge in commodity
        prices, particularly steel, which is one of Ukraine’s leading exports. However, during the
        expansion the country failed to implement all the necessary reforms required for broad-
        based financial stability and durable economic growth.
        The recent global economic crisis affected the economy: in 2009, real GDP contracted by
        15% and FDI inflows fell by 56%. The national currency, the hryvnia, dropped sharply
        against the US dollar and the banking sector was hit. Capital outflows culminated in
        emergency financing of USD 10.5 billion granted by the IMF. Following this deep recession,
        the country reverted to growth in 2010, albeit at a slower pace than before the crisis. Under
        the current policy settings, GDP growth over 2012-13 is projected to be below Ukraine’s
        potential. In June 2011, the World Bank projected Ukraine’s GDP growth at between 4.5%
        and 5% over 2012-13.


The need to boost competitiveness

        The fact that Ukraine was among the emerging economies most affected by the crisis
        underscores the need for further reforms to increase the country’s competitiveness and
        therefore to pursue a more stable path to growth.
        Based on the OECD definition, competitiveness is “the degree to which a country generates,
        while being and remaining exposed to international competition, relatively high factor
        income and factor employment levels” (OECD, 1997 – according to this definition, “factor”
        refers to production factors). This definition contains two key elements. First, competitiveness
        is related to productivity, focusing on factor income or value-added from inputs. Secondly,
        maximising the value-added is a key feature of competitive economies. Competitive
        economies push idle factors producing insufficient value-added to more productive uses,
        attract further investment, achieve high employment levels and generate higher living
        standards.




                                                                                                           17
EXECUTIVE SUMMARY



         However, the convergence in productivity between countries is likely to be a long process.
         Therefore, the stage of development of an economy needs to be taken into account to
         assess its current and future competitiveness. The crisis showed that the temporary
         drivers of competitiveness which sustained Ukraine’s recovery over the last decade – such
         as a global rise in commodity prices – have almost exhausted their potential, leaving the
         economy more vulnerable to shocks. Ukraine is also in a transition period, moving from a
         resource-led economy to an efficiency-led economy, according to the definition of three
         stages of development (X. Sala-i-Martin and E. Artadi, 2004). In this phase the nature of its
         comparative advantage is evolving from a cost advantage, mainly built on natural
         endowments and a cheap labour force, to a capability advantage. Building entrepreneurial,
         managerial and technical capabilities is particularly important to operate efficiently and
         maintain competitiveness over time.
         Within the framework of the OECD Eurasia Competitiveness Programme, the OECD has worked
         with both the government of the Republic of Ukraine and the private sector in order to
         enhance the country’s competitiveness and to improve its attractiveness to foreign direct
         investors. A country-specific “Sector Competitiveness Strategy for Ukraine” project is being
         carried out, based on two pillars:
         ●   Horizontal policy: an Investment Policy Review of Ukraine, which assesses the country’s
             ability to comply with the principles of liberalisation, transparency and non-
             discrimination and to bring its investment agenda closer to recognised international
             standards. This work also paved the way towards Ukraine’s adherence to the OECD
             Declaration on International Investment and Multinational Enterprises.
         ●   Vertical policy: a Sector Competitiveness Review of Ukraine, which analyses those sectors
             with important potential, which could competitively attract investments. The study
             presents some policy recommendations needed to lift the barriers currently hindering
             private sector development in the selected sectors.


Horizontal policy: the role of the legal 
and regulatory framework

         The Investment Policy Review shows that Ukraine has made progress in developing a legal
         framework to attract FDI, but several implementation challenges continue which can affect
         the perspective of domestic and foreign investors, preventing the country from mobilising
         private investment commensurate with its economic potential and investment needs.
         General transparency in terms of access to investment-related information has improved, but
         public consultations and public-private dialogue are still limited. Investment policy
         implementation continues to suffer from a lack of regulatory transparency due to frequent
         changes in legislation, the complexity of existing measures and the absence of, or delays in
         issuing, implementation regulations. Recommendations include the implementation of
         regulations to facilitate the rapid and effective application of the law on public-private
         partnerships (PPPs) and the development of public-private consultations with the business
         community, including with foreign investors, on business-related legislation and regulations.
         Ukraine’s investment promotion activities have been subject to frequent reorganisation
         resulting in the multiplication of agencies, often with overlapping responsibilities. It is
         essential that the new State Agency for Investments and National Projects, created at the
         end of 2010, and the restructured Council of Local and Foreign Investors fulfil their main


18                                                 COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012
                                                                                           EXECUTIVE SUMMARY



         tasks, notably the creation of a single-window facility for foreign investors. It is also
         advisable to take into account the interests and concerns of foreign investors in small and
         medium-sized enterprises (SMEs), which are particularly affected by frequent legislative
         and regulatory changes and related regulatory uncertainty.
         Public policies promoting principles for responsible business conduct, such as those
         embodied in the OECD Guidelines for Multinational Enterprises, could contribute to investment
         inflows, in turn supporting sustainable development. However, corruption remains the key
         impediment to investment and the main reason for the country’s poor ranking in available
         international business surveys.


Vertical policy: removing barriers to investment 
in key sectors of the economy

         The Sector Competitiveness Review of Ukraine aims at both enhancing the sectoral
         competitiveness of the country’s economy and improving its attractiveness to foreign
         investors. Three initial sectors have been prioritised, on the basis of key assets and market
         attractiveness:
         ●   Agribusiness, including the grain and dairy value chains.
         ●   Energy-efficiency and renewable technologies, including the biomass value-chain.
         ●   Machinery manufacturing and transport equipment, including the civilian aircraft value
             chain.1
         The analysis shows that these sectors could attract domestic and foreign investments at
         different levels of the value chain. However, a number of specific policy barriers are
         currently hindering their potential. The comparative advantages of the selected sectors
         and the factors hampering their growth are summarised below.


Grain sector

         Traditionally agriculture has been one of the largest components of the Ukrainian
         economy, contributing 8.2% of value added in 2010 and 25% of total exports in 2009.2
         In the grain sector Ukraine benefits from a significant cost advantage, with production
         costs estimated at around half those of other European producers, such as Germany. It also
         benefits from proximity to growing markets such as the Middle-Eastern and African
         countries. The country also has the potential to increase productivity further and to use
         the vast areas of unused arable land, which could lead to an increase of up to 80% in grain
         output. These significant strengths could help the country to further consolidate its
         leading role as a grain producer and exporter, in a context where growing population, rising
         personal incomes in developing countries and increasing feeding requirements for fast-
         growing livestock sectors are expected to drive global grain consumption upwards in the
         future. Ukraine, which is already the third-largest world exporter of grain after the USA and
         the EU27, is expected to become a global leader in grain exports by the end of the decade,
         together with other key players such as Kazakhstan and Russia.
         However, some issues are hindering the development of the sector. Productivity is low, as a
         result of the limited use of high-quality inputs and the lack of investment in fixed assets,
         such as machinery and storage facilities, especially by small and medium-sized farms.


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EXECUTIVE SUMMARY



        Second, the quality of output does not meet the standards of neighbouring markets,
        impeding exports. Difficulties in accessing finance are a primary concern for small and
        medium-sized farmers, limiting their ability to invest in operational activities and in fixed
        assets which could improve productivity and quality. Thirdly, the current moratorium on
        the purchase and sale of land, which restricts access to the sector, has an adverse impact
        on both agri-finance and foreign investments, since land cannot be used as collateral by
        farmers, nor can it be owned by foreign individuals or foreign companies.


Dairy sector

        Ukraine has traditionally had a robust dairy sector, although herd sizes and output have
        recently been decreasing. The country enjoys low production costs (47% of France’s milk
        production costs in 2007), a growing domestic market in the medium term, and proximity
        to both large, mature export markets such as the EU and developing markets such as
        Russia and the Commonwealth of Independent States (CIS). Rising incomes in developing
        countries will trigger a surge in the consumption of a diversified basket of processed dairy
        products, shifting the sector towards higher value-added dairy production.
        In order to progress up the dairy value chain, Ukraine must still overcome some important
        challenges, such as low-quality of output and low productivity. For example, in large
        modern Ukrainian farms, milk yield approximates 2.9 tonnes per cow, compared with the
        3.5 tonnes in Russia and the OECD average of 4.8 tonnes. The reasons for Ukraine’s low
        productivity are the lack of cattle breeding skills, the low level of private investment and
        the high level of taxation of inputs. Moreover, high fragmentation of production
        significantly increases the costs of milk collection, since most households own only one or
        two cows, with a subsequent negative impact on the quality and safety of milk.


Energy-efficiency and renewable technologies 
with a focus on biomass

        The country’s abundant agricultural and forestry waste constitutes an asset to the
        development of alternative energy production based, in particular, on biomass. The low
        energy prices Ukraine has enjoyed so far have stimulated specialisation in energy-
        intensive industries. However, energy efficiency in the country is, on average, one third of
        that in its industrialised peers. The planned convergence of natural gas import prices to
        European levels, agreed by the Ukrainian government under the IMF plan in 2010, should
        trigger a switch to alternative (non-fossil) sources of energy.
        The diffusion of green technologies such as biomass-based energy – which could partially
        satisfy rising energy consumption and replace the traditional heat and power production
        system – depends predominantly on the steps that the government takes to facilitate the
        transition to these alternative sources. Administrative barriers currently limit investment
        opportunities in the sector, and a national plan defining the role and objectives of biomass
        in the energy landscape is still lacking. One of the consequences is limited communication
        and low awareness among farmers, industrial companies and utilities about the possible
        use of biomass. Development is also held back by the lack of access to capital for most
        players, indebtedness of local utilities and arrears in payments by consumers.




20                                               COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012
                                                                                              EXECUTIVE SUMMARY




Civilian aircraft manufacturing sector

         Ukraine has traditionally been involved in the civilian aircraft sector, having inherited a
         significant part of the former USSR’s capabilities in the aerospace industry. The high
         technical skills of the labour force, its relative cost competitiveness and the quality of its
         products are the main comparative advantages of the Ukrainian industry. Ukraine’s
         education system focuses on scientific curricula and produces a significant number of well
         qualified aerospace scientists and engineers compared to other emerging economies. The
         main Ukrainian aircraft manufacturer, Antonov, designed and manufactured the largest
         operating cargo aircraft in the world – the An-225 Mriya.
         Global demand for finished aircraft is projected to increase over the next 20 years. In OECD
         countries the forecast rise in demand will be driven by the need to replace outdated and fuel-
         inefficient aircraft. In the Asia Pacific region, both passenger travel and cargo transportation
         are expected to boom. The Ukrainian aircraft manufacturing sector could leverage its
         existing capabilities and take advantage of the favourable prospects for the industry.
         However, the existing governance system should be revised, since it is currently hindering
         competitiveness. Both the military and civilian aircraft sectors currently enjoy a national
         interest status with a high level of protection and control. The military aerospace sector is
         closely protected and controlled, and the same level of protection and control applies to
         the civilian aircraft sector. It does not allow for interactions with foreign investors or
         industrial partners, unless approved at ministerial level or higher, which virtually
         eliminates opportunities to implement a business-centred industrial policy.


The way forward

         Targeted policies could be implemented to overcome the existing challenges and foster
         competitiveness in the prioritised sectors. In the next phase of the project, the OECD
         Secretariat will support Ukraine in implementing one or two specific policy recommendations
         per sector. Moreover, efforts will be made to develop dedicated local capabilities, enabling
         the government to continue the process of building a dynamic comparative advantage
         beyond the timeframe of the project.
         ●   In order to improve productivity and raise the quality of output in the grain sector access
             to finance is required. The private sector needs to have access to credit, to invest in
             assets, such as machinery and storage facilities, and to purchase high-quality inputs,
             such as seeds and fertilisers. This could be achieved by fostering the development of
             instruments like supply-chain financing, leasing, and insurance to cover against risk.
             Easier access to finance will probably require the completion of land reform, as a
             prerequisite for using land assets as collateral.
         ●   The growth of the dairy sector depends on an improvement in the quality and
             productivity of raw milk production. It is recommended that policy development focuses
             on the alignment of the available human capital with the private sector’s needs. Specific
             interventions include, for example, human capacity building programmes in the fields of
             veterinary medicine, feeding efficiency, animal husbandry skills and management. Once
             the quality of milk has become closer to international standards and the dairy
             processing sector has acquired the proper technological capabilities, the next steps



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EXECUTIVE SUMMARY



           could include an export diversification strategy, which would entail expanding the trade
           base to growing regional markets.
       ●   The development of energy production based on biomass requires a major reform of the
           energy sector, with the alignment of prices to market values and a review of existing
           payment mechanisms. At the same time, it is recommended that reforms are introduced
           in the area of investment policy and promotion. To facilitate the attraction of
           investment in sustainable energy, administrative processes should be streamlined
           (e.g. permits), implementing a single-window approach for investors, and creating a pre-
           approval process for green tariffs. A further recommendation is the design and
           execution of a comprehensive development plan for the production of alternative energy
           with an initial focus on biomass.
       ●   The civilian aircraft manufacturing sector would benefit from a revision of its corporate
           governance. A reorganisation of the supervision of the sector was announced in 2010. It
           is necessary to use the momentum created by this announcement to shape a new
           governance system with separate branches for the military and civilian sectors. The
           civilian aircraft manufacturing part of Antonov could become a corporation and be
           allowed to interact with global suppliers and partners.
       The recommended next steps include the establishment of three public-private working
       groups, focusing on agribusiness, production of energy based on biomass, and civilian
       aircraft, respectively. These working groups will become permanent bodies in charge of
       designing and implementing the needed reforms for each sector, beyond the timeframe of
       the OECD project.
       Finally, it is recommended that the government of Ukraine include a sub-national
       dimension in its efforts to improve its sectoral competitiveness. At present, an uneven
       distribution of FDI persists between regions: two-thirds of Ukraine’s FDI stock is currently
       concentrated in six regions. A first step in this direction is the OECD Territorial Review of
       Ukraine, started in 2011. The Territorial Review is a national-level diagnosis providing
       evidence-based and detailed analyses of regional policies. Following on from this, specific
       efforts to develop a sub-national level strategy should also be pursued.



       Notes
        1. The sectors were selected after a consultation phase with government experts and current and
           prospective foreign investors. The list was presented to the Coordination Council for OECD-Ukraine in
           December 2010 and validated by the key stakeholders.
        2. WTO, (2011), International Trade Statistics, Trade Profiles, Statistics Database.




22                                                   COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012
                                                                                                   INTRODUCTION




                                                     Introduction
         A    s part of the OECD Eastern Europe and South Caucasus Initiative (see box on the next
         page), a sector competitiveness review was conducted for the Republic of Ukraine to
         improve sectoral competitiveness and enhance its policy convergence with OECD
         investment instruments. The Sector Competitiveness Report is part of a wider project
         following a three-phase approach over five years (2009-14): first, by developing a sector
         competitiveness strategy (Phase I), secondly, by implementing specific aspects of the
         recommended policies to address the existing constraints (Phase II), and finally, by putting
         in place the mechanisms to embed sustainable reform (Phase III). The aim of the first
         phase of the project, co-financed by the Swedish International Development Agency and
         the Polish government, is to enhance the country’s productivity level by identifying policy
         barriers that should be removed to boost the competitiveness of selected economic sectors.
             This report constitutes the output of the first phase of the project. It identifies the
         sector-specific sources of competitiveness for agribusiness, energy-efficiency and
         renewable technologies, and aircraft sectors and draws up a list of recommendations on
         how to overcome the structural weaknesses that are currently hampering growth. The
         report is the result of a collaborative effort with the Ukrainian authorities and
         representatives of the private sector. It should facilitate the prioritisation of a strategy for
         the country and pave the way for a series of structural reforms that could lead to
         sustainable long-term economic growth. The scope of this report does not extend to
         macroeconomic reforms; however it is helpful to underline that sound monetary and fiscal
         policies remain a prerequisite for putting the country firmly on the map of foreign
         investors, especially given the current risk-averse attitudes of most investors.
             The work is presented in three parts. Part I discusses the framework and methodology
         used to select those sectors to be the objects of the study (Chapter 1). Part II includes a
         broad macroeconomic analysis of the Ukrainian economy (Chapter 2) and presents the
         findings of the Investment Policy Review of Ukraine (Chapter 3). Part III presents in depth
         analyses of the agribusiness (Chapter 4), grain (Chapter 5), dairy (Chapter 6), energy-
         efficiency and renewable technologies (Chapter 7), and aircraft (Chapter 8) sectors.
         A roadmap for the Ukrainian government to improve sectoral competitiveness in the
         selected sectors concludes the study (Conclusion and roadmap for the implementation
         phase), with a set of strategic recommendations being at the same time the starting point
         of the next implementation phase of the project.




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INTRODUCTION




           Launched in April 2009, the OECD Eastern Europe and South Caucasus Initiative is the
         part of the OECD Eurasia Competitiveness Programme, which aims to contribute to
         economic growth in Armenia, Azerbaijan, Belarus, Georgia, Moldova, and Ukraine. Its
         objective is to share with the governments of the region the knowledge, experience and
         best practices of OECD countries to create a sound business climate for investment,
         enhance productivity and support entrepreneurship, develop the private sector, and build
         knowledge-based economies to render its sectors more competitive and attractive to
         foreign investment. Its approach comprises both a regional policy dimension, which
         entails peer dialogue and capacity building, and a country-specific aspect supporting the
         implementation of a number of prioritised reforms. A sector analysis is also included,
         covering the formulation of targeted policies and strategies requested at the industry level.
         Within the framework of the programme, public authorities, the private sector and civil
         society in these countries have been engaged in a dialogue and collaboration process to
         support policy actions and identify the key barriers to sectoral competitiveness. The
         participation of all the stakeholders in the reform process, including foreign investors, is
         considered to be crucial for guaranteeing the effectiveness and transparency of the
         recommended policies.




24                                               COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012
                                                           PART I




                                          Methodology




COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012
Competitiveness and Private Sector Development: Ukraine 2011
Sector Competitiveness Strategy
© OECD 2012




                                                    Chapter 1




                  Approach and methodology


         This chapter presents the approach and methodology used to provide a sector
         competitiveness strategy. This includes the definition of the concept of competitiveness
         and the description of some tools to prioritise high potential sectors, analyse them,
         and formulate policy recommendations. Finally, it examines a framework to
         prioritise among policy recommendations.




                                                                                                    27
I.1.   APPROACH AND METHODOLOGY




          T  he OECD Sector Competitiveness Review aims to support the reforms needed to enhance
          Ukraine’s competitiveness and to improve its attractiveness to foreign investors. The
          project is designed to follow a three-phase approach over five years (2009-14): Phase I
          includes the Investment Policy Review of Ukraine – offering recommendations on the
          improvement of the overall policy environment – and the development of a sector
          competitiveness strategy – for the enhancement of the policy environment of individual
          sectors; Phase II tests the implementation of the defined competitiveness strategy and
          introduces quantifiable and measurable objectives; and Phase III aims to put in place the
          mechanisms to embed sustainable reform. This report summarises the key findings of
          Phase I and paves the way for targeted implementation.
              During Phase I of the project, OECD experts worked closely with public authorities and
          the private sector in Ukraine, as well as with representatives from business associations in
          OECD member countries, to develop a sectoral competitiveness strategy focusing on specific
          sectors identified as being promising for the Ukrainian economy. This approach allows the
          allocation of scarce resources to specific sectors, while increasing the likelihood that policy
          reforms are successfully implemented. The domestic and international private sector was
          involved early in the process (e.g. through industry associations and chambers of commerce).
               This chapter first presents a summary of the concept of competitiveness, its sources
          and how it evolves over time, and what governments can do to sustain it. Secondly, it
          describes the framework used to prioritise the sectors in which Ukraine can sustain
          competitiveness. Finally, it includes a framework to prioritise policy interventions in the
          selected sectors.

The definition of competitiveness
          Competitiveness is related to productivity and to the maximisation of value-added
              Academic literature provides different definitions of competitiveness and the concept
          has been of interest to policymakers in industrialised economies for centuries. Reinert
          (1995) considers that, over the years, this concept has expressed the concerns of policy
          makers regarding “national wealth”, “good trade” and “productive power”. Nevertheless,
          the concept lacks a universally-accepted definition and a broad consensus on the
          appropriate empirical measures has yet to emerge.
              Competitiveness is a relevant concept for firms, which can expand their market shares
          or lose them, be profitable or exit the industry. Krugman (1994) argues that competitiveness
          cannot be applied to national economies as countries cannot go out of business. However,
          countries tend to be concerned with shifts in market shares at a sectoral level, as these
          changes affect the sectoral composition of output, the allocation of resources, and,
          ultimately, living standards (OECD, 1998).
              In an earlier report, the OECD defined competitiveness as “the degree to which a country
          generates, while being and remaining exposed to international competition, relatively high
          factor income and factor employment levels” (OECD, 1997 – “factor” in the definition refers to


28                                                 COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012
                                                                               I.1.   APPROACH AND METHODOLOGY



         production factors).1 This definition contains two key elements. First, competitiveness is
         closely related to productivity, by focusing on factor income or value-added from inputs.
         Secondly, maximisation of value-added is a key feature of competitive economies. More
         competitive economies shift idle factors not producing sufficient value-added to more
         productive uses, achieve relatively high factor employment levels and come closer to
         attaining their production potential. For the purposes of this publication, the key issues
         related to competitiveness are the nature of its sources and how they evolve over time.

         Competitiveness evolves over time
              The convergence in productivity between countries is likely to be a long process.
         Therefore, the stage of development of an economy needs to be taken into account when
         assessing its current and future competitiveness. In this regard, it is possible to
         differentiate between factor-driven, efficiency-driven and innovation-driven economies
         (X. Sala-i-Martin and E. Artadi, 2004). The first category includes economies with low
         incomes and a reliance on natural resources.2 Cost is particularly relevant for factor-driven
         economies. Competition is mainly through prices.
             When a country in this first group becomes more competitive, its wages will rise,
         eroding its comparative advantage. At this point, it will enter a transition phase which will
         bring it into the efficiency-driven group, which must rely on productivity increases through
         developments such as increases in supply-chain efficiency and improvements in physical
         and IT infrastructures to offset the effect of rising wages. Capabilities are particularly
         important when a country transitions between the first and second levels of development.
         At this stage competition is through quality.
              By building capabilities in the labour market, deepening the financial market,
         investing in technology and ensuring efficiency, a country can reach the “innovation-
         driven” stage. This is the stage reached by the most advanced economies, which must rely
         on technological progress. Countries in this final stage cannot compete on price or quality,
         but need to innovate (M. Porter, 2001, 2005).
             According to the World Economic Forum’s Global Competitiveness Index (GCI), which
         uses the stages developed by Sala-i-Martin and Artadi (2004), Ukraine is considered to be in
         transition between the factor-driven and efficiency-driven phases. This means that to
         sustain its competitiveness it needs to improve its productivity by addressing current
         inefficiencies related to its supporting institutional framework, human capital, financial
         markets and other capabilities. The statistical correlation between the GCI for 2011-12 and
         GDP per capita in USD at current prices (used as a proxy for wages) highlights that Ukraine
         could perform better in terms of global competitiveness (Figure 1.1). Poland, which belongs
         to the efficiency-led group, gets a higher score in competitiveness than some comparable
         countries with a similar level of GDP per capita. The Czech Republic has already improved
         its efficiency and has moved into the last group of innovation-driven economies.

         Governments can adopt different tools to support competitiveness
              Governments can use three sets of levers to support competitiveness. First, they can
         implement macro-economic measures, such as monetary, fiscal or exchange rate policies.
         Second they can improve the legal and judicial framework to promote the rule of law and
         good governance. The third lever aims at improving the investment and business climate,
         either at the horizontal or at the vertical level.


COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012                                   29
I.1.   APPROACH AND METHODOLOGY



                           Figure 1.1. Ukraine needs to move from a factor-led economy
                                            to an efficiency-led economy
                        Correlation between the WEF Global Competitiveness Index 2011-12 and GDP per capita
                                                     (2010, USD current prices)
          WEF global competitiveness score 2011-12


           5.5
                                                                                                      y = 3E – 05x + 3.9587
                                                                                                           R 2 = 0.7507
           5.0

                                 POL       CZE
           4.5


           4.0           UKR


           3.5


           3.0


           2.5


           2.0
                 0             10 000     20 000     30 000        40 000       50 000       60 000         70 000         80 000
                                                                                                       GDP per capita USD current

          Source: World Economic Forum (2011), Global Competitiveness Report 2011-12, London; World Bank (2011), World
          Development Indicators (2011), http://data.worldbank.org, accessed 15 December 2011.


               This study does not cover the first two levers, although macro-economic fundamentals,
          good governance and institutions are essential pre-conditions for successful growth and
          stability. This analysis focuses instead on the third lever.
                     Horizontal policies include market-friendly interventions which create a favourable,
          sound environment without selecting certain activities over others. For example, the
          Investment Policy Review of Ukraine calculated the OECD Foreign Direct Investment (FDI)
          Restrictiveness Index, measuring statutory restrictions on FDI in 22 sectors of the economy.
          The review proposes some recommendations for improving the overall investment
          climate, based on the principles of liberalisation, transparency and non-discrimination. It
          is based on the OECD Policy Framework for Investment, which covers the following areas:
          investment policy, investment promotion and facilitation, trade policy, competition level,
          tax policy, corporate governance, responsible business conduct, human resource
          development, infrastructure and financial sector development, and public governance.
             Vertical policies are specific interventions related to sectors with important assets and
          market potential but which still present some barriers to growth. Policy makers could
          decide to intervene selectively to improve the business environment of specific sectors and
          eliminate the restrictions. An example of improvement of the sectoral business
          environment would be a reorganisation of the aerospace sector, in order to separate
          civilian aircraft manufacturing from military production, and to lift the obstacles to private
          investment in the former. The likelihood of successful intervention depends partly on the
          government’s ability to identify market failures, and to select and implement the reforms
          required. Experience suggests that a transparent framework with objective criteria for
          selection and institutional processes that consult the private sector in reviewing policies
          and indentifying priorities is likely to prove effective. Measures oriented towards an active


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                                                                                 I.1.   APPROACH AND METHODOLOGY



         involvement of the government in individual sectors, such as subsidies or equity
         investments, are not the focus of this study.

         Foreign direct investment can contribute to productivity enhancement 
         and competitiveness
             The perspective of foreign investors is beneficial to the sectoral competitiveness
         improvement, in at least two ways.
             First, FDI can support increases in productivity. FDI can have a positive effect on
         growth in total factor productivity (TFP) both directly, via the diffusion of foreign
         technology and expertise, and indirectly, via a spill-over effect on local firms and sectors
         (OECD, 2007). Empirical studies of the effects of FDI on economic growth in developing
         countries suggest that the diffusion of new technologies and techniques boosts economic
         growth. Moreover, under certain circumstances, FDI has an even more significant impact
         on growth than domestic investment (Borensztein, De Gregorio and Lee, 1998).
               Second, attempts to promote FDI help to focus the policy interventions on specific
         areas. Foreign-owned multinational enterprises (MNEs) play a significant role in the
         economies of many developed and developing countries. Public policies can help a country
         both to attract more foreign investment and to maximise the effects of FDI on the economy.
         Depending on the importance of FDI in a given sector, governments have an incentive to
         improve the specific sectoral policies that best suit the various motives behind FDI (Kudina
         and Jakubiak, 2008). These motives can be categorised as:
         ●   Resource seeking: depending on the availability of natural resources, cheap unskilled or
             semi-skilled labour, creative assets and physical infrastructure. The evidence suggests
             that FDI takes place when resource-abundant areas lack capital for resource extraction,
             the necessary technical skills, or the infrastructure to deliver the goods.
         ●   Market seeking: traditionally related to markets with high barriers to trade, FDI allows
             access to these markets by producing locally. Country market size, per capita income
             and market growth are the main determinants of such investment.
         ●   Efficiency seeking: occurs when the investing firm wishes to benefit from common
             governance, culture, systems, and politics, in geographically dispersed areas. Greater
             efficiency is achieved through coordination of international production, from a location
             which supplies several markets.
              Therefore, the objective of this study is to provide sector-specific, targeted policy
         recommendations to the Government of Ukraine to enhance both the sectoral competitiveness
         of the economy and its attractiveness to FDI. The focus of this project is also to initiate a
         process whereby government and sector-specific firms engage in strategic co-ordination
         and to develop strong local capabilities of the policy makers.

Identifying sectors for intervention
               The approach adopted in this study is:
         ●   Private sector-driven: leveraging feedback from the domestic private sector and OECD
             foreign investors to identify their sector priorities in Ukraine and the barriers they face
             in developing their business.
         ●   Sectoral: focusing on enhancing sectoral competitiveness and addressing policy barriers
             from a sector perspective. This aspect is particularly relevant for Ukraine, as well as in
             other post-Soviet countries, where the centrally-planned economic system led to poorly
             informed choices and to an inefficient allocation of resources.
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I.1.   APPROACH AND METHODOLOGY



          ●   Value chain-based: encompassing all the activities and services involved in bringing a
              product from conception to end use or from input supply to distribution, this report
              analyses the major constraints and opportunities faced by businesses at multiple levels
              of the value chain.

          Sector identification: The Sector Prioritisation Framework
               The first stage of the approach consists of making an informed choice about the
          sectors that need to be selected to improve the sectoral competitiveness of Ukraine’s
          economy. The identification of the sectors was carried out based on the Sector
          Prioritisation Framework (SPF) methodology. This approach relies on a three-step process
          involving: first, an analysis of FDI trends; second, a consultation with stakeholders about
          high potential sectors; and then a final selection and validation of results with key
          stakeholders (Figure 1.2).

                           Figure 1.2. Sector Prioritisation Framework methodology


                                                                 Step 2                            Step 3
                               Step 1
                                                             Consultations                          Final
                              Analysis                            about                          selection
                           of past trends                    high potential                   and validation
                                                                 sectors                     with stakeholders
                                                              in the future



          Source: OECD (2010), Ukraine Sector Competitiveness Review, internal working document, OECD, Paris.


          Step 1: Analysis of past trends
               The OECD Secretariat performed a quantitative analysis of the current situation and
          growth trends of 24 sectors in Ukraine. To facilitate data collection, the sector breakdown
          corresponds to the Classification of Economic Activities in the European Community NACE 1
          (KVED classification in Ukraine). Data was collected from the following sources: OECD,
          Central Bank of Ukraine, Ukrainian State Committee of Statistics, UNIDO, UNCTAD,
          International Labour Organisation and European Commission.
               This evaluation allowed a comparison of sectors in two main dimensions: sector
          attractiveness and country benefits. The first dimension includes those variables capturing
          the degree of attractiveness of a given sector, such as its share in total value-added, sector-
          specific labour costs benchmarked against a cluster of emerging countries, and the average
          annual growth rate of world FDI inflows over a number of years. The second dimension
          analyses the positive effect of the given sector on a country’s economy, along dimensions
          such as the share of the sector in total employment, innovation, labour productivity based
          on value added, and other factors.
              Both dimensions were scored on a scale of 0 (low benefits or attractiveness) to 100
          (high benefits or attractiveness). To determine the score, each variable within the
          dimension was allocated a weight, based on a correlation with FDI inflows at sector level,
          and validated through a comprehensive literature review. The framework is based on the
          principle that the sectors in each of the four quadrants require different intervention
          strategies to maintain or improve their competitiveness (Figure 1.3).
          ●   “Sustaining competitiveness” is required if both country benefits and market
              attractiveness are high.

32                                                           COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012
                                                                                                                                    I.1.    APPROACH AND METHODOLOGY



                            Figure 1.3. Sector Prioritisation Framework, analysis for Ukraine
              Country benefits
                   index
           50
                       Defend                                                                                                              Sustain       Financial
           45                                                                          Rubber,                                                           activities
                                                                                       plastics products

           40                                 Machinery and equipment         Real                                    Business     Trade
                                                                              estate                                  services
                                                                                                Chemicals
                             Coke, refined petroleum
           35               products and nuclear fuel                                                 Construction

           30                                 Electrical, optical equipment
                           Communication
           25                                                                                                             Metals
                                        Transport                                                           Mining
           20           Electricity, gas and water                                                Food
                                  supply
                                            Fishing                                                   Other non-metallic mineral
             15                                                                                       products
                                                                        Wood,
                                Textiles leather                        forestry        Hotels and restaurants
             10
                                                                 Paper, Publishing
                                          Transport equipment
             5
                      Re-evaluate                                                                                                                    Leverage
             0
                  0                      10                       20                      30                         40                    50                   60
                                                                                                                                            Sector attractiveness
                                                                                                                                                    index

         Source: Analyses and calculations based on data provided by the State Statistics Committee of Ukraine (SSCU) (2011);
         State Statistics Service of Ukraine website, www.ukrstat.gov.ua, accessed 30 September 2011.

         ●    “Defending” is required if country benefits are high but relative market attractiveness is
              low (e.g. in the case of traditional manufacturing sectors). For sectors in this quadrant,
              the objective is to improve the sector attractiveness to private investors.
         ●    “Leveraging” of existing market attractiveness is required if country benefits are low. And,
         ●    “Re-evaluating” a sector is required if both dimensions are low.
             These strategies are not, of course, mutually exclusive. Countries generally combine
         them. The framework can be used as a tool to tailor different intervention strategies
         according to the current assessment of a given sector. No value judgment is attached to it.

         Step 2: Consultations about sectoral competitiveness
              Government representatives were asked to provide a list of sectors which they believe
         are the most attractive in Ukraine and have the highest potential for development.3 The list
         of sectors collected was then cross-checked against investment strategies and information
         available in government reports and on websites. Using the list of sectors identified as
         promising, an initial shortlist of sectors was created. Suggestions and comments
         concerning the selection of sectors were elicited from private sector organisations,
         including the European Business Association of Ukraine and the Ukrainian Chamber of
         Commerce and Industry (Figure 1.4).

         Step 3: Final selection and validation with stakeholders
             Combining the shortlist of priority sectors identified by government experts with the
         additional results of quantitative analysis, three promising sectors were identified for
         focus. The choice of sectors was presented to the Coordination Council for OECD-Ukraine
         relations under the chairmanship of the Deputy Prime Minister of Ukraine in
         December 2010 and finally validated:
         1. Agribusiness, with two pilots focusing on the dairy and grain value chains.
         2. Energy-efficiency and renewable technologies, including the biomass value chain as a pilot.

COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012                                                                                              33
I.1.   APPROACH AND METHODOLOGY



          Figure 1.4. Results of consultations with private and public sector representatives



                                                 Fair interest Rather high interest High interest
              Public sector expressed interest
                                                                                                                                                        Machine and equipment
                                                                                                                                                           manufacturing
                                                                                                                                                                                  Manufacturing of food
                                                                                                                                                                                       products




                                                                                                                                                                           Agriculture, hunting
                                                                                                                                     Waste treatment, materials
                                                                                                                                              recovery


                                                                                                                      Manufacturing of chemicals
                                                                                                                        and chemical products
                                                                                                                    Remediation
                                                                                                                     activities         Construction              Hotels
                                                                                                    Low interest             Fair interest             Rather high interest            High interest
                                                                                                                   Private sector expressed interest
          Source: Analyses and calculations based on a survey conducted by the OECD in 2009-10 with private and public sector
          representatives; OECD (2011), “Country Capability Survey”, internal working document, OECD, Paris.


          3. Machinery manufacturing and transport equipment, including the civilian aircraft value
             chain as a pilot.
               These sectors present strong synergies with government strategies, and opportunities
          to develop core capabilities in areas applicable across other sectors, namely human capital,
          knowledge and innovation, and access to finance.

          The Sector Performance Review: An in-depth analysis of the selected sectors
              Following the identification of the priority sectors, the review undertook a series of
          steps, aiming to answer four key questions:
          ●   Which sub-sectors are promising for private domestic and foreign investors? And why,
              given domestic and global trends?
          ●   How could the selected sub-sectors position themselves in order to attract FDI?
          ●   Which policy barriers are hindering growth and competitiveness in these sub-sectors?
               The following paragraphs describe each of these questions and the analytical process
          followed to prioritise the number of sub-sectors selected.

          Which sub-sectors are promising for private sector and foreign investors? 
          And why, given the domestic and global trends?
               Within each category, the analysis focused on the identification of those sub-sectors
          which are particularly promising for private domestic and foreign investors in Ukraine. The
          sub-sectors of interest were identified on the basis of specific criteria depending on the
          sector, and following consultations with stakeholders. For instance, agribusiness sub-
          sectors were selected based on demand and supply trends both at the global and domestic
          level, and also on government stakeholders’ assessments.
               As already mentioned, an important driver of competitiveness is cost: when costs are low,
          then a country can export goods and supply the domestic market with an advantage over
          foreign competitors. Secondly, quality becomes more relevant when the country loses its cost-
          related comparative advantage and also when products become more sophisticated (OECD,
          1998). Figure 1.5 illustrates for the grain sub-sector the production cost advantage that Ukraine
          enjoys compared to its competitors. Production costs, including transport costs, are a key
          feature of competitiveness in the grain business. However, quality of grain is also an important

34                                                                                                                        COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012
                                                                                                              I.1.    APPROACH AND METHODOLOGY



                      Figure 1.5. Agribusiness example: Comparison of production costs
                                    for wheat (USD per metric tonne), 2009
                                               Direct costs – seeds, fertilizers, plant protection products
                                               Operating costs – labour, contractor, machinery diesel
           200

           180

           160

           140

           120         123          91
                                                    85                                                33
           100
                                                                     78                                               39
                                                                                     91
            80

            60                                                                                                                    51
                                                                                                      91
            40                                                                                                        72
                                    69              65
                        57                                           55
            20                                                                       40                                           38
             0
                       y




                                    ia




                                                   li a




                                                                  an




                                                                                   nd




                                                                                                      ia




                                                                                                                      da




                                                                                                                                  e
                                                                                                                               in
                      an




                                                                                                   ss
                                ar




                                                ra




                                                                                                                     na
                                                                  st




                                                                                  la




                                                                                                                              ra
                  rm




                               lg




                                                                                                 Ru
                                                                                Po
                                                                kh
                                               st




                                                                                                                Ca




                                                                                                                             Uk
                              Bu




                                              Au
                 Ge




                                                             za
                                                           Ka




         Source: Von Tunen Institute, 2010.

         element, since even in such a commoditised industry grains are targeted to specific market
         demands and price discrimination is implemented according to product quality.

         How could the selected sub-sectors position themselves in order to attract foreign 
         direct investment?
             Provided that each sub-sector has a specific value chain, the analysis focused on the
         identification of those segments that could attract FDI. Sub-sectors were analysed as value
         chains involving numerous players. Therefore, the areas of potential interest for foreign
         investors were defined. For instance, as illustrated by Figure 1.6, civilian aeronautics is a
         complex value-chain dominated by the OEM, which integrates numerous components and
         sub-systems produced by hundreds of suppliers. Components range from low to high-end
         components, while aeronautic firms can be positioned at different stages along the supply-
         chain, from tier-4 to tier-1. An initial outline for sub-sector strategies to attract FDI was
         developed in collaboration with government stakeholders.

         Which policy barriers are hindering growth and competitiveness in these sub-sectors?
              Primary research was conducted in order to identify key constraints on the ability of
         firms to produce, invest and grow in Ukraine in the selected sub-sectors. The combination
         of semi-directional qualitative interviews and quantitative data collection and analysis
         allowed the OECD to build up a solid understanding of the key success factors, challenges
         and policy barriers faced by firms in the sub-sectors covered by the study.
              Primary research started with interviews with a full range of stakeholders, including
         government representatives, domestic business associations, private Ukrainian
         companies, foreign investors and foreign companies potentially interested in investing in
         Ukraine. The semi-directional interviews included two types of data collection
         methodologies: focus groups and in-depth interviews during company visits. The
         qualitative survey was carried out by the OECD using a sample of four to six companies per
         sub-sector selected for focus. Country missions were conducted with the aim of carrying
         out consultations with the public and private sectors on the results.

COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012                                                                   35
I.1.        APPROACH AND METHODOLOGY



  Figure 1.6. Civilian aircraft industry example: Areas for potential FDI along the supply-chain
                                         Hundreds of suppliers produce components at various technological levels


                                                                        Original equipment manufacturer
   OEM




                                                                                           Power          Landing                            In-flight
                Engine              Avionic            POD          Aerostructure                                         Brakes                             Interior
                                                                                          systems          gear                           entertainment



                General              Various          General          General             General         General         General            General         General
               contractor           suppliers        contractor       contractor          contractor      contractor      contractor         contractor      contractor
   TIER 1




                 Design,           Electronics         Design,          Design,             Design,         Design,         Design,            Design,         Design,
               production               and          production       production          production      production      production         production      production
              of key-parts,         informatic      of key-parts,    of key-parts,       of key-parts,   of key-parts,   of key-parts,      of key-parts,   of key-parts,
              assembling           equipments       assembling       assembling          assembling      assembling      assembling         assembling      assembling
   TIER 2




                Various              Various          Various           Various            Various         Various         Various            Various         Various
               suppliers            suppliers        suppliers         suppliers          suppliers       suppliers       suppliers          suppliers       suppliers
   TIER 3




                Various              Various          Various           Various            Various         Various         Various            Various         Various
               suppliers            suppliers        suppliers         suppliers          suppliers       suppliers       suppliers          suppliers       suppliers




                Various              Various          Various           Various            Various         Various         Various            Various         Various
   TIER 4




               suppliers            suppliers        suppliers         suppliers          suppliers       suppliers       suppliers          suppliers       suppliers



                              High-end components                              Mid-end components                                     Low-end components

Source: OECD (2010), Ukraine Sector Competitiveness Review, internal working document, OECD, Paris.


                     Interview guidelines were framed using the Policies for Investment (PFI) framework. The
                PFI draws on good practices from OECD and non-member economies to propose guidance
                in ten policy fields identified as critically important for improving the quality of a country’s
                environment for investment. It involves asking appropriate questions about the economy,
                institutions and policy settings in order to identify priorities, to develop an effective set of
                policies and to evaluate progress. The PFI encompasses different policy areas including
                investment policy and promotion, trade policy, competition policy, tax policy, corporate
                governance, human resources development, infrastructure and financial sector development,
                public governance and policies for promoting responsible business conduct (OECD, 2009).
                The outcome of the qualitative interviews helped to develop sound hypotheses concerning
                the most critical issues and policy barriers that private sector and foreign investors face in
                Ukraine in the selected sub-sectors.
                     The OECD Country Capability Survey (CSS) – a quantitative survey questionnaire – was
                further refined, using the outcome of interviews to narrow down the scope and focus on the
                most specific and critical issues (Table 1.1). The CCS focuses on sector-specific business and
                policy constraints experienced in Ukraine. The CCS specifically aims at capturing data that:
                1. examines companies’ general operational activities;
                2. establishes firms’ perceptions of key success factors and obstacles to business growth;
                   and
                3. gathers feedback on a range of suggested policy recommendations.



36                                                                                   COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012
                                                                                                                             I.1.   APPROACH AND METHODOLOGY



                                     Table 1.1. Sample size of the survey questionnaire
          Value chain                                Company type                                                        Number of companies surveyed

          Grain                                      Grain producer – wheat, corn, barley (farm)                                      85
                                                     Grain processor                                                                  55
          Dairy products                             Raw milk producer (farm)                                                         83
                                                     Milk processor                                                                   40
          Production of energy from biomass          Forestry company                                                                 11
                                                     Wood processor                                                                   33
                                                     Pellet makers                                                                    16
                                                     Public utilities                                                                 40
          Civilian aircraft manufacturing            Aircraft manufacturing or maintenance company                                    31
          Total                                                                                                                      395

         Source: OECD (2011), Country Capability Survey, internal working document, OECD, Paris.


             The survey questionnaire was elaborated by the OECD and implemented in Ukraine
         by GfK Ukraine. The survey consisted of approximately 40-45 questions, depending on
         the sub-sector and the step on the value chain within this sub-sector. The survey was
         typically completed by firms’ directors, accountants and human resource managers. To
         secure maximum participation in the survey and ensure data quality, the data have been
         kept confidential.
              The CCS highlighted areas where Ukrainian policy-makers should focus their efforts
         to improve the competitiveness of sub-sectors. In the dairy industry, for instance, difficult
         access to finance is possibly due to weak relations between farmers and dairy processors:
         fewer than half of farmers benefit from the support of processors, while this figure is much
         higher in comparable countries such as Poland (Figure 1.7).


             Figure 1.7. Dairy sub-sector example: Difficult access to finance is partly due
                          to the weak links between farmers and processors
                         Does the processor(s) you work with provide you with financial or technical support?

                   Question asked


            Does the processor(s)                                                                     Yes                      About 40% of milk
                                                                                     39%
            you work with                                                                                                      producers surveyed
            provide you with                                            61%                           No
                                                                                                                               benefits from support
            financial or technical                                                                                             from processors
            support?


                   Question asked

                                                 Providing cold chain services                                 66
                                                     Providing milk collection
                                                                   equipment                              53

            If yes, please specify               Lending short-term to finance                                                 Both technical and
                                                               working capital                       44
            what type of support                                                                                               financial support
                                              Transferring know-how and skills         13

                                                  Providing milking equipment          13

                                                                                 0         20   40        60        80
                                                                                                                    %

         Source: OECD Country Capability Survey (dairy farms without processing capabilities); Excerpt from CCS results
         – Questionnaire targeting dairy farmers without processing capabilities.




COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012                                                                                 37
I.1.     APPROACH AND METHODOLOGY



A prioritisation framework to select policy recommendations 
for the implementation phase
                   Based on OECD member countries’ best practices, sector-specific policy improvements
               were drawn up and checked against the views of industry experts, private sector representatives
               and government representatives. Suggested recommendations were formulated to be relevant
               and actionable, and will be implemented in the next phase of the project.
                    The prioritisation of the policy recommendations for Phase II has been conducted
               taking into account a two-dimension assessment (Figure 1.8).

               Figure 1.8. A framework to prioritise among policy recommendations for Phase II
                   based on the country’s strategic advantage and the areas of intervention
                                                        An example from the Agribusiness sector

       Strategic advantage

                                                                  Investment               Access to finance
       Dynamic                                                      policy                                                  Human capital
       comparative                                                                    – Co-operative banks
       advantage                Quality standards             – Attract FDI in the    – Supply chain financing,         – Initial education
                                                                dairy processing        warehouse receipts              – Vocational education
       Based on              – Food safety regulation           industry              – Leasing                         – Continued education
       high-value added      – Streamline of controls         – Geographical                                            – Match the needs
                                                                                      – Credit guarantee schemes
       long term             – Certifications                   export
                                                                diversification       – Microfinance                      of the private sector

                                                                                                   Infrastructures
       Static                                 Land reform
       comparative                                                                           – Road system
       advantage                                                                             – Grain carriers
                                       – Land reform completion
                                                                                             – Port infrastructure
       Based on
                                       – Lift the moratorium on land sale                    – Storage facilities
       natural resources
                                                                                             – Cold chain
       labour cost
       short term
                                                 Rules                                                   Capabilities           Area of intervention


Source: OECD (2010), Ukraine Sector Competitiveness Review, internal working document, OECD, Paris; Framework based on Krugman (1987)
and Lall (1990); Krugman, P. (1987), “The Narrow Moving Band, the Dutch Disease, and the Competitive Consequences of Mrs. Tatcher.
Notes on Trade in the Presence of Dynamic Scale Economies”, Journal of Development Economics, Vol. 27, No. 1, pp. 41-55; S. Lall, (1990),
Building Industrial Competitiveness in Developing Countries, OECD, Paris.

                    The first element captures the country’s strategic advantage. As explained earlier, a
               country’s comparative advantage evolves over time and it is subject to shocks. A static
               comparative advantage is based on natural resources, low labour costs and similar short-
               term drivers. These advantages erode as income rises and the level of wages converges with
               that in competitor countries. In contrast, a dynamic comparative advantage is sustainable
               over the longer term, since it is based on learning by doing, high-skills and high-value added
               activities. For example, at the moment Ukraine has a static comparative advantage in the
               production of grain, given the low production cost and the abundance of resources. However,
               in order to maintain a dynamic comparative advantage over time it needs to improve the
               quality of its output and to deepen its activity into higher-value products and services.
                    The second dimension takes into account the areas of intervention that the
               government can leverage. Rules and regulations build the framework for a sector; however
               they can easily be reversed. Also, new legislation can be passed but then not implemented,
               or it may be translated into concrete action only after a long delay. Capacity-enhancing
               measures, in contrast, develop long-term capabilities, such as human capital, financial
               deepening or innovation. Both rules and capabilities are important, but capabilities create
               positive externalities for the economy. For example, the completion of the land reform is a
               necessary step that the government needs to address. However, this reform alone, if not


38                                                                       COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012
                                                                                         I.1.   APPROACH AND METHODOLOGY



         combined with other capacity-enhancing interventions, would not be sufficient to
         guarantee the country’s ability to defend its comparative advantage and move up into
         another stage of development. Vocational training in farm economics, extension services
         to update farmers on how to improve quality, and similar interventions can empower the
         private sector and create positive externalities.
              Areas of intervention selected for Phase II of the project were those with the highest
         assessments in terms of both dynamic comparative advantage and capabilities.
         Nevertheless, the strategies are not mutually exclusive. This selection does not mean that
         interventions targeting, for instance, infrastructure in the agribusiness sector are less
         important. Upgrading the road system is certainly an element that would enhance the
         country’s ability to produce and trade more efficiently. However, it would not change the
         nature of Ukraine’s strategic advantage if, even with better road infrastructure, it still
         produced low quality grain.
               There are some caveats associated with the proposed framework. First, within each
         broad category of recommendations the various different measures may have different
         assessments. For example, upgrading the road system does not receive the same assessment
         as upgrading grain carriers. Interventions belonging to the same macro-area
         (e.g. infrastructure) may fall in different quadrants of the matrix. The framework has been
         simplified by mapping only macro-categories, in order to provide a practical tool that is easy
         to visualise and to interpret. Second, it is in line with the OECD’s mandate to “promote policies
         that will improve the economic and social well-being of people around the world” and with the
         mandate of the OECD Eurasia Competitiveness Programme, which focuses on empowering
         the domestic and foreign private sector and building local capabilities in the region. Thirdly,
         the selection also needs to be complemented with a cost-benefit analysis. However, it does
         provide the government with an instrument to guide strategic policy-making.



         Notes
          1. According to the OECD definition “factor incomes comprises compensation of employees by, and
             operating surplus of, producers” (OECD, 2011).
          2. This is measured by the share of exports of mineral products in total exports.
          3. This includes the Ministry of Economic Development and Trade, the Ministry of Finance, the
             Ministry of Industrial Policy, the Ministry of Food and Agrarian Policy, and the State Agency of
             Ukraine for National Projects.



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40                                                         COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012
                                                      PART II




  Economic overview and findings
   of the Investment Policy Review
              of Ukraine




COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012
Competitiveness and Private Sector Development: Ukraine 2011
Sector Competitiveness Strategy
© OECD 2012




                                                    Chapter 2




                                Economic overview


         This chapter presents a broad analysis of the Ukrainian economy. It briefly describes
         its macroeconomic performance and the contribution of different sectors to growth,
         which frames the sectoral analyses of the next chapters. Also, it assesses the
         endowments which have sustained economic growth and the challenges that still
         remains unaddressed.




                                                                                                 43
II.2.   ECONOMIC OVERVIEW




A country with abundant natural resources and a well qualified labour force
               With a geographical area of 603 548 square kilometres, Ukraine is the second-largest
           country in Europe, strategically located at the crossroads between Europe, Russia and
           Central Asia. It has 324 784 square kilometres of arable land, the largest such area in
           Europe. It has the largest manganese-ore fields and the second-largest mercury deposits in
           the world. It also has access to other abundant mineral resources, including coal, iron,
           nickel, uranium and natural gas. The country has access to the Black Sea through the ports
           of Odessa and Sevastopol and it is a key energy transit country for Russian oil and gas
           exports to Western Europe.
                Having dropped by around 6 million since independence, Ukraine’s population stands
           at around 46 million, which given its vast land area, results in a low population density.
           Since 1991, income inequality has worsened, with the Gini coefficient rising from 25.7
           in 1992 to 35.1 in 1996. According to the World Bank’s estimates, the Gini index was 27.5
           in 2008, lower than other neighbouring countries such as Armenia (30.9), Azerbaijan (33.7),
           Georgia (41.3) and Russia (42.3).
               The labour force is highly skilled, thanks to the legacy of the rigorous and scientifically-
           oriented education system of the Soviet Union, and relatively inexpensive. For instance,
           Ukraine has universal literacy and high general school enrolment: the combined gross
           enrolment ratio in education of both sexes was 90% in 2009, higher than those of Czech
           Republic (83.4%) and Poland (87.7%). According to the World Bank (2011), female labour
           participation is also higher than the average for Europe and Central Asia (Figures 2.1
           and 2.2).1 At the same time, the Ukrainian wage in 2006 was USD 206 per month, while in


                  Figure 2.1. Ukraine’s labour force has a high level of tertiary education
                                    Percentage of total labour force with tertiary education, 2005

                                                     Labour force with tertiary education (% total) 2005
             50
                                 45.2
             45

             40                                                                                                     38.3
             35
                                                                       30.4
             30

             25

             20

             15

             10

              5

              0
                               Ukraine                       Europe and Central Asia                       Europe and Central Asia
                                                               (all income levels)                            (developing only)

           Source: World Bank (2011), World Bank Development Indicators, http://data.worldbank.org, accessed 15 September 2011.



44                                                             COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012
                                                                                                                        II.2.   ECONOMIC OVERVIEW



                  Figure 2.2. Female labour participation in Ukraine is high compared
                                            to regional peers
                                     Labour participation rate, female population over 15, 2010

                                          Labour participation rate, female (% female over 15 population) 2010


                             51.8




                                                                                                                 50.1




                                                                     48.7




                           Ukraine                        Europe and Central Asia                     Europe and Central Asia
                                                            (all income levels)                          (developing only)

         Source: World Bank (2011), World Bank Development Indicators, http://data.worldbank.org, accessed 15 September 2011.


         Poland it was USD 798 (Raiser, 2007). Despite this abundant pool of relatively cheap labour,
         Ukrainian firms find it difficult to compete on quality in non-CIS markets. This poor
         performance, in a context of considerable natural and human resources, can be attributed
         mainly to fundamental institutional bottlenecks and poor framework conditions for
         entrepreneurship. These ultimately affect productivity, and are weaknesses that the
         government urgently needs to address.

After struggling immediately following independence, the Ukrainian economy
enjoyed a period of robust growth
              After independence in 1991, Ukraine’s output contracted sharply and more severely
         than in other Central and Eastern European countries, with real GDP falling by almost 60%
         in 1990-99. The official data overestimate the decline as they do not take into account the
         impact of the shadow economy or the various factors that led output to be over-reported in
         the Soviet era.2 Even accounting for this, the economy experienced eight consecutive years
         of severe recession, making the transition from a centrally-planned to a market-based
         economy a long and difficult process. It did not help that successive governments often
         prevented structural change rather than implementing necessary reforms. The economy
         finally returned to growth in 1999, and real GDP grew strongly in the early 2000s, rising at
         an annual average rate of 7% during 2000-08, among the fastest in Europe (World Bank,
         2010). In the same period, FDI inflows to the country grew by an annual average of 43.8%
         and peaked at USD 10.9 billion in 2008 (Figure 2.3). For a regional comparison, FDI inflows
         to Georgia in 2000-08 grew by an annual average of 36.3% (UNCTAD, 2011; UNCTADstat).
             This strong growth was facilitated by the existence of substantial spare capacity in the
         industrial sector. Temporary external factors also assisted the rebound, including the
         competitive exchange rate policy that followed the sharp devaluation of the hryvnia after the
         1998 financial crisis and the rise of international commodity prices. In addition, the gas
         prices paid by Ukrainian firms were very low, giving a cost advantage with respect to
         European countries and an incentive to specialise in highly energy-intensive industries, such


COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012                                                                      45
II.2.   ECONOMIC OVERVIEW



                                 Figure 2.3. Annual inward FDI flows in the region
                                         USD bn at current prices and current exchange rates

                                     Armenia               Azerbaijan                Georgia                Ukraine

             11

              9

              7

              5

              3

              1
              0
             -1

             -3

             -5
                    1999      2000        2001      2002       2003       2004       2005      2006       2007        2008

           Source: UNCTAD (2011), World Investment Report, UNCTAD, Geneva; UNCTADstat, Statistical Database, http://unctadstat.
           unctad.org/ReportFolders/reportFolders.aspx?sCS_referer=&sCS_ChosenLang=en, accessed 15 June 2011.


           as chemicals, metallurgy and machine processing. During the recovery, Ukraine did not take
           the opportunity to diversify its industrial base into other promising sectors, but kept
           expanding those activities that already existed under the central planning system. As a
           result, it lagged behind other transition countries in terms of diversification and innovation.

The global financial crisis highlighted existing weaknesses
                Ukraine was severely affected by the global economic and financial crisis. In 2009, the
           US dollar appreciated by 47.9% against the hryvnia and real GDP shrank by almost 15%
           (IMF, 2010). Economic activity was dragged down by a 41.5% drop in fixed investment
           combined with a 15% decline in private consumption (State Statistics Service of Ukraine,
           2011). As a result of the fall in output, the external debt ratio soared to 88.3% of GDP,
           according to the National Bank of Ukraine. The government budget deficit as a percentage
           of GDP widened from 3.1% in 2008 to 8.7% in 2009. Due to the adverse impact of the global
           recession, funding dried up and external sources of financing became unavailable to the
           country’s banks, leading to significant liquidity problems in the banking system.
           Prominvest Bank, the sixth largest in the country, failed in the last quarter of 2008. In the
           first quarter of 2009, credit rating agencies downgraded Ukraine’s long-term foreign
           currency rating to CCC+, seven levels below investment grade. FDI inflows to the country
           fell by more than 50%, dropping to USD 4.8 billion in 2009. The cumulative FDI stock stood
           at almost USD 52 billion and FDI per capita was only USD 1 078, significantly lower than in
           its peers in the region (Figure 2.4).
               The IMF extended support to Ukraine during 2008-09 to stabilise the banking system
           and mitigate the impact of the collapse in output. This helped to ease concerns over
           Ukraine’s sovereign debt position. The package was subject to specific conditions such as
           reducing the budget deficit, applying a more flexible exchange rate regime and increasing
           the price of gas. The total loan package was initially supposed to be around
           USD 16.4 billion, but after the release of USD 10.5 billion disbursements were suspended in
           November 2009, when domestic reforms stalled and the government refused to cut



46                                                            COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012
                                                                                                          II.2.   ECONOMIC OVERVIEW



                 Figure 2.4. FDI per capita in Ukraine is lower than in its regional peers
                       FDI inward stock, USD at current prices and current exchange rates per capita, 2009

                                                            FDI inward stock per capita 2009 (USD)

                Kyrgyzstan
                 Azerbaijan
                   Ukraine
                   Armenia
              Turkmenistan
                   Georgia
                Kazakhstan
                    Poland
                   Slovenia
                   Slovakia
             Czech Republic
                    Estonia
                   Hungary
                              0         5 000          10 000           15 000           20 000       25 000        30 000

         Source: UNCTAD (2011), World Investment Report, UNCTAD, Geneva; UNCTADstat, Statistical Database, http://unctadstat.
         unctad.org/ReportFolders/reportFolders.aspx?sCS_referer=&sCS_ChosenLang=en, accessed 15 June 2011.


         spending ahead of presidential elections. In 2010, the government obtained another
         USD 7.5 billion loan from the IMF and VTB, a state-owned Russian bank.
             The global financial crisis and the subsequent recession had a severe impact on
         incomes and living standards. Disposable income contracted and GDP per capita at
         constant prices declined by 14.7% year on year, from UAH 16 019 in 2008 to UAH 13 668
         in 2009 (IMF, 2010), making Ukraine one of the poorest countries in the region.
         Unemployment went up from 6.4% in 2008 to 8.8% in 2009. Average real wages declined by
         9.2% in 2009 and unit labour costs dropped by almost 20%. Emigration of younger
         Ukrainians to countries with better job prospects has intensified, causing an ageing of the
         demographic structure. This human capital flight entails high social costs for the country,
         and could undermine its long term development.

Economic activity relied mainly on agriculture and highly energy intensive
industries
             Once called the “breadbasket of Europe”, Ukraine has traditionally specialised in
         agriculture. In the 1990s, agriculture accounted for around 20% of GDP, but its share
         gradually declined to 8.2% of GDP in 2010 following a reallocation of labour from
         agriculture into the industry and services sectors (Figure 2.5).3 Agriculture still accounted
         for 25% of total exports in 2009 (WTO, 2010), and the country is the world’s largest exporter
         of barley and the seventh-largest exporter of wheat. However, agricultural exports consist
         mainly of goods with a low degree of processing.
              In 2001, the Land Code introduced a moratorium on the purchase and sale of farm
         land. This was supposed to be in effect only until the end of 2004, but is still in place and
         will remain so until at least 2012. There is still no operational land cadastre detailing
         property holdings and usage, despite the fact that a project to develop one started in 2004.
         Moreover, since 2006 the government has adopted an unpredictable and non-transparent
         system of export quotas on grain, originally intended as a temporary response to lower-
         than-expected grain harvests. However, the restrictions have been lifted and re-imposed
         several times and were finally removed only in May 2011, with important consequences for

COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012                                                        47
II.2.   ECONOMIC OVERVIEW



                  Figure 2.5. The share of services in GDP has expanded since independence
                           Agriculture % GDP           Industry % GDP                Services % GDP                 Real GDP
            800

            700

            600

            500

            400

            300

            200

            100

              0
                   1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

           Source: World Bank (2011), World Bank Development Indicators, http://data.worldbank.org, accessed 15 September 2011.


           the domestic agribusiness sector and the widening current account deficit (Figure 2.6).
           Such measures have created uncertainty over the volumes of crops that could be delivered
           by Ukraine, increasing the risks shared by producers, suppliers, traders, financial
           institutions and households. Also, the quotas have not always been administered in a
           transparent way, contributing to greater inefficiency of both resource allocation and
           investment in the sector. The unclear quota allocation procedures have resulted in the
           exclusion of many international traders from the export market.

                                Figure 2.6. The current account deficit has widened
                                                   Current account balance (% GDP)

                                                           Current account balance (% GDP)
             12

             10

              8

              6

              4

              2

              0

             -2

             -4

             -6

             -8
                    2000      2001        2002      2003          2004       2005        2006         2007   2008        2009

           Source: World Bank (2011), World Bank Development Indicators, http://data.worldbank.org, accessed 15 September 2011.


               Another challenge concerns transport infrastructure. The limited capacity of Ukraine’s
           ports restrains exports of commodities and agricultural products. For example, in 2008 the
           utilisation ratio of the five major Ukrainian sea ports was 96%, i.e. approaching full
           capacity. As a consequence of the current constraints, the share of agriculture in the total
           FDI stock remains modest at 2%.




48                                                               COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012
                                                                                                                                                             II.2.    ECONOMIC OVERVIEW



              Ukraine is the world’s eighth-largest producer and fourth-largest exporter of steel, and
         the fifth-largest exporter of nitrogen-based fertilisers. Industry value added accounted for
         30% of GDP in 2010 (World Bank, 2011), while the share of total exports represented by fuels
         and mining products was 12.3% and that accounted for by manufactured products was
         62%, according to the WTO. During 2001-06, there was spare capacity in several sectors of
         industry, allowing the manufacturing sector to grow faster than GDP, with growth
         averaging around 10% on an annual basis. In the six years after the 1998 financial crisis,
         productivity growth in industry was strong, especially in the machine building and wood-
         products sectors, where Ukraine had a comparative advantage. However, productivity
         growth slowed in 2005-06 (OECD, 2007). Labour productivity grew at an annual average of
         12.5% in 2001-06, driven by spare capacity, the restructuring of firms and the resultant
         shedding of labour. The sector also enjoyed a substantial comparative advantage in terms
         of cost of inputs, as the natural gas price was lower than that paid by Ukraine’s European
         peers. Since the price shocks of 2006, a sharp annual increase in the gas import price has
         put pressure on firms’ cost structures; despite the incentive to modernise the capital stock,
         industry remains an inefficient and highly-intensive user of energy.
              The rise of commodity prices that peaked at record levels in 2007 supported the growth of
         the ferrous metallurgy sector and its satellite industries. Real GDP growth has been closely
         linked to the evolution of the price of steel, which accounts for more than one third of total
         goods exports. In July 2008, the IMF estimated, using a VAR framework, that a 10% decline in
         steel prices would slow Ukraine’s annualised GDP growth by between ½ and ¾ of a percentage
         point over a full year (IMF, 2008). Steel prices crashed by 38% in the first quarter of 2009 and
         bottomed out at 58.5% below their pre-crisis level in the second quarter (Figure 2.7).


            Figure 2.7. The evolution of real GDP has been closely linked with steel prices
                             Quarterly Real GDP (% yearly change) and Steel price (USD/tonne) % yearly change

                                   Real GDP % yearly change                                                       Steel price (USD/tonne) % yearly change
             15                                                                                                                                                             120

                                                                                                                                                                            100
             10
                                                                                                                                                                            80
              5
                                                                                                                                                                            60
              0
                                                                                                                                                                            40

             -5                                                                                                                                                             20

                                                                                                                                                                            0
            -10
                                                                                                                                                                            -20
            -15
                                                                                                                                                                            -40
            -20                                                                                                                                                             -60

            -25                                                                                                                                                             -80
                   Q1


                             Q2


                                       Q3


                                                 Q4


                                                           Q1


                                                                     Q2


                                                                               Q3


                                                                                         Q4


                                                                                                   Q1


                                                                                                             Q2


                                                                                                                       Q3


                                                                                                                                 Q4


                                                                                                                                           1


                                                                                                                                                    2


                                                                                                                                                             3


                                                                                                                                                                       4
                                                                                                                                          Q




                                                                                                                                                            Q


                                                                                                                                                                        Q
                                                                                                                                                   Q
                  07




                                   07




                                                       08
                                             07




                                                                                               09




                                                                                                                                       10
                         07




                                                                           08




                                                                                                                                                         10
                                                                                                                    09
                                                                                     08




                                                                                                                                                                     10
                                                                                                                             09
                                                                 08




                                                                                                         09




                                                                                                                                                10
                                                                                                                                      20




                                                                                                                                                        20


                                                                                                                                                                 20
                                                                                                                                               20
             20




                                  20


                                            20
                        20




                                                      20




                                                                                              20
                                                                          20


                                                                                    20




                                                                                                                  20
                                                                20




                                                                                                                            20
                                                                                                        20




         Source: State Statistics Committee of Ukraine (SSCU), (2011), State Statistics of Ukraine website, www.ukrstat.gov.ua,
         accessed 30 September 2011; Economist Intelligence Unit (2011), Country Report: Ukraine, EIU, London.



             As a result of the reallocation of labour from agriculture and industry into services, the
         speed of service sector growth since 2000 has been important. Services accounted for 60.9% of
         GDP in 2010 and around 22% of the inward FDI stock. The financial sector, in particular, has
         experienced dynamic growth, with rapid increases in consumer and mortgage lending until

COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012                                                                                                            49
II.2.   ECONOMIC OVERVIEW



           the onset of the financial crisis, when credit growth stalled. The retail sector also expanded
           strongly from 2000 onwards, driven by the rise in real incomes and consumer demand.
           However, the global financial crisis has severely constrained households’ purchasing power.
           This, combined with consumer price increases and the alignment of utility prices towards
           European levels, has recently hampered the growth of private consumption.

           Structural reform priorities need to improve the business climate, consolidate 
           the financial sector and deepen the labour force’s skill set
                Ukraine’s business climate has always been very difficult, but the instability and
           uncertainty triggered by the financial crisis have contributed to a further deterioration. The
           World Bank’s “Doing Business” project ranked Ukraine 128th out of 175 countries in 2006;
           in 2011, it was downgraded to 145th out of 183 economies, despite the new legislation
           adopted in 2009-10 to simplify the procedures required to start a business. According to the
           World Bank’s assessment, its scores have worsened in the categories “registering a
           property”, “getting credit”, “protecting investors”, and “closing a business”.
              The long-term policy goal of the country is to improve competitiveness. Greater
           macroeconomic stability is a prerequisite to attracting foreign investment and switching to
           a long-term sustainable growth path. Ukraine urgently needs to stabilise its budget deficit
           and reform its fiscal system to support private and public investments, especially
           investments in infrastructure. These structural fiscal reforms have to be combined with
           reforms aimed at improving the investment climate, targeting the investment framework
           and taking into account the importance of foreign investments. For instance, the
           bureaucratic procedures needed to operate in the country should be streamlined and the
           entry and exit barriers for companies should be removed. Corruption needs to be tackled
           to improve governance, accountability and transparency. SMEs need to have access to
           finance to meet the cost of inputs and to improve the quality of their outputs. Therefore
           capital market reforms targeting a deepening of financial markets are a priority. Finally,
           there is a need for education reforms to upgrade the skill-set of the labour force, modernise
           the education system and minimise the existing skills gap.

           A sector-specific approach to investment promotion
                A national long-term investment promotion strategy based on available resources and
           capabilities must be developed to improve sector competitiveness and increase awareness
           of strategic opportunities among foreign investors. It is advisable to develop a dialogue on
           this theme between the government, investment institutions and the private sector. More
           competitive economies can provide higher levels of income and higher standards of living
           for their citizens through higher wages. Higher productivity also entails higher returns on
           capital, which in turn attract higher volumes of investment into the economy. The
           experience of OECD countries shows that economies with a sector-specific focus on
           investment promotion activities achieve better results and attract higher volumes of
           foreign direct investment. Therefore, an investment promotion strategy needs to focus on
           specific sectors and FDI-originating countries.
               The OECD will continue to work closely with the government of Ukraine to formulate
           and implement a number of specific policy recommendations to maximise the potential
           and competitiveness of these sectors.




50                                                  COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012
                                                                                                  II.2.   ECONOMIC OVERVIEW



         Notes
          1. According to the State Statistics Service of Ukraine the female labour participation rate was 58.4%
             in 2010, based on the Labour Force Survey conducted at the national level. The World Bank uses
             the data published by the International Labour Organisation (ILO), which applies harmonised
             methodologies ensuring cross-country and over-time comparability. The discrepancy between the
             two sources are attributable to differences in the census scope, coverage and definitions. For
             example, the definition of unemployed people differs between the ILO and the Labour Force
             Survey, affecting all the other indicators.
          2. During the Soviet era, managers tended to over-report production to obtain bonuses for exceeding
             production targets. In addition, goods for which there was no market demand were produced
             anyway.
          3. The share of Agriculture, Industry and Services Value added to GDP published by the State
             Statistics Service of Ukraine differs slightly from the data published by the World Bank. This
             discrepancy can be attributed to different definitions. For example, the World Bank uses the United
             Nations International Standard Industrial Classification of All Economic Activities, while the State
             Statistics Service of Ukraine is based on the NACE classification.



         Bibliography
         Economist Intelligence Unit (2010), Country Forecast: Ukraine, EIU, London.
         Economist Intelligence Unit (2011), Country Report: Ukraine, EIU, London.
         European Bank of Reconstruction and Development (2011), Transition Report: Recovery and Reform, EBRD,
            London.
         International Monetary Fund (2010), International Financial Statistics, IMF, Washington, DC.
         Kuddo, A. (2009), Labor Market Monitoring in Europe and Central Asia Countries: Recent Trends, World Bank,
            Washington, DC.
         Kupets, O. and N. Leshchenko (2008), “Black Sea Labour Market Reviews: Ukraine Country Report”,
            prepared for ETF by BEST LCC, Kiyv.
         OECD (2007), Economic Assessment of Ukraine 2007, OECD, Paris.
         Raiser, M. (2007), “Are Wages in Ukraine too Low? And What Could Be Done to Increase Them?”, draft
            available from: http://siteresources.worldbank.org/UKRAINEEXTN/Resources/wages_in_ukraine_eng.pdf,
            accessed 20 September 2011.
         State Statistics Committee of Ukraine (SSCU) (2011), State Statistics Service of Ukraine website,
            www.ukrstat.gov.ua, accessed 30 September 2011.
         UNCTAD, (2010), World Investment Report, UNCTAD, Geneva.
         UNCTAD, (2011), World Investment Report, UNCTAD, Geneva.
         Voigt, S. (2009), “The Effects of Competition Policy on Development. Cross-Country Evidence Using
            Four New Indicators”, Journal of Development Studies, Vol. 45, No. 8.
         World Bank (2011), World Bank Development Indicators, http://data.worldbank.org, accessed 15 September
           2011.
         World Bank (2010), World Development Report, Washington, DC.
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COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012                                                51
Competitiveness and Private Sector Development: Ukraine 2011
Sector Competitiveness Strategy
© OECD 2012




                                                    Chapter 3




       2011 OECD Investment Policy Review
            of Ukraine – Key findings


         This chapter summarises the key findings of the Investment Policy Review of Ukraine.
         Based on the OECD Policy Framework for Investment, it assess the country’s ability to
         comply with the principles of liberalisation, transparency and non-discrimination and
         to bring the investment agenda closer to recognised international standards. The
         chapter provides first general investment policy recommendations and secondly
         suggests some measures to improve the business climate.




                                                                                                 53
II.3.   2011 OECD INVESTMENT POLICY REVIEW OF UKRAINE – KEY FINDINGS




           T  he general objective of the OECD Investment Policy Reviews is to facilitate dialogue
           between OECD and partner countries, share experience and support investment policy
           reforms. The work on Ukraine’s Review has been carried out in close cooperation with the
           Ukrainian authorities, in particular the Ministry of Economic Development and Trade. The
           draft Review prepared by the OECD Secretariat in cooperation with the Ukrainian
           authorities, notably the Ministry of Economic Development and Trade, was examined by
           the Investment Committee’s Advisory Group on Investment on 22 March 2011 at the OECD
           headquarters in Paris. The final version of the Review published in the OECD Investment
           Policy Review series in July 20111 reflects discussions during this meeting and OECD
           delegations’ subsequent written comments.
                The Review assesses the country’s ability to comply with the principles of liberalisation,
           transparency and non-discrimination and its policy convergence with recognised
           international investment standards such as the OECD Declaration on International Investment
           and Multinational Enterprises. Based on the OECD Policy Framework for Investment, the Review
           also analyses the interaction and coherence of Ukraine’s investment policy with other
           areas such as investment promotion and facilitation, trade and competition policy and
           responsible business conduct. In addition, a separate chapter addresses Ukraine’s specific
           challenge to attract investment in support of energy efficiency.
                Ukraine’s foreign direct investment (FDI) inflows, which were strongly affected by the
           economic crisis in 2009, picked up in 2010 but remain below pre-crisis levels. Financial
           services and manufacturing together absorb almost two-thirds of the total inward FDI
           stock. EU27 countries are the main source of Ukraine’s inward FDI, representing over 75%
           of the total stock. Foreign investors have participated in a number of privatisation deals, in
           particular in the metallurgical sector in 2005, but the privatisation process has stalled in
           recent years. The 2010 government reform programme stresses the contribution of foreign
           investment not only as a source of external financing but also as a market-transformation
           and competition-enhancing tool and encourages increased participation of foreign
           investors in the revamped privatisation process (see Chapter 1 of the Review).
                Ukraine’s legal framework forinternational investment embodies the principle of
           non-discrimination against foreign investment and general provisions on foreign
           investment protection. These include protection against nationalisation and changes in
           relevant legislation as well as guarantees for compensation and the repatriation of profits.
           All categories of investment are subject to the same establishment procedures, notably
           state registration, business permits and licensing. Notwithstanding this equal treatment,
           new foreign investors – usually less familiar with local practices than incumbent firms –



           1 More information about OECD Investment Policy Reviews and Ukraine’s Review is available at
             www.OECD.org/daf/investment/countryreviews. Ukraine’s Review was prepared by Blanka Kalinova and
             Stephen Thomsen, Senior Economists in the Investment Division of the OECD Directorate for
             Financial and Enterprise Affairs (DAF) and Wojciech Paczynski from the Center for Social and
             Economic Research (Chapter 4).


54                                                    COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012
                                                         II.3.   2011 OECD INVESTMENT POLICY REVIEW OF UKRAINE – KEY FINDINGS



         have often been discouraged by complex, protracted and costly procedures and resulting
         regulatory uncertainty. The government’s recent efforts to streamline administrative
         procedures should be pursued vigorously.
             Ukraine applies several trans-sectoral and sectoral restrictions on foreign
         investment, which qualify for the list of exceptions to national treatment and measures
         reported for transparency in the meaning of the OECD Declaration on International Investment
         and Multinational Enterprises. FDI is prohibited in unspecified strategic sectors and
         territories in cases where foreign capital would lead to Ukraine’s “critical dependence on
         the business cycles of international markets” or “jeopardise its economic independence”.
         According to the 1992 privatisation law, legal entities in which more than 25% of equity is
         owned by a state cannot participate in the privatisation of state and municipal property.
         Defining clearly the scope of “strategic” sectors closed to foreign investors or subject to
         authorisation procedures would considerably reduce legal uncertainty concerning foreign
         investment in these sectors. More generally, while safeguarding its essential national
         security interests, the country’s policy should be designed and implemented to ensure the
         smallest possible impact on investment flows and be guided by the principles of non-
         discrimination, proportionality, transparency and accountability as recommended in the
         OECD Guidelines for Recipient Country Investment Policies relating to National Security.
              The moratorium on foreign ownership of agricultural land, prolonged until 2012, is
         perceived by foreign investors as a significant limitation on their activities especially given
         additional bottlenecks such as the absence of a unified registration system for land and
         real estate. As part of its WTO accession commitments, Ukraine has opened a number of
         sectors to foreign investment, including transport, telecommunications and banking.
         Several remaining restrictions, notably on providing insurance services by direct branches
         of foreign insurance companies and a 30% limit on foreign ownership in the wholesale
         trade of books, magazines and newspapers, have to be eliminated within 5 years of the
         country’s WTO accession, i.e. by May 2013.
            Several other measures would qualify for the list of measures reported for transparency
         under the OECD Declaration on International Investment and Multinational Enterprises, notably
         public monopolies, specifically in energy transport and distribution, railways and local
         telephone communications. Taking into account the existing statutory FDI restrictions,
         Ukraine’s score under the OECD FDI Restrictiveness Index is higher than the OECD average
         but lower than the average of non-OECD countries covered by the FDI Index. Ukraine’s
         relatively favourable performance with respect to the formal FDI restrictions captured by
         the OECD FDI Index contrasts with a poor perception of its investment climate in most
         international comparisons, which assess actual implementation of existing laws and
         regulations (see Chapter 2 of the Review).
              Based on the OECD Policy Framework for Investment, which evaluates various policies
         relevant for the country’s investment climate, Ukraine has made progress in several
         important areas such as investment facilitation and promotion, trade and competition
         policies. But more remains to be done to create a favourable investment environment (see
         Chapter 3 of the Review). General transparency in terms of access to investment-related
         information has improved, but public consultations and public-private dialogue have not yet
         been generalised. Investment policy implementation continues to suffer from a lack of
         regulatory transparency due to frequent changes in legislation, the complexity of existing
         measures and the absence of, or delays in issuing, implementing regulations. This allows too


COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012                                                  55
II.3.   2011 OECD INVESTMENT POLICY REVIEW OF UKRAINE – KEY FINDINGS



           much room for administrative discretion and hence the possibility of corruption. Protection
           of intellectual property rights is probably one of the most critical areas where the gap
           between national legislation – generally in line with international standards – and its
           inadequate enforcement in practice is particularly harmful to foreign investment. Ukraine’s
           investment promotion activities have been subject to frequent reorganisations resulting in
           the multiplication of agencies often with overlapping responsibilities. It is essential that the
           new State Agency for Investments and National Projects, created at the end of 2010, and the
           restructured Council of Local and Foreign Investors become efficient tools for enhancing
           policy implementation in close association with the investment community.
               After its unsuccessful experience with Special Economic Zones (SEZs), Ukraine
           abolished the differentiated tax and customs regimes applied in SEZs in 2005 but it is now
           considering reintroducing a preferential investment regime in selected areas. The
           government’s commitment gradually to reimburse export VAT-refund arrears, which have
           constituted one of the major disincentives to firms’ operations and investment, is part of
           an ambitious tax reform package aimed at reducing the weight of taxes in business costs
           and improving tax management.
               Ukraine’s accession to the WTO in May 2008 has enhanced trade policy transparency
           and predictability. The country has concluded a number of free trade agreements, mainly
           with the countries of the former Soviet Union. Efforts to streamline border procedures and
           trade facilitation measures should be intensified, especially the introduction of electronic
           customs documents and procedures as well as the adoption of international technical
           standards and conformity certification procedures. In the area of competition policy,
           Ukraine has gradually put in place an appropriate legal and institutional framework. But
           the development of a competitive environment remains constrained by the size of the
           public sector, particularly the large number of public monopolies operated by state-owned
           enterprises, the scope of price controls and the pervasive system of licensing and business
           permits, which prevent the entry of new firms.
                Public policies promoting responsible business conduct, such as those embodied in
           the OECD Guidelines for Multinational Enterprises, contribute to attracting investment.
           However, both public awareness and responsible business practices, such as compliance
           with and reporting on environmental performance and management, are still less
           common in Ukraine than in other emerging economies. Corruption remains the key
           investment impediment and the main reason for the country’s poor ranking in available
           international business surveys. Recent delays in adopting new anti-corruption legislation
           have cast doubts on the authorities’ willingness to deal with this issue.
               Ukraine faces specific challenges in attracting the investment required to reduce its
           currently high energy intensity, increase its energy production and upgrade its
           deteriorating energy infrastructure (see Chapter 4 of the Review). Energy efficiency efforts
           and investment have been hampered by distortions in energy price setting and the energy
           market structure, which is dominated by state-owned firms. The June 2010 government
           economic reform programme addressed these critical issues and set objectives for
           accelerating the privatisation process in the energy sector and for gradually adjusting
           energy prices to market levels. Given that public financing will be unable by itself to cover
           the huge need for energy efficiency investment, implementing these reforms without
           delay is essential in order to attract private, including foreign, investment.




56                                                    COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012
                                                         II.3.   2011 OECD INVESTMENT POLICY REVIEW OF UKRAINE – KEY FINDINGS



             Improving efficiency remains the main focus of Ukraine’s energy policy, but the
         importance of developing renewable energy resources should not be underestimated. In
         some cases, there are synergies between energy efficiency and environmentally-friendly
         energy production and technologies, for example in the case of heat production based on
         biomass and waste. Ukraine has developed a basic policy framework in support of
         environmentally-friendly energy resources and technologies, but in the absence of energy
         price reforms, the incentives for such investment have been limited. The government has
         an important role to play in promoting both public awareness and corporate initiatives
         aimed at improving the measurement and reporting of environmental performance.
              The Review shows that Ukraine has made progress in developing a legal framework for
         attracting FDI, but implementation problems continue to affect domestic and foreign
         investors alike and prevent the country from mobilising private investment commensurate
         with its economic potential and investment needs. Although necessary macroeconomic
         reforms are not expressly addressed in the Review, it is clear that they remain a
         prerequisite for putting the country firmly on the map of foreign investors. To encourage
         capital inflows, the country has to shore up its public finances and reform its fiscal system
         to support public and private investment, particularly in infrastructure. Proposed
         investment policy recommendations have to be a part of broader reforms that target public
         and private investment, including foreign capital, and which remove entry and exit
         barriers for all categories of firms.

General investment policy recommendations include:
         ●   Define the strategic sectors in which foreign investment is prohibited or subject to
             specific authorisation procedures; specify relevant authorisation procedures, including
             the conditions/documents required for applications and the deadline for reply to
             applicants by the responsible authority.
         ●   Specify clearly the conditions for foreign participation in the privatisation process in the
             new law on privatisation currently under preparation and avoid leaving room for
             administrative discretion in selecting those sectors and firms excluded from privatisation.
         ●   Observe the guiding principles of non-discrimination, proportionality, transparency and
             accountability in implementing investment measures related to national security, as
             expressed in the 2009 OECD Guidelines, and consider the formal acceptance of these
             recommendations.
         ●   Make sure that the new law on investment currently in preparation confirms the non-
             discrimination principle for foreign investment.
         ●   Implement the state e-registration system and continue to simplify business permit
             procedures, including applying the “declarative principle” as foreseen by the law.
         ●   Abolish the moratorium on agricultural land ownership in 2012 as currently foreseen and
             accelerate the implementation of the unified registry of land and real estate property.
         ●   Develop implementing regulations to make possible the rapid and effective application
             of the law on public-private partnerships.




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II.3.   2011 OECD INVESTMENT POLICY REVIEW OF UKRAINE – KEY FINDINGS



Suggested measures to improve the investment climate:
           ●   Develop public-private consultations on business-related legislation and regulations
               with the business community, including foreign investors, notably within the new
               Council of Local and Foreign Investors.
           ●   Take into account the interests and concerns of foreign investors in small and medium-
               sized enterprises, which are particularly affected by frequent legislative and regulatory
               changes and related regulatory uncertainty.
           ●   Consider setting up an ombudsman’s office to tackle concrete problems faced by new
               and established foreign investors in Ukraine.
           ●   Ensure that the State Agency for Investments and National Projects established in
               December 2010 fulfils its main tasks in line with the planned schedule, notably the
               creation of the single window facility for foreign investors before 2012.
           ●   Finalise refunding of VAT arrears and improve VAT administration as foreseen by the IMF
               agreement and the government’s plan.
           ●   Carry out a thorough costs-benefit analysis before reintroducing preferential investment
               regimes in special economic zones and priority development territories.
           ●   Promote public awareness and corporate initiatives aimed at improving the
               measurement and reporting of energy efficiency and environmental performance.




58                                                    COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012
                                                          PART III




                        Sector-specific analysis




COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012
Competitiveness and Private Sector Development: Ukraine 2011
Sector Competitiveness Strategy
© OECD 2012




                                                    Chapter 4




                                          Agribusiness


         This chapter provides an in-depth analysis of the agribusiness sector in Ukraine.
         Examining the demand and supply sides, it explains why agribusiness is promising for
         private domestic and foreign investors given domestic and global trends. It identifies the
         role that foreign investors could play along the value chain, including farming,
         processing and retail. It also presents key issues and policy barriers hindering
         competitiveness in the sector and proposes a prioritised list of policy recommendations.




                                                                                                      61
III.4.   AGRIBUSINESS




Summary
                 Agribusiness represents a comprehensive value chain that covers all aspects of
           agricultural production (e.g. farming, seed and other agricultural inputs, crop production,
           post-harvest handling, and animal husbandry), processing, and distribution
           (e.g. wholesaling, retail sales to final consumers) (FAO, 2010; OECD, 2008). World
           production, consumption and trade of agricultural products are expected to increase
           sharply over the coming decade. This trend will be driven by non-OECD countries.
                On the demand side, strong income growth in emerging economies will boost demand
           for a wide variety of agricultural products and processed foods. Slow but steady
           convergence with the food demand patterns of developed countries will require higher
           attention to quality standards, health, and variety. On the supply side, the main trends are
           likely to be the concentration of operators at all levels of the value chain (production,
           processing, distribution), and increased concerns over food security. Emerging economies
           are forecast to develop their domestic production capacities (OECD/FAO, 2010), both
           through improved productivity and through better utilisation of available arable land.
           Increased production capacity will satisfy domestic demand and increase exports of
           commodities and processed agricultural products.
                Ukraine has a significant opportunity to further strengthen its already important role
           in agribusiness. The country has more arable land (around 32 million hectares) than any
           other European country. Moreover, Ukraine enjoys an abundance of black soil, which is
           very fertile and offers potential for high agricultural yield. Climatic conditions are
           favourable to the production of most agricultural products in different areas of the country.
           Other sources of competitiveness include the country’s long tradition in agriculture and
           low labour costs. Since the country’s independence, agriculture’s contribution to total
           output has been volatile. Its share of GDP increased in the 1990s, while non-agricultural
           industries contracted, but fell back sharply when non-agricultural sectors recovered.
           In 2009, the share was still higher than 8% (World Bank, 2011) and agribusiness accounted
           for 25% of total exports.
                The global context and the country’s endowments could open a wide range of
           opportunities for domestic and foreign investors. The expected rise in prices for agricultural
           products in real terms could also make this sector more attractive to private investors.
           Foreign agro-food companies investing in emerging economies could play a significant role
           by improving productivity while implementing the highest food safety and regulatory
           standards, allowing access to developed country markets such as the European Union.
                However, the Ukrainian agribusiness sector still faces a number of challenges. Some of
           them derive from the general approach of Ukraine to investment policy. For example, the
           issues of restrictions on land ownership are rooted in an unfinished land reform, and in the
           moratorium on sales of agricultural land, expected to end in 2012. Similarly, the quotas on
           grain exports introduced in 2010-11 relate to the more general issue of export-restricting
           measures during periods of global commodity price increases. Other challenges are more


62                                                  COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012
                                                                                               III.4. AGRIBUSINESS



         sector-specific. The productivity level is still low for many agricultural commodities, and the
         quality of products is still not up to the standards of neighbouring markets, therefore impeding
         high-quality exports. Quality is certainly affected by the limited availability of funds, which
         ultimately hampers both operational activities, such as the purchase of seeds and fertilisers,
         and capital expenditures, for example on storage facilities and modern harvesting equipment.
         Another aspect which has an impact on quality is the set of knowledge, skills, and abilities in
         the fields of agronomy and agro-management. At the moment this human capital is only
         partly aligned with demand from the agribusiness companies.
              The government could intervene in a number of policy areas in order to leverage the
         country’s endowments, make the agribusiness sector more competitive, and ultimately
         attract more investment. Improving access to finance could be a tool to empower the
         private sector and facilitate the improvement of the quality of output. The private sector
         will also benefit from a set of reforms in the human capital field aimed at improving the
         technical skills of the labour force and aligning them with market demand. The proposed
         recommendations also include improvements in safety and quality standards, the lifting of
         the present land sale moratorium and the amelioration and upgrading of infrastructure.
              In order to focus the government’s efforts on specific actions, a prioritisation of
         agricultural sub-sectors was carried out, based on an analysis of demand and supply. This
         prioritisation led to the identification of two pilot sub-sectors for reform efforts: the grain
         and dairy value chains. The next two chapters of this publication offer an in-depth analysis
         of these sub-sectors, along with specific policy recommendations.

Sector definition and segmentation
              Agribusiness can be defined as a value chain that includes all aspects of agricultural
         production, processing and distribution and spans a number of industries. The FAO (2010)
         defines agribusiness as “collective business activities that are performed from farm to fork.”
         Agribusiness refers to the supply of agricultural inputs and agricultural production
         upstream, and downstream business activities such as storage and distribution of
         agricultural products to final consumers (FAO, 2010; OECD, 2008). Agribusiness refers to the
         sum total of all operations involved in the production and distribution of food and fibre.
             All operations in the agribusiness supply-chain can be grouped into five major
         segments: agricultural inputs, primary agricultural production, primary processing, food
         processing and production, and distribution and retail (Figure 4.1).
         ●   The agricultural inputs segment covers producers and suppliers of seeds, fertilisers,
             agricultural chemicals, tools and agricultural machinery and technologies for crop
             cultivation and animal breeding.
         ●   The primary agricultural production segment includes activities such as cultivation of
             food and non-food crops, animal husbandry and includes such sectors as grains,
             oilseeds, meat, dairy, fish and horticulture.
         ●   Primary processing comprises basic processing of agricultural commodities, such as milling
             and crushing, as well as handling and delivery of produce that does not require further
             processing (such as fresh fruits and vegetables) through various distribution channels.
         ●   The food processing and production segment covers companies engaged in deeper
             processing of agricultural crops and production of food. Products include meat, poultry,
             bread, snacks, beverages, and frozen food.



COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012                                      63
III.4.   AGRIBUSINESS



                                         Figure 4.1. The agribusiness supply-chain
                                               A simplified example of the supply-chain

                             Up-stream                               Middle-stream                    Down-stream




                                                                                                                 Distribution
                        Agricultural        Agricultural            Primary                 Food
                                                                                                                     and
                          inputs            production             processing            production
                                                                                                                    retail




           Source: OECD (2010), Ukraine Sector Competitiveness Review, internal working document, OECD, Paris.


           ●   The distribution and retailing segment covers the operations of wholesale, retail and
               food service companies.
                 The organisation of the value chain and the links between these segments vary widely
           between segments of the industry. For example, food processing firms are integrating
           backward to primary production as well as forward to retail distribution, while a number of
           large multinational suppliers of seeds, feeds and fertilisers are well diversified in product
           processing and distribution. However, the scope of co-operation and integration and the
           nature of relationships differ between the various levels of the agro-industry value chain.
                Agribusiness connects agricultural producers and consumers by processing,
           transporting, marketing and distributing agricultural and food products. Thus, a robust
           agribusiness sector can stimulate the development of agriculture, and create positive spill-
           over effects on other sectors such as logistics or the chemicals industry, and ultimately
           economic development overall (World Bank, 2007).

Global trends
                World production, consumption and trade of agro food products are all expected to
           increase sharply over the coming decade and this trend will be driven by non-OECD
           countries. In emerging economies, strong income growth will boost food demand and
           imports of a wide variety of agricultural products and processed food. Slow but steady
           convergence with the food demand patterns of developed countries will increase pressure
           to develop domestic production capacity further. This will open a wide range of
           opportunities for domestic and foreign investors. The expected rise in prices for
           agricultural products in real terms might also make this sector more attractive to private
           investors. Foreign companies operating in emerging economies could play a key role by
           implementing the highest food safety and quality standards, thus allowing emerging
           country products to access developed country markets such as the European Union.

           World demand growth will be driven by emerging economies
               World consumption and trade of agricultural products will expand rapidly over the
           coming decade (OECD/FAO, 2011). Emerging economies will lead and stimulate the growth
           of agricultural consumption and international trade. This faster pace of consumption
           growth is mainly driven by rising per capita incomes, expanding populations and
           urbanization (Figure 4.2).




64                                                            COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012
                                                                                                                             III.4. AGRIBUSINESS



          Figure 4.2. Consumption of crop and livestock products to increase more rapidly
                                      in non-OECD countries
                                        OECD                              Non-OECD                               World
             %      Projected compounded annual growth rate of world consumption of key crop products from 2009 to 2020, %
          0.030


          0.025


          0.020


          0.015


          0.010


          0.005


              0
                      Wheat            Coarse grains          Rice              Oilseeds         Protein meals       Vegetable oils


             %         Projected compound annual growth rate of consumption of livestock products from 2009 to 2020, %
          0.035

          0.030

          0.025

          0.020

          0.015

          0.010

          0.005

              0
                   Beef and veal         Pigmeat           Poultry meat        Fresh dairy           Butter              Cheese
                                                                                products

         Source: OECD/FAO (2011), OECD/FAO Agricultural Outlook 2011-2020, OECD, Paris.


         World agricultural production growth should be driven by emerging economies 
         as well
              World agricultural production has been growing steadily during the last four decades;
         for example, over the 2001-10 period, global agricultural production grew at an annual
         average of 2.6% (OECD/FAO, 2011). This was made possible by advances in technology and
         policy improvements. In crop growing, for example, increased usage of irrigation and
         fertilisers as well as improved crop varieties have been the main factors behind rising
         cereals yields. The average global yield of cereals grew from 1.49 tonnes per hectare in 1964
         to 3.51 tonnes per hectare in 2008, an increase of 135%.
              Agricultural production in emerging economies has been growing faster on average
         than in OECD countries. Between 1960 and 2001, the production growth rate averaged 3.4
         to 3.8% per annum, which was more than double the average growth rate in developed
         economies (FAO, 2006). Over the coming decade, emerging economies are expected to
         increase their production at a faster pace (Figures 4.3 and 4.4).



COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012                                                                    65
III.4.   AGRIBUSINESS



                   Figure 4.3. Agricultural production growth over the last decade was driven
                                              by non-OECD countries
                                   Production growth comparison for key agricultural commodities, 2003-10, in %

                                                                           OECD countries                                                 Non-OECD countries
              1.0


             0.8


             0.6


             0.4


             0.2


               0


             -0.2




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           Source: OECD/FAO (2011), OECD/FAO Agricultural Outlook 2011-2020, OECD, Paris.


                             Figure 4.4. Agricultural production in non-OECD countries to grow
                                            at a faster pace than OECD countries
                                                        Compound agricultural production growth rate, 2010-19

                                                                 World                                        OECD                                      Non-OECD
             4.0

             3.5

             3.0

             2.5

             2.0

             1.5

             1.0

             0.5

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           Source: OECD/FAO (2011), OECD/FAO Agricultural Outlook 2011-2020, OECD, Paris.


           Emerging economies are beginning to resemble OECD countries in their food
           purchasing patterns
                Emerging economies, especially middle-income ones, seem to be following the food
           purchasing trends associated with OECD countries. A USDA analysis of food expenditures
           across 47 countries indicates that over the last 20 years, food expenditures for high value-
           added products and packaged food in developing economies have been converging with those
           in the developed countries (Figure 4.5). This movement reflects food consumption growth in

66                                                                                               COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012
                                                                                                                   III.4. AGRIBUSINESS



              Figure 4.5. Demand for high value added products in modern retail outlets
                                        grows as incomes rise
                                                              Share of packaged food in total food expenditure
                                                              Share of food sales in standardized retail outlets



              Lower middle-income




              Upper middle-income




          Sample of OECD countries


                                     0                 25                        50                         75           100
                                                                                                                          %
         Note: Sample of OECD countries includes Canada, USA, Australia, Japan, France, UK, Germany, Netherlands, Austria,
         Belgium, Finland, Greece, Italy, Spain, Sweden, Denmark, Ireland, Portugal; upper middle-income countries include
         Czech Republic, Hungary, Poland, Chile, Mexico, Malaysia, South Africa; lower middle-income countries include
         Brazil, Colombia, Peru, China, Indonesia, Philippines, Thailand, Algeria, Egypt, Jordan, Morocco, Tunisia. Algeria is
         excluded from the survey of packaged foods.
         Source: USDA (2008), Convergence in Global Food Demand and Delivery, USDA Economic Research Service, Washington, DC.

         middle-income countries, primarily driven by income growth (USDA, 2008). Growing incomes
         allow consumers to shift away from carbohydrate-rich products toward healthier but more
         expensive foods such as meat and dairy as well as fresh fruits and vegetables.
               This convergence trend has important implications for private domestic and foreign
         agribusiness investors (Box 4.1). The majority of the food basket in middle-income countries
         still consists of intermediate food products with lower added value, such as cereals, dry



                          Box 4.1. Defining “convergence” in food demand patterns
              The term “convergence” implies dynamics, or movement toward some common outcome.
            Convergence has been defined and examined most often as convergence in income levels.
            Barro and Sala-i-Martin (1992) defined beta convergence, in which the income growth of
            lower income regions or countries is faster than the world average and that of high-income
            regions is slower. The faster growth rates imply that lower income regions will even-tually
            “catch up” with higher income regions and all regions will reach a “steady state.” The
            concept of convergence has been applied to food expen-ditures to assess, for example, if
            income dynamics and market integration in the European Union are over-coming historical
            differences in preferences (Hermann and Röder, 1995; Gil et al., 1995).
              In food demand, the dynamics leading to convergence are driven primarily by income
            growth. It has long been recognised that diets change in predictable ways as incomes rise.
            For example Bennett’s Law states that the share of animal products in calories consumed
            increases as incomes rise (Bennett, 1941; Delgado et al., 1999). Recent research has
            highlighted how dietary upgrades in middle- and high-income countries include high-value
            products, in addition to meat (Regmi and Gehlhar, 2005). Generally, these changes in food
            consumption patterns include an increased demand for services and quality attributes, and
            are accompanied by the modernization of the retail sector (Reardon and Berdegué, 2002).
            Seale et al. (2003) demonstrate that lower income consumers make bigger changes in food
            expenditures as income levels change.



COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012                                                          67
III.4.   AGRIBUSINESS




                        Box 4.1. Defining “convergence” in food demand patterns (cont.)
                For example, an average consumer in the United States is expected to increase meat
              expenditures by 1% for every 10% increase in income. But, in a middle-income country
              such as Brazil, a 10% increase in income is likely to translate to a 7% increase in meat
              expenditures. As income-induced changes occur more rapidly in lower income countries,
              consumption patterns across countries trend toward convergence. The projected outcome
              is some universal “saturation” level of demand for food, including demand for higher
              quality food, which is achieved at high income levels.
              Source: USDA (2008), Convergence in Global Food Demand and Delivery, USDA Economic Research Service,
              Washington, DC.




           pasta, vegetable oils and other dried products. Rising demand for higher value-added food
           products will thus generate considerable opportunities for growth along the whole value-
           chain, including agricultural producers, processors, distributors, and modern retailers.

           Higher prices in real terms are expected, strongly influenced by dynamic global 
           food demand
                The recent global recession together with high volatility of oil prices had a strong
           impact on non-oil commodity prices. Commodity prices fell sharply from the pre-recession
           highs of 2007-08, but they started recovering in 2010 (Figure 4.6). In 2011-20, real prices of
           all agricultural products are expected to be above their average 2001-10 levels, but below
           the recent levels of 2008-10 (OECD/FAO, 2011) (Figure 4.7). This is partly due to the fact that
           energy prices will remain high by historical standards and should increase further with
           global economic recovery.


                         Figure 4.6. Price changes for selected commodities in 2005-10
                                                         Price index, 2005 = 100

                                Wheat          Coarse grains          Oilseeds          Poultry meat         Cheese
             250




             200




             150




             100




              50
                         2006                  2007                  2008                   2009              2010e

           Source: OECD/FAO (2011), OECD/FAO Agricultural Outlook 2011-2020, OECD, Paris.



           Increasing requirements for food safety and standards to access 
           developed country markets
               The role of standards and food safety has been growing over the last 20 years in
           developed countries. Stricter standards have been introduced by many governments over


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                         Figure 4.7. Most commodity prices in real terms to remain
                                        above the last decade’s level
             Changes in % between projected real prices over 2011-20, and: i) 2008-10; ii) the last decade (2001-10)

                                               Base 2008-10                            Base 2001-10
            %
            80
            70
            60
            50
            40
            30
            20
            10
             0
           -10
           -20
           -30
                 Wheat   Maize   Rice   Oilseeds Oilsee   Veg. oils   Beef   Pigmeat Poultry   Butter   Cheese   SMP     WMP
                                                 meals

         Source: OECD/FAO (2011), OECD/FAO Agricultural Outlook 2011-2020, OECD, Paris.


         the last decade and have placed primary legal responsibility for ensuring food safety on
         food operators. Private companies responded by implementing stricter public standards as
         well as developing their own standards. The introduction of various certification schemes
         for farmers, processors and producers in the entire agro-food value chain is a good
         example of the growing role of standards.
             The increasing role of food safety regulation in developed countries has several
         implications for developing countries (Box 4.2). First, it influences access to growing
         markets for agro food exports, particularly high-value fresh and perishable products such
         as dairy products: when standards are different, this can be an additional barrier for
         developing country exporters. Second, it has a “push” effect on food safety regulation in
         developing countries, by creating expectations among developing-country consumers
         regarding acceptable levels of safety. It can even determine best practice for regulations in
         developing-country food systems (IFPRI, 2003).



                 Box 4.2. Food safety regulation in developed countries has implications
                                         for developing countries
            A demand for higher levels of food safety in developed countries
              Food safety is affected by the decisions of producers, processors, distributors, food service
            operators, and consumers, as well as by government regulations. In developed countries, the
            demand for higher levels of food safety has led to the implementation of regulatory programs
            that are intended to improve public health by controlling the quality of the domestic food
            supply and the increasing flow of imported food products from countries around the world.
              Countries regulate food safety through the combined use of process, product (performance),
            or information standards. For example, specifications for acceptable in-plant operations may
            be backed up with final product testing to monitor and verify the success of safety assurance
            programs. Labelling that instructs final consumers on proper food handling techniques may
            further back up these systems.



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                 Box 4.2. Food safety regulation in developed countries has implications
                                      for developing countries (cont.)
              A price of entry into developed country markets
                 Stronger public health and consumer welfare emphasis in decisions by regulatory agencies. This
              leads to a focus on the food supply chain, on identifying where hazards are introduced into
              it, and on determining where those hazards can be controlled most cost effectively in the
              chain. This approach is referred to as “farm to table” or “farm to fork” analysis. When the
              supply chain extends across international borders, risk analysis may encompass farm or
              processing practices in developing countries.
                Adoption of more stringent safety standards, with a broader scope of standards. These
              evolving standards create continuing challenges for producers and regulatory agencies in
              exporting countries.
                 Adoption of the Hazard Analysis Critical Control Point (HACCP) approach to assuring safety.
              Under HACCP, companies are responsible for analysing how hazards such as food-borne
              pathogens may enter the product, establishing effective control points for those hazards,
              and monitoring and updating the system to assure high levels of food safety. Since HACCP
              is primarily a process standard for company-level activity, inspection to assure compliance
              is challenging for imported products coming from plants in other countries.
                Increased reliance on certification, including traceability. In developed countries, regulatory
              systems increasingly require that safety assurance actions be documented internally by
              the company and externally to government agencies. The system may require
              documentation tracing a food product back through the supply chain to its source or
              forward through the chain to the consumer. For example, the European Union is moving
              forward with mandatory traceability for all food products. The quality control systems
              required by buyers (such as supermarket chains) have frequently moved faster in the
              direction of certification and traceability requirements than have government programs.
                Export of some regulatory responsibility and burden. HACCP and other certification
              approaches to food safety assurance are process oriented. Assuring compliance for
              imported products may require oversight and inspection of farms or plants in other
              countries. This has resulted in some exporting of regulatory responsibility and burden to
              other countries as the price of entry into developed country markets.
              Source: International Food Policy Research Institute (2003), Food Safety in Food Security and Food Trade,
              Washington, DC.




The role of foreign investors along the agribusiness value-chain
               Growing demand for food and increasing globalisation of trade opens a wide range of
           opportunities for multinational companies in developing countries along the whole value
           chain, including farming, processing and retail.
               Inward FDI flows in agriculture were higher in developing countries than in developed
           countries over 2001-07. This seems to indicate the increasing attractiveness of developing
           regions and new market opportunities, namely in Asia and Oceania, Latin America and the
           transition economies of South-East Europe and the CIS (Figure 4.8). In developing
           countries, MNCs have increasingly focused on other segments of the value-chain,
           including trading, processing and retailing. Higher average profitability is a key reason.
           This is reflected in global FDI stocks, with agriculture accounting for a considerably smaller
           share than food and beverages (UNCTAD, 2009).


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             Figure 4.8. FDI stock in agriculture is rising in CIS countries and South-East
                   Europe but it is much smaller than in Latin America and Africa
                              Inward FDI stock in agriculture by region, 2001-07, billions of US dollars

                                        Average 2002-2004                             Average 2005-2007
          2 000



          1 500



          1 000



           500



              0



           -500
                     Europe       North America      Other         Africa      Latin America     Asia and       CIS and
                                                   developed                                     Oceania       South-East
                                                   economies                                                     Europe

         Source: UNCTAD (2009), World Investment Report: Transnational Corporations, Agricultural Production and Development,
         United Nations Publications, New York and Geneva.


              Along the same lines, food manufacturers are adapting their investment plans. New
         strategies include geographic expansion in developing countries and a greater emphasis
         on product category management. This two-fold approach enables food manufacturing
         companies to become leaders in certain core product lines in different markets, including
         developed and developing countries. “Therefore, while manufacturer concentration is not
         evident at the global level for total packaged food sales, firm concentration may exist in
         specific product lines and regional markets. Firm concentration is particularly evident for
         those products where the manufacturer’s brands are popular, such as in soup, breakfast
         cereal, and baby food” (USDA, 2009b).
             US and European modern retail firms have expanded their presence in developing
         countries and small retail firms’ share has become increasingly smaller. The leading
         15 global retail companies account for approximately one-third of world retailers’ turnover,
         which was around USD 4 trillion in 2008 on USDA estimates. Those firms benefit from cost
         advantages, due to economies of scale and the use of improved technology.

Ukraine agribusiness sector at a glance
         Agriculture plays a significant role in the economy
             Ukraine’s excellent soil and favourable climate allow for large-scale production and
         export of agricultural products. Ukraine has over 40 million hectares of agricultural land, of
         which about 80% (around 32 million hectares) is arable (Figure 4.9). The country is home to
         over 16 million hectares of chernozem (“black earth”), a very fertile black-coloured soil with
         high content of humus and minerals, which produces high agricultural yields.
              Ukraine’s climatic conditions are favourable for growing grains and oilseed crops.
         Wheat is the most cultivated grain in Ukraine (Figure 4.10). It accounts for nearly half total
         grain production in volumes in 2008. Barley was the second largest grain produced, with
         more than 12.6 million tonnes (24% of the total grain crop) harvested over 4.2 million
         hectares (27% of total land under grains) in 2008. Corn is the third most important grain

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III.4.   AGRIBUSINESS



                                Figure 4.9. Arable land in selected European countries,
                                              thousand square kilometres
             350

             300

             250

             200

             150

             100

              50

               0
                      Ukraine          France          Spain           Poland         Germany          Romania           United
                                                                                                                        Kingdom

           Source: State Statistics Service of Ukraine, 2011; Central Intelligence Agency (CIA) (2009), The World Factbook 2009,
           Central Intelligence Agency, Washington, DC.


                        Figure 4.10. Production of agricultural commodities in Ukraine,
                                             millions of USD, 2008
            3 000


            2 500


            2 000


            1 500


            1 000


             500


               0
                    Wheat    Cow milk, Sunflower Potatoes Indigenous Indigenous Hen eggs, Indigenous   Barley       Sugar   Maize
                            whole, fresh seed                cattle    chicken   in shell   pigmeat                  beet
                                                             meat       meat

           Source: FAOSTAT (2011), FAO Statistical Databases, http://faostat.fao.org, accessed 15 September 2011.


           crop. Ukraine is also a large producer of sunflower oil and rape seed: in 2008, it exported
           over 1.6 million tonnes of sunflower oil and was the largest exporter globally, ahead of
           Argentina, the Netherlands and Russia. The red meat and dairy sectors are also an
           important part of agriculture and agribusiness in Ukraine. Both sectors suffered severe
           declines during the transition period from the planned economy.
               The share of agriculture in the country’s GDP has been decreasing for most of the last
           decade and dropped from 17.1% in 2000 to 8.2% in 2009 according to the World Bank (2011)
           (Figure 4.11). Although this is a significant drop, it does not necessarily mean that
           agriculture is declining. Rather, it shows that other sectors are developing faster and that
           their contribution to GDP is becoming bigger. While Ukraine has an overall trade deficit,
           agriculture is a net exporting sector (Figure 4.12). In 2008-10, agro-food trade accounted for
           nearly 14% of the country’s external trade turnover (OECD, 2011). Agro-food trade expanded



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                    Figure 4.11. Ukraine: Share of agriculture sector in GDP, 1999-2009
                                                           Agriculture % of GDP
           %
           15

           14

           13

           12

           11

           10

            9

            8

            7

            6
                  1999       2000        2001       2002   2003     2004       2005       2006     2007      2008         2009

         Source: World Bank (2011), World Bank Development Indicators, http://data.worldbank.org, accessed 15 December 2011.


                                      Figure 4.12. Export structure of Ukraine, 2008
                         Agricultural and food products            Fuels and mining products               Manufactures




                                                                              25%
                                                                             25%




                                                                             12%
                                                            62%




         Source: WTO, 2011, International Trade Statistics, Trade Profiles, http://stat.wto.org/CountryProfile/WSDBCountryPFView.
         aspx?Language=E&Country=UA, accessed 15 March 2011.


         particularly rapidly in 2010, driven by the depreciation of the hryvnia and the liberalisation
         of the border regime after accession to the WTO.

         Agriculture is still recovering from the transition years
              After declining in the 1990s, agricultural production rebounded and has grown for
         most of the last decade. Herd size and volumes of milk production declined in the first
         decade of independence. The cattle headcount has fallen sharply during the last two
         decades from 24.6 million in 1990 to 4.8 million in 2009. However, during the last five years
         gross output in the agricultural sector has showed robust growth. In volume terms, total
         agricultural production in 2009 was 80.7% of the volume in 1991. The horticultural sector
         has seen strong growth in the last decade, with production levels in 2009 reaching 11.1%
         above the level of 1991. However, livestock production has not fully recovered and by 2009
         had only reached 56.8% of the 1991 level.




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           The food-processing industry is developing rapidly
                The food-processing sector in Ukraine has grown rapidly over the past 5 years with an
           average growth rate of over 15%, largely driven by population and income growth (USDA, 2010).
           The food processing industry’s share in manufacturing is around 20%. In 2010, the industry’s
           total output was estimated at approximately USD 12 billion. Over 20 000 enterprises operate in
           the food processing sector. Production growth rates are particularly high in dairy processing,
           fruit and vegetable processing, edible oils production, pastry and biscuits, and in the
           production of alcoholic beverages.
              The Ukrainian food processing industry is forecast to be driven first of all by domestic
           demand, through production of dairy products, especially hard cheese and whole milk
           products. The potential for exports to former CIS countries (Russia, South-Caucasus,
           Central Asia) is also promising, especially for dairy products and beef.
               The growth of the food processing industry is currently impeded by inadequate
           domestic supply of raw agricultural products and limited export opportunities. A key
           obstacle is the lack of quality: only a few food manufacturers stick to EU quality and
           packaging standards (mainly dairy, meat, confectionery, and beverages). As a result, large
           food processors purchase raw materials and food ingredients directly from foreign exporters.
               Key issues and policy barriers to achieving Ukraine’s competitive potential requires an
           improvement in output quality and a rise in productivity. While the country’s natural
           endowments are impressive, the sector is held back by insufficient investment in capital
           equipment and inputs, low quality of output, gaps in technical and entrepreneurial skills,
           and frequent ad hoc interventions in trade by the government. Enhancing the
           competitiveness of the agribusiness sector will require aligning its standards to
           international benchmarks and improving the quality of its output. The experience of OECD
           countries shows that the government can play a pivotal role in this area, encouraging and
           monitoring quality. Improving processing and food safety control systems would allow
           Ukraine to produce and sell competitive high quality products. Foreign direct investment
           in the processing and retail segments could help to improve the overall level of quality of
           processed products (World Bank, 2008).

           Agricultural productivity needs to be improved and stabilised
                Agricultural productivity in Ukraine as measured by the value added per worker
           started to recover after a decade of declines in the 1990s and reached USD 1 375 in 2000 and
           USD 2 461 in 2009. Nevertheless, it is still lower than neighbouring Russia (USD 3 031),
           Belarus (USD 5 184) or Romania (USD 8 993) (World Bank, 2010).
                The performance of Ukrainian agriculture is still unstable, with large annual
           variations in the production of crops. For example, according to OECD/FAO, annual wheat
           production can vary by 30% or more (Figure 4.13). Low use of plant protecting products due
           to limited access to short term finance largely explain these variations.

           Dominance of household plots results in a lack of large-scale investment
               Lack of investment and slow technological improvements in the sector are partially
           due to the farm structure of Ukrainian agriculture (OECD, 2009). Commercial large-scale
           production provides approximately one-third of total agricultural output, while the
           remaining two-thirds comes from small family-type peasant farms and household plots.




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                 Figure 4.13. Variation in production of selected commodities in Ukraine,
                                         2006-09, index 100 = 2005
                            Wheat                    Coarse grains                  Rice   Oilseeds
           200

           180

           160

           140

           120

           100

            80

            60

            40

            20

             0
                           2006                       2007                       2008      2009

         Source: OECD/FAO (2011), Agricultural Outlook 2011-2020, OECD, Paris.


              There are three broad types of agricultural production structures in the country:
         corporate farms, peasant farms, and household plots (Lerman et al., 2007). Corporate
         farms, which number around 17 500, are the successors to the former collective and state
         farms. They account for approximately 60% of agricultural land, and 40% of the country’s
         gross agricultural output. Some corporate farms are modern, reaching the productivity
         levels of developed countries. There are approximately 43 000 peasant farms accounting
         for 8% of agricultural land and 5-10% of gross agricultural output. Finally, there are roughly
         5.3 million household plots, which account for 30% of agricultural land and almost half of
         agricultural output.
             Household plots are largely subsistence-oriented. In a survey conducted in 2005,
         Lerman et al. (2007) determined that the average household plot sold 21% of its output and
         consumed 48%, with the rest being stored and used as intermediate inputs. The
         corresponding shares for the corporate farms and peasant farms are 57/64% and 10/9%,
         respectively (World Bank, 2008).

         WTO membership provides an incentive to improve quality
              WTO membership has provided an additional incentive to improve quality, strengthen
         entrepreneurship and improve the regulatory framework. Ukraine became the 152nd member
         of the WTO in 2008. New import tariffs agreed within the WTO framework implied a significant
         reduction in protection for specific agricultural goods, including pork, poultry and sugar. Those
         sectors are now exposed to stronger import competition while domestic agricultural support is
         expected to be downscaled to respect the country’s international commitments.
             The regulatory system is currently burdensome (Box 4.3), with an overlapping of rules
         and complex administrative procedures. There is a need for harmonisation of domestic
         food safety controls with international standards. The current negotiations concerning a
         free trade agreement (FTA) with the EU could provide new opportunities for the agricultural
         sector to address the existing issues, creating additional pressure to be competitive in
         domestic and international markets.




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                                        Box 4.3. Regulatory system of Ukraine
                Ukraine’s food safety system is implemented by various state agencies that often have
              overlapping functions. The following agencies are involved in assuring the safety of
              domestically-produced and imported food products, and animal and plant health issues:
              ●   State Epidemiological Service (SES) of the Ministry of Health Care of Ukraine (MHCU)
                  establishes food safety standards and is responsible for all aspects of food safety.
              ●   State Department of Veterinary Medicine (SDVM) of the Ministry of Agricultural Policy of
                  Ukraine (MAPU) is responsible for animal health, safety of meat, seafood and other
                  products of animal origin.
              ●   Main State Phytosanitary Inspection Service (MSPIS) of the MAPU is responsible for plant
                  health issues.
              ●   State Committee of Ukraine on Technical Regulations and Consumer Policy (SCUTRCP) is
                  responsible for compliance of food products with existing quality and safety standards.
              ●   State Ecological Inspection Service (SEIS) of the Ministry of Environment and Natural
                  Resources of Ukraine (MENRU) is responsible for radiological and environmental control.
              Source: USDA (2009a), Global Food Markets: International Consumer and Retail Trends, USDA Economic Research
              Service, Washington, DC.




           Improvements are needed in the field of land ownership, quality standards, 
           access to finance and human capital
               A first area of improvement is the completion of the land reform, which will lift the
           moratorium on land transactions, implement the unification and digitalization of the
           cadastre and title system, and design the appropriate institutions to supervise the land
           market. Asset ownership has played an important role in economic growth at the
           household level (Blanchflower and Oswald, 1998; Hoff, 1996). Poorly defined land tenure
           and the lack of ownership rights have restricted foreign investors’ involvement in the
           Ukrainian agribusiness sector. Furthermore, without asset ownership, small and medium-
           sized farmers lack the collateral needed to secure access to credit.
               Secondly, state support has created distortions. An evaluation of support to agriculture
           suggests that the Producer Support Estimate (PSE was 7% in the period 2008-10).* This is
           lower than the PSE estimated over the same period in Russia (22%) and the OECD average
           (20%), however it disguises the taxation of exported commodities and subsidies of imported
           products (OECD, 2011). There are significant disparities in protection among commodities.
           The share of the potentially most distorting types of support represented 84% of Ukraine’s




           * According to the OECD definition (OECD, 2000), “the PSE is an indicator of the annual monetary value of
             gross transfers from consumers and taxpayers to agricultural producers, measured at the farm gate
             level, arising from policy measures, regardless of their nature, objectives or impacts on farm production
             or income. The PSE measures support arising from policies targeted to agriculture relative to a situation
             without such policies – i.e., when producers are subject only to general policies (including economic,
             social, environmental and tax policies) of the country. The PSE is a gross notion implying that any costs
             associated with those policies and incurred by individual producers are not deducted. It is also a nominal
             assistance notion meaning that increased costs associated with import duties on inputs are not
             deducted. But it is measured net of producer contributions to help finance the policy measure
             (e.g. producer levies) providing a given transfer to producers. The PSE includes implicit and explicit
             transfers. The percentage PSE is the ratio of the PSE to the value of total gross farm receipts, measured
             by the value of total farm production (at farm gate prices), plus budgetary support.”


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         PSE in 2008-10 compared to 73% in 2005-07. In Russia it accounted for 81% of the PSE, while
         in the European Union it represented less than 30% of the PSE (OECD, 2011; OECD, 2009).
             A third important area of improvement is the alignment to international quality
         standards and the implementation of transparent and efficient quality controls. Tools
         which could ultimately improve quality are human capital development and access to
         finance. Although the region has a positive legacy of high attainment rates in tertiary
         education, there is a skills gap that affects both the public and private sectors. Farmers
         rarely have critical skills needed in a market economy, in areas such as financial literacy,
         farm management and organisation, and marketing. Technical professionals such as
         veterinarians lack training in updated animal health management practices. Government
         bodies, such as the ministries responsible for designing and implementing policies, often
         suffer from a lack of analytical capacity. With regard to the educational system, tertiary
         education does not deliver the technical skills demanded by the private sector. Specific
         actions would synchronise educational outcomes with the industry’s requirements. Also,
         in rural areas credit may be particularly rationed and access to finance for small and
         medium-sized enterprises (SMEs) is limited, due to lack of collateral, high interest rates
         and information asymmetries. Policy measures must support investment and
         entrepreneurship, mobilising financial resources through instruments such as credit
         guarantee schemes, supply chain financing and microfinance programmes. SMEs may also
         benefit from the introduction of leasing schemes, the establishment of futures markets for
         commodities and the development of insurance products tailored to agribusiness.

         Public private consultations and dialogue could accelerate the reform process
              During the assessment of policy barriers and the design of reforms, dialogue between
         the public and private sectors could bring productive interactions, ultimately accelerating
         the reform process. A free flow of information on policy issues needs to be encouraged,
         ensuring independent cooperation among the domestic and foreign private sector, the
         government and academia. Public-private consultations will also ensure that the reform
         design fits actual needs. However, consultations need to be transparent and to include
         small and medium-sized entrepreneurs, in order to avoid the reinforcement of vested
         interests and rent-seeking behaviour (Herzberg and Wright, 2006).

Why focus on the grain and dairy sub-sectors
              In order to target the government’s resources and efforts, an analysis of agricultural
         sub-sectors was carried out in order to prioritise the selection strategy. The process was
         conducted in cooperation with the various stakeholders. The decision-making process
         included quantitative criteria to trace demand and supply trends in domestic and global
         markets, with data input from both the government of Ukraine and the OECD Secretariat.
         More qualitative criteria were also used, based on the inputs collected from the
         stakeholders and the priorities indicated by the government.
             The sub-sectors included in the analysis were grain, dairy products, beef, poultry, oilseeds
         and sugar beet. The consultation process led to the identification of two pilot sub-sectors for
         targeted interventions: grain and dairy. Both have strong existing production capabilities and
         benefit from favourable natural endowments, with favourable demand prospects in domestic
         and world markets. Also, interventions could upgrade the technological advancement of both
         sectors and strengthen specialised skills. The beef sub-sector was not identified as a focus for
         this phase of interventions, as the effort required to meet food and safety quality standards

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III.4.   AGRIBUSINESS



           and to bridge the technical skills gap would be significant. The oil seed sub-sector was not
           identified as a target, due to concerns raised during the consultation process over the
           environmental sustainability of this type of cultivation.

           Demand and supply overview
               According to the OECD/FAO, domestic consumption of oilseed-based commodities,
           dairy products, and beef products is expected to grow strongly (Figure 4.14). World trade in
           these products is also expected to grow rapidly, while grain trading volumes are also
           expected to increase significantly (Figure 4.15). On the supply side, raw milk and grain are
           Ukraine’s most significant agricultural products in value terms,). In 2008, production of
           both commodities exceeded USD 2.5 bn, as previously indicated (Figure 4.10).


            Figure 4.14. Domestic consumption status and outlook for key agricultural products
            CAGR of domestic consumption 2009-2018, %
              12
                         Whole
                      milk powder
              10                                                             Beef


                8       Cheese
                                                                         Oilseeds
                              Oilseeds       Vegetable                   products
                                               oils                                              Oilseeds
                6              meals

                        Butter                           Pork
                4
                            Skim
                        milk powder
                2                                                            Poultry
                                              Refined
                                               sugar                                                            Wheat
                0
                    0                 500       1 000           1 500          2 000           2 500            3 000           3 500
                                                                                       Domestic consumption in 2009, millions of USD
           Note: Domestic consumption value in 2009 is based on consumption volumes in 2009 multiplied by international
           average prices of the commodities in USD in 2009; expected CAGR 2009-18 of the domestic consumption is based on
           Ukraine consumption volume forecasts multiplied by the international trade prices in USD in years 2009 and 2018.
           Source: OECD/FAO (2009), Agricultural Outlook 2009-2018, OECD, Paris.


Stakeholder consultations

           Climatic conditions are exceptional for grain growing
               Concerns were raised by stakeholders regarding the sustainability of the oilseeds
           sector in the short and medium term (Table 4.1). Oilseed crops in Ukraine exceed 30% of
           arable area, and they are planted every three years on average. Such frequency is close to
           the accepted agronomic limit for sunflower seed, making further increases in production
           hard to realise. Future increases in output could possibly be achieved through improved
           land productivity, but due to the current growing practices of Ukrainian farmers (who use
           limited amounts of pesticides and fungicides) yield improvement efforts would be
           undermined by soil exhaustion and soil-borne fungal diseases (EBRD/FAO, 2010).

           The grain and dairy sub-sectors both have potential to add value
               Stakeholders paid special attention to the potential of the different sub-sectors to
           expand deep processing. Both grain and dairy sub-sectors present opportunities to add
           value to primary commodities.



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                Figure 4.15. Annual world imports of agricultural products, status in 2009
                                           vs. outlook in 2020
          Projected growth of annual world imports in 2020, %
            100
                                Butter
                                 Cheese
              80                          Pigmeat
                           SMP
                                                                                                                              Vegetable oils
              60                                                     Beef and veal


                       WMP                Poultry
              40                                              Coarse
                                                              grains
                                                                                 Wheat                             Oilseeds
                                   High fructose
              20                    corn syrup
                                                         Rice          Protein
                                                                       meals             Sugar
               0
                   0                      10                    20                   30                50     40            60
                                                                                       World imports in 2009, billions of USD
         Note: Annual world import values (in 2009 and in 2020) are calculated according to the following methodology:
         volumes * world prices in USD in nominal terms.
         Source: OECD/FAO (2011), OECD/FAO Agricultural Outlook 2011-2020, OECD, Paris.

                         Table 4.1. How are domestic agro-climatic conditions favourable
                                         to more intensive crop growing?
          Key natural endowment feature             Grain-wheat, corn, barley                    Sugar beet                   Oilseeds

          Quality of climate                                    +                                   ++                           +
          Quality and availability of soils                     ++                                  ++                           –1
          Water availability                                    +                                    +                           +

         1. Agronomic and environmental limit is close to be reached under current farmers’ practices.
         Source: Ministry of Food and Agrarian Policy of Ukraine (2010), internal working document.

              In the grain sub-sector a first priority for Ukraine is to become a major producer and
         supplier of high quality grain for the domestic and global markets. It could then consider
         the possibility of moving up the value-chain into processed products, such as gluten and
         starch, for which there is a demand on the domestic market.
             In the dairy sub-sector, raw milk is rarely exported while processed dairy products are
         traded. The country has the opportunity to develop higher value-added products, such as
         pasteurised and branded milk, cheese and butter or milk powder, which are expected to
         grow significantly both in the domestic market and on a global scale.


         Bibliography
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         Central Intelligence Agency (2009), The World Factbook 2009, Central Intelligence Agency, Washington, DC.
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         Food and Agriculture Organization of the United Nations (FAO) (2006), World Agriculture:
            Towards 2030/2050: Interim Report, Global Perspective Studies Unit, FAO, Rome.
         FAO (2010), Agribusiness Development, Rural Infrastructure and Agro-Industries Division, Agriculture
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            index.html, accessed 12 April 2011.
         FAO (2011), The State of Food and Agriculture 2010-2011, FAO, Rome.
         FAOSTAT (2011), FAO Statistical Databases, http://faostat.fao.org, accessed 15 September 2011.

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           Humphrey, J. (2006), “Policy Implications of Trends in Agribusiness Value Chains”, The European Journal
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              Washington, DC, www.ifpri.org/publication/food-safety-food-security-and-food-trade, accessed
              15 September 2008.
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           Lall, S. (1990), Building Industrial Competitiveness in Developing Countries, OECD, Paris.
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              Discussion Paper No. 7130, Rehovot.
           Lerman, Z. et al. (2007), Rethinking Agricultural Reform in Ukraine, Studies on the Agricultural and Food
              Sector in Central and Eastern Europe, Leibniz-Institut für Agrarentwicklung in Mittel- und
              Osteuropa (IAMO), Halle.
           OECD (2000), Agricultural Policies in OECD Countries 2000: Monitoring and Evaluation, OECD, Paris.
           OECD (2004), Achieving Ukraine’s Agricultural Potential, OECD, Paris.
           OECD (2008), Business for Development: Promoting Commercial Agriculture in Africa, OECD, Paris,
             http://dx.doi.org/10.1787/9789264044708-en, accessed September 2011.
           OECD (2009), Agricultural Policies in Emerging Economies 2009: Monitoring And Evaluation, OECD, Paris.
           OECD (2010), “Ukraine Sector Competitiveness Review”, internal working document, OECD, Paris.
           OECD (2011), Agricultural Policies in OECD Countries and Emerging Economies, OECD, Paris, forthcoming.
           OECD/FAO (2009), OECD/FAO Agricultural Outlook 2009, OECD, Paris, http://dx.doi.org/10.1787/agr_outlook-
              2009-en, accessed 15 September 2011.
           OECD/FAO (2010), OECD/FAO Agricultural Outlook 2010-2019, OECD, Paris.
           OECD/FAO (2011), OECD/FAO Agricultural Outlook 2011-2020, OECD, Paris.
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              www.ukrstat.gov.ua, accessed 30 September 2011.
           Stiglitz, J.E. and S. Yusuf (eds.) (2001), Rethinking the East Asian Miracle, World Bank and Oxford
               University Press, Oxford and Washington, DC.
           UNCTAD (2009), World Investment Report: Transnational Corporations, Agricultural Production and
             Development, United Nations Publications, New York and Geneva.
           USDA (2008), Convergence in Global Food Demand and Delivery, USDA Economic Research Service,
              Washington, DC.
           USDA, (2009a), Global Food Markets: International Consumer and Retail Trends, USDA Economic Research
              Service, Washington, DC.
           USDA (2009b), Global Food Markets: Global Food Structure, Washington, DC.
           USDA (2010), Ukraine Exporter Guide, USDA, Washington, DC.
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           World Bank (2011), World Bank Development Indicators, http://data.worldbank.org, accessed 15 September 2011.




80                                                          COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012
Competitiveness and Private Sector Development: Ukraine 2011
Sector Competitiveness Strategy
© OECD 2012




                                                    Chapter 5




              Focus on the grain value chain


         This chapter provides an in-depth analysis of the grain value chain in Ukraine.
         Examining the demand and supply sides, it explains why the grain value chain is
         promising for private domestic and foreign investors given domestic and global
         trends. It identifies the role that foreign investors could play along the value chain,
         for instance in improving technology and supply-chain efficiency. It also presents
         key issues and policy barriers hindering competitiveness in the sector and proposes
         a prioritised list of policy recommendations.




                                                                                                   81
III.5.   FOCUS ON THE GRAIN VALUE CHAIN




Summary
                The grain sector includes wheat, rice and coarse grains (corn, barley, sorghum, oats,
           rye, millet and other grains). Wheat, barley and corn represent 60% of the total area used
           for crops in Ukraine. The focus of this project is wheat, barley and corn, since these three
           products are complementary: they can be used in crop rotation schemes, thus helping to
           maintain soil fertility. Grain is processed in various products, both for human and non-
           human consumption. Typically, the grain value chain is composed of four stages: growing,
           milling for first grinding, secondary processing for production of basic food products like
           pasta or biscuits, and tertiary processing for more refined products such as sugar and bio-
           fuel. Grain waste can also be used as a primary input for biomass-based energy production.
                Market trends for the grain sector are driven by an expected increase in global
           consumption. World wheat consumption is projected to rise by around 1.1% annually
           during the next decade to reach 746 million tons in 2020 (OECD/FAO, 2011). The growth of
           grain demand will come mainly from non-OECD countries, largely due to increasing GDP
           per capita, rising feed requirements for fast-growing livestock sectors, and dynamic
           population growth. The main importers will be middle-eastern, African, and South-Asian
           countries. Food-security concerns will also increase, due to a combination of steadily rising
           demand and doubts about the availability of supply.
              As a consequence, prices are expected to increase, making the grain sector potentially
           more attractive for investment, both domestic and foreign. On the supply side, Ukraine,
           Russia and Kazakhstan have emerged as strong competitors to the USA and the EU27 as
           exporters of grain. Ukraine is already amongst the top five exporters of grain, while
           Ukraine, Russia and Kazakhstan have the potential to become the global leaders in the
           export of grains by the end of the decade.
                Ukraine has significant strengths and untapped potential that could allow it to further
           consolidate its leadership role as a grain producer and exporter. Its production costs are
           estimated to be about 50% lower than those of European producers like Germany.
           Moreover, Ukraine’s geographic position guarantees low freight costs for exports to
           neighbouring Western Europe, and to growing importers such as middle-eastern and
           African countries. Finally, the potential for productivity increases and the availability of
           unused arable land could lead to an increase in Ukrainian grain output by as much as 80%.
                 Nevertheless, medium to low quality of grain and limited yields affect competitiveness.
           Low productivity is the result of limited use, especially by small and medium-sized farms, of
           high-quality inputs, and lack of investment in fixed assets, such as machinery and storage
           facilities. Difficulties in accessing finance are a main concern for small and medium-sized
           farmers, limiting their ability to invest in operational activities and in fixed assets. Several
           other policy barriers also hinder the competitiveness of the sector. The land sales
           moratorium has had an adverse impact on access to finance, since land is rarely owned and
           as a result cannot easily be used as collateral, and on foreign investments, since land cannot
           be purchased by foreign individuals or foreign companies. Trade policy is not consistent over


82                                                   COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012
                                                                                                 III.5.   FOCUS ON THE GRAIN VALUE CHAIN



         time, for example restrictions on exports were implemented during the global grain price
         rise in 2010, lifted in May 2011 and replaced by custom duties on grain exports in June 2011.
         The logistics infrastructure, including roads, rail, ports, and elevators is either obsolete or
         close to being fully utilised, and is thus a bottleneck for commodities trade.
                  To improve productivity and raise the quality of output, access to finance has been
         selected as the prioritised area of intervention, as it can empower the private sector. It
         must be enhanced by fostering the development of instruments like supply-chain
         financing, leasing, and insurance to cover against risk. Easier access to finance will
         probably require the completion of land reform, as a prerequisite for the full usage of land
         assets as collateral. The alignment of the supply of human capital skills with the needs of
         the sector is a second area for improvement. Technical skills, financial literacy and
         entrepreneurship must be better tailored to the requirements of Ukrainian farmers.
         Another area for improvement is the introduction of institutional services, such as credit
         information services, collateral registration, and market information services. Finally, the
         improvement of trade policies is increasingly perceived as an essential condition for
         improving the attractiveness of the grain sector to domestic and foreign investors.
                  The short- to medium-term strategy for the grain sector should be based on:
         ●   Raising the quality of grain output.
         ●   Improving productivity.
         ●   Facilitating high-quality exports both from a regulatory and from an infrastructural
             point of view.
         ●   Building and consolidating trade relationships with high-potential grain importing
             countries.
         ●   Attracting foreign investments into deep processing.

Sub-sector definition and segmentation
              Wheat and rice dominate the staple foods, while a significant share of maize
         production is for non-human consumption (Table 5.1). Corn and barley are complementary
         to wheat growing as they can be used in crop rotation schemes, thus helping to maintain
         fertility by growing in sequential seasons plants that draw different nutrients from the soil.


                           Table 5.1. World grain production and harvest area, 2009
                                                              Area harvested (ha)                         Production (tonnes)

          Maize                                                  159 531 007                                  817 110 509
          Rice                                                   161 420 743                                  678 688 289
          Wheat                                                  225 437 694                                  681 915 838
          Other                                                  162 105 324                                  311 587 032
          Total                                                  708 494 768                                2 489 301 668

         Source: FAOStat, FAO Statistical Database, http://faostat.fao.org, accessed 15 June 2010.



             Wheat can be used as an illustrative example to map the grain value chain. The wheat
         value chain is divided into four levels at which value is added. The four main stages are
         growing, first processing, second processing and third processing (Figure 5.1).
                  Stage one is milling, the process of grinding the wheat into flour.



COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012                                                             83
III.5.   FOCUS ON THE GRAIN VALUE CHAIN



                                     Figure 5.1. Example of the wheat value chain
                  Stage 0                     Stage I                        Stage II                    Stage III


                 Growing                   First processing              Second processing            Third processing



                             Grain                            Flour                      Gluten                          Bioethanol


                             Straw                                                       Starch


                                                                                         Pastas


                                                                                         Bread

           Source: OECD (2010), Ukraine Sector Competitiveness Review, internal working document, OECD, Paris. The growing stage
           covers the growing of wheat. Wheat can be grown on small-scale or large-scale corporate farms.


                Stage two refers to second processing, whereby raw materials are then processed into
           final products for the consumer (pasta, bread), as well as starch and gluten. The starch and
           gluten industry extracts starch and gluten from wheat and processes these into a number
           of products that can be used as ingredients and functional supplements in food or non-
           food applications.
                Stage three covers third processing and results in the production of sugar and bio-fuel.
           Ethanol production processes include grinding, cooking, liquefaction, fermentation and
           distillation. The starch-based mash goes into a liquefaction tank, where enzymes complete
           the conversion of starch into sugar. Using yeast, the sugars can then be converted to ethanol.

           Ukraine’s grain value chain is highly fragmented upstream
                Following independence in 1991, the animal husbandry sector suffered a decline,
           partly caused by the disappearance of farm subsidies. Diminishing herds freed up feed
           grains for export. But this surplus grain was exported only in limited amounts until the
           mid-1990s when state price controls and export restrictions, including export licenses and
           quotas, were reduced. Grain production has rebounded in recent years (Figure 5.2).
                Ukraine is a major producer of wheat and coarse grains (Figure 5.3) and it is among the
           world’s top exporters of both products (Figure 5.4). Wheat is the most cultivated type of
           grain in Ukraine, which produces 18-19 million tonnes of wheat per year (the average
           for 2006-07/2010-11 market years), and consumes around 11-12 million tonnes per year in
           the domestic market. The excess is exported to North Africa, the Middle East, the EU and
           Asia. In recent years, wheat exports varied from as little as 1.2 million tonnes in 2007-08 to
           the high of 13.0 million tonnes in 2008-09. Barley remains one of the main feed grains in
           the country and constitutes a sizeable portion of exports, most of which go to the Middle
           East, North Africa and Europe. Barley was the second-largest grain produced in Ukraine
           with more than 12.6 million tonnes (24% of total grains volume) harvested on an area of
           4.2 million hectares (27% of the total under grains). Corn is the third most important grain,
           and it is widely used for domestic consumption in the production of mixed fodder for
           poultry and pigs. It is exported as feed to the Middle East, Europe and North Africa.
                Households and individual private farms contributed around 22% of grain production
           in 2009, according to the State Statistics Committee of Ukraine (SSCU). In 1990, their



84                                                                COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012
                                                                                                                       III.5.     FOCUS ON THE GRAIN VALUE CHAIN



                           Figure 5.2. Ukraine’s grain production has rebounded in recent years
                                        Example of wheat production, thousands of metric tonnes (mt), 1992-2010
                30 000


                25 000


                20 000


                15 000


                10 000


                 5 000


                      0
                           1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010e

            Source: For the series 1992-2009, data published by OECD/FAO (2011), OECD/FAO Agricultural Outlook 2011-2020, OECD,
            Paris. The 2010 data point has been provided by the Ministry of Agrarian Policy of Ukraine.


                                     Figure 5.3. Ukraine’s production of wheat and coarse grains
                          Production of wheat (left) and coarse grains (right), average over 2005-09, thousands of tonnes
 160 000                                                                                    350 000

 140 000                                                                                    300 000

 120 000
                                                                                            250 000
 100 000
                                                                                            200 000
  80 000
                                                                                            150 000
  60 000
                                                                                            100 000
  40 000

  20 000                                                                                     50 000

      0                                                                                           0
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Source: OECD/FAO (2011), OECD/FAO Agricultural Outlook 2011-2020, OECD, Paris.


            production accounted for nearly 3% of the total. However, their role has declined when
            compared with the period 2005-06 when they accounted for around 25% of grain output.
            In 2009, agricultural enterprises accounted for almost 78% of grain production. Currently
            the maximum land plot size that can be owned by one person is limited to 100 ha.
            A breakdown shows that more than half of the total number of agricultural enterprises
            operating in the grain segment sow an area smaller than 50 ha; firms operating on an area
            bigger than 1 000 ha are less than 10% of the total number of enterprises. At the same time,
            a process of consolidation and vertical integration is underway in which larger farms lease
            arable land from private households for a given number of years. In 2008, the largest
            40 farms controlled 4.5 million ha or 13.6% of cultivated area (Lissitsa, 2010). The role and
            bargaining power of these large players along the value chain is significant.




COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012                                                                                                           85
III.5.   FOCUS ON THE GRAIN VALUE CHAIN



                       Figure 5.4. Ukraine is amongst the top exporters of wheat and coarse grains
                             Exports of wheat (left) and coarse grains (right), average over 2005-09, thousands of tonnes
  30 000                                                                           60 000


  25 000                                                                           50 000


  20 000                                                                           40 000


  15 000                                                                           30 000


  10 000                                                                           20 000


    5 000                                                                          10 000


         0                                                                               0
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Source: OECD/FAO (2011), OECD/FAO Agricultural Outlook 2011-2020, OECD, Paris.


Global trends
              Grain consumption will grow steadily, driven by emerging economies
                   Since 1980, wheat demand in non-OECD economies has grown from 50 million tonnes to
              125 million tonnes. In the longer term, world wheat imports are expected to sustain an upward
              trajectory as increasing amounts of wheat are required to meet demand for staple food
              products in countries with low but rising incomes and expanding populations (Figure 5.5).


                            Figure 5.5. Growth of world grain consumption is projected to be higher
                                                    in non-OECD countries
                  Wheat (left) and coarse grains (right) world consumption, past trends and projections, millions of tonnes

                                                                   OECD                            Non-OECD
                  600                                                              800


                  500                                                              700


                  400                                                              600


                  300                                                              500


                  200                                                              400


                  100                                                              300


                       0                                                           200
                             2000           2005   2010e   2015f      2020f                  2000           2005          2010e          2015f              2020f

              Source: OECD/FAO (2011), OECD/FAO Agricultural Outlook 2011-20, OECD, Paris.



                  Wheat imports by non-OECD countries are projected to increase by 2.1% per year to
              120 million tonnes in 2020, representing 83% of global wheat trade, while aggregate coarse


86                                                                        COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012
                                                                                                               III.5.   FOCUS ON THE GRAIN VALUE CHAIN



         grain imports by developing countries are projected to increase by 2.3% per year to
         102 million tonnes, representing 71% of the global total (OECD/FAO, 2011). African, Middle
         Eastern and East Asian countries will be the fastest-growing wheat importers in the next
         decade. With the growing consumption of meat, and the resulting growth of the livestock
         sector, and increasing use of grains for production of bio-fuels, imports of barley and corn are
         also expected to increase over the next decade. Middle-eastern, European and Asian
         countries are expected to significantly increase their imports of corn and barley (Figure 5.6).


                       Figure 5.6. Africa, Middle-East and East Asia will drive the additional
                                        grain imports over the coming decade
                       Wheat imports in 2010 and projected additional wheat imports in 2020 (thousand tonnes)
           Projected additional wheat imports in 2020 (th tonnes)
           7 000
                                                                                                                               Sub-Saharian Africa
           6 000

           5 000

           4 000

           3 000
                          Pakistan                                                                                            Egypt
           2 000
                                South                                                         Brazil
                                Africa      Saudi Arabia
           1 000       India                     Bangladesh
                                                         United States           Algeria
               0                                        Mexico
                       China                Iran Turkey         Korea             Japan
          –1 000           Malaysia                                                EU27
                                               Russia
          –2 000
                   0                       2 000                 4 000              6 000              8 000                 10 000            12 000
                                                                                                                   Imports of wheat, 2010 (th tonnes)



            Coarse grains imports in 2010 and projected additional coarse grains imports in 2020 (thousand tonnes)
           Projected additional coarse grain imports in 2020 (th tonnes)
           4 000
                                                                     Saudi Arabia

           3 000
                                                        Egypt

           2 000
                                             Iran
                                  China
                       Turkey
                                                                EU27
           1 000                 Chile    Sub-Saharan Africa
                        United
                        States           Malaysia                                           Mexico

               0                         Algeria
                                 Canada                                  Korea
                       Brazil
          –1 000
                                                                                                                                          Japan
         –2 000
                   0                                5 000                  10 000                      15 000                       20 000
                                                                                                         Imports of coarse grains, 2010 (th tonnes)

         Source: OECD/FAO (2011), OECD/FAO Agricultural Outlook 2011-20, OECD, Paris.



         Ukraine has become an important wheat exporter, although quality remains an issue
             The traditional five largest wheat-exporting nations (USA, EU, Australia, Argentina,
         and Canada) accounted for 77% of world trade in 2001-10, but Russia, Kazakhstan and
         Ukraine are expected to increase their wheat export share. These CIS countries have
         become significant wheat exporters in recent years with a combined world market share of


COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012                                                                                87
III.5.   FOCUS ON THE GRAIN VALUE CHAIN



           about 18%. Over the last decade, wheat yields rose by 32% in Russia and 25 per cent in
           Kazakhstan, compared with average yields in the nineties, while Ukrainian yields also rose
           slightly (USDA, 2010). In these three countries export growth has been driven by improved
           production, generated by the rise of large, vertically-integrated farming operations actively
           pursuing better agronomic and management practices (OECD/FAO, 2011).
                By 2020, CIS countries could account for around 30% of world wheat exports. Although
           low-quality food wheat is a feature of CIS production, importers have compensated by
           using food additives that enable bread to be baked from low-quality grain (OECD/FAO,
           2011). However, wheat quality is an important differentiating factor when determining
           price on the global market. Protein content and other quality factors determine the type of
           wheat and its respective end-use by millers and bakers. In an increasingly competitive
           world market, the OECD experience shows that diversifying production into high-quality
           grain exports has proved to be important in maintaining a competitive advantage (Box 5.1).



                  Box 5.1. Diversifying into high-quality grain: Australia’s best practice
                Australia is an important producer and exporter of grain: over 2005-10, it accounted for
              an average of 10.4% of global wheat exports. Rather than processing domestically, the
              country has diversified its strategy and specialised in exports of high quality grain; grains
              are sorted by quality and tailored towards the requirements of specific markets and final
              products which require different protein levels. Unprocessed exports account for
              20.3 million tonnes out of a total of 31.3 million tonnes of domestic production, with only
              3.8 million tonnes being processed domestically into food or higher value products. The
              remaining domestic consumption is used for seed or animal feed purposes.
                The Australian government has implemented a number of policy initiatives aimed at
              ensuring competition within the domestic supply chain and ultimately a high quality end
              product. Prior to the 1990’s, the major roles of grain marketing, storage and handling
              facilitation and rail transport were controlled by state-owned enterprises. Now, however,
              the majority of facilities are owned and operated by three private companies; CBH Group,
              ABB and Graincorp, which operate as natural monopolies in their respective ports. This
              deregulation culminated in the opening up of the wheat marketing function, previously
              controlled by the Australian Wheat Board which operated as a monopsony buyer from the
              three key bulk handling and storage companies and was the only legal seller of Australian
              wheat on the international market.
                The country has built an international reputation for clean, low moisture grain that
              produces high quality flour. The government supports this reputation through state-
              sponsored research and training facilities, providing best practices in grain production and
              farm management. Breeding programmes aim to increase resistance to environmental
              stresses such as salinity and aluminium toxicity. Australian grains are segregated based on
              protein content and quality, grain hardness and starch quality; this differentiation allows grain
              to be targeted to specific market demands and price discrimination to be implemented.




           Prices in real terms are expected to be relatively high, turning food security 
           into a major concern
               The relative high price of grains in the coming decade should make this sector even
           more attractive for investment and possibly lead to an increase in foreign investment.
           By 2020, nominal wheat prices are expected to approach USD 240 per tonne, a price above


88                                                      COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012
                                                                                    III.5.   FOCUS ON THE GRAIN VALUE CHAIN



         the historical average. In real terms, prices are expected to decline slightly, although they
         will remain at higher levels than in the past decade. While increasing in nominal terms,
         corn prices might reach USD 203/t in 2020, which would be much higher than the historical
         average; however in real terms, they are still heading for a decline (OECD/FAO, 2011).
                The growing concern about world food security and whether supply can keep pace with
         demand is an important development. In particular, the food crisis of 2007-08, with its
         dramatic spikes in global food prices, focussed attention on the need to address the issue of
         whether the current global food production system will be able to meet this challenge. At the
         national level, some countries have taken measures to address food security concerns,
         including through efforts to increase investment and productivity in agriculture, restrictions
         on exports or, in the case of food-importing countries, investments in overseas farming.

Sources of competitiveness
         Favourable natural endowment has driven a long tradition in grain production
              In 2009, Ukraine harvested 27 million hectares of crops. According to the Ministry of
         Agrarian Policy and Food of Ukraine, wheat, corn and barley accounted for nearly 52% of
         crop area. Favourable endowments such as the black soil and the abundant water supply
         are partially offset by climate variability, which has caused volatility in output (Box 5.2). As
         over 95% of wheat grown in the country is winter wheat, which is planted in the autumn


                  Box 5.2. Ukraine has favourable climatic conditions for grain growing
            Land
                Land quality is particularly well-suited to crop growth:
            ●   54% of Ukraine’s land area is covered with a 40-50 cm thick humus layer, which creates
                the extra-fertile “black soil” or Chornozem land.
            ●   80% of Ukraine is covered with a thick (5 m) layer of mineral-rich loess sediments that
                greatly improve the soil’s ability to grow crops.
            ●   Topographically, the country is mainly flat with 95% of land consisting of plains (60%
                sloped less than 1 degree, 95% sloped less than 3 degrees).

            Climate
              Climate allows for diverse crops. Ukraine comprises three distinct climatic zones, which
            allows producers to vary crop growth across the country.
            ●   The western regions are best-suited to crops that demand high humidity, specifically
                vegetables and spring grains. It is marked by mild temperatures (–3 to –6 degrees Celsius in
                January and below 18 degrees Celsius in July) and a high precipitation rate (over 600 mm of
                rainfall per year). The precipitation does, however, introduce the risk of sowing and
                harvesting delays.
            ●   The conditions in the central and north-eastern regions are favourable for all kinds of
                grains. The region has a more continental climate (warmer summers, colder winters), with
                lower precipitation than the west. Colder winter temperatures and a lack of snow increase
                the risk of winterkill, while lower rainfall simplifies harvesting and sowing procedures.
            ●   The southern regions are best-suited to winter crops, as the area is Ukraine’s warmest
                overall (average January temperature above –3 degrees Celsius). Summers, however, can
                get hot enough to introduce the risk of droughts.
            Source: BG Capital (2010), “Ukrainian Agriculture: Farming Fortune”, February 2010, BG Capital, Kyiv
            http://sintalagriculture.com/uploads/files/BG.pdf, accessed 15 March 2010.



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III.5.    FOCUS ON THE GRAIN VALUE CHAIN



              and harvested in the summer of the following year, winterkill is a serious threat and during
              the last decade ranged from 2 to 65% of the total planted territory.

              Cost-competitiveness
                   Ukraine’s average cost of production per tonne of grain is lower than its competitors.
              Low production costs on average result from low usage of inputs, low labour costs and a
              lack of proper accounting for depreciation of equipment. At the same time, yields are still
              relatively high thanks to the high quality soil (Figure 5.7).


           Figure 5.7. Grain production costs are competitive, while yield still offers opportunity
                                     to improve efficiency of production
                                                           Wheat example, production costs and yields, 2008
                    Average cost of wheat production per hectare, US dollars, 2008
200


000
                                                                                                                      Average cost of wheat production per ton, US dollars, 2008

800                                                                                                200

                                                                                                   180
600                                                                                                160

                                                                                                   140
400
                                                                                                   120

200                                                                                                100

                                                                                                    80
   0                                                                                                60




                                                                                               =
          United       Brazil      Romania    Australia    Russia       Canada       Ukraine
         Kingdom                                                                                    40

                                                   X                                                20
                                      Wheat yield, tons/ha, 2008                                     0
   9                                                                                                      Canada      Australia       Brazil      United       Romania       Russia         Ukraine
                                                                                                                                                 Kingdom
   8
                                                                                                         Conclusion
   7
                                                                                                         • Ukraine is competitive because Ukrainian farmers are producing grain
   6                                                                                                     at a relatively low cost
   5                                                                                                     • Relatively low yield in Ukraine still offers opportunity to improve efficiency
                                                                                                         of production, through better farm organization, mechanization, use of inputs
   4                                                                                                     (chemicals)

   3

   2

   1

   0
           United        Romania        Russia        Ukraine       Australia        Canada
          Kingdom

Source: Bidwells Agribusiness Bidwells website, www.bidwells.co.uk/agribusiness, accessed 15 May 2010; OECD/FAO (2009), OECD-FAO
Agricultural Outlook 2009-18, OECD, Paris.


                   On the distribution side, Ukraine has a dense railway network that covers all the
              regions, providing transportation of crops across the country and to sea ports. Railway
              freight costs are rather low in Ukraine, since railway transport tariffs are still state-
              controlled. Ukraine’s shorter distances and more developed transportation infrastructure
              provide significant cost advantages compared with its closest competitors and neighbours,
              especially Russia and Kazakhstan. Proximity to high potential grain importing countries
              further provides a transportation cost advantage to the Middle East, North Africa and the
              European Union (Table 5.2).




90                                                                                       COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012
                                                                                                                  III.5.   FOCUS ON THE GRAIN VALUE CHAIN



                        Table 5.2. Black Sea ports have a cost advantage for grain exports
                                           to middle-eastern countries
                                  Freight cost comparison for grain, 31 December 2008, USD per tonne

                                    Origin
                                               Argentina      Australia            Canada         US PNW         US Gulf         EU          Black Sea
          Destination
          Egypt – Alexandria                      28               28                20             29             22            18              10
          Morocco                                 20                                 17                            17            13              13
          Tunisia                                 23                                 22                            23            16              12
          Spain – Mediterranean                   21                                 17             29             19            13              13
          Pakistan                                                 15                26                            28                            14

         Source: International Grain Council (2009), Internal working document, unpublished.


         Grain production could increase significantly over the coming years
         Yields can be improved significantly
              Current production relies mainly on natural land fertility, leaving significant scope for
         improved agricultural productivity. Low yields are closely correlated with the low use of
         fertilisers and plant protection products. For instance, Ukraine currently applies only one-
         third of the fertiliser volume today that it used during the peak of agricultural productivity
         20 years ago (Figure 5.8).


                        Figure 5.8. Ukraine could apply more fertiliser to increase yields
                                              2007 wheat yields vs. fertiliser use in selected countries
          Wheat yield kg/ha
             9
                                                                                                                                           Ireland
               8
                                                           Germany
               7                                                                 United Kingdom
                           Sweden
               6

               5                  Austria
               4                                                        Poland               Slovenia

               3
                        Ukraine
               2

               1

               0
                    0                 100                    200                       300                 400                  500                    600
                                                                                                                             Mineral fertilizer use, kg/ha

         Source: BG Capital (2010), “Ukrainian Agriculture: Farming Fortune”, BG Capital, Kyiv, February 2010,
         http://sintalagriculture.com/uploads/files/BG.pdf, accessed 15 March 2010.



              In the last years of the Soviet Union, Ukraine exported around 16 million tonnes of
         wheat to the Union’s other republics. In contrast, the average export volume for the first
         half of the last decade was around 3 million tonnes, although exports increased in the
         second half to an average of 6.5 million tonnes. Assuming that wheat croplands remain at
         7 million ha and reach historical high yields of 4 tonnes per ha, production would total
         27-30 million tonnes with export potential of 15-18 million tonnes per year.
             For barley, Ukraine is already among the world’s largest exporters, ranking first in
         three of the last four seasons. If crop yields increase to 4 tonnes per ha, Ukraine would
         strengthen its leadership with export potential of 10-12 million tonnes per year. Corn also


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III.5.   FOCUS ON THE GRAIN VALUE CHAIN



           has the potential to double at least, which could make Ukraine one of the most significant
           exporters after the US, competing with Argentina and Brazil.

           Some arable land suitable for grain growing is still unused
                Between 5 and 7% of arable land could be returned to agricultural production,
           according to private sector estimates. Total sown area fell from 32.0 to 25.9 million hectares
           between 1991 and 2006, which represents a drop of 6.1 million hectares or nearly 20%. The
           decline can be attributed almost exclusively to a reduction in forage-crop area coincident
           with a sharp slide in livestock inventories. Total sown area has slowly but steadily
           increased again since then. However a number of factors could prevent some of this land
           from being returned to agricultural production in the near future, including: arable land
           intentionally left unplanted to replenish subsurface reserves; formerly drained land that
           has become unsuitable for cultivation; and the existence of unreported sown areas, used
           for household vegetable production and consumption.

The role of foreign investors in the grain value chain
           Lease or acquisition of farmland
               Investing in Ukrainian farmland over the long-term could be profitable. Moreover
           farmland investors might also be encouraged by the inflation hedge that farmland
           provides, as land prices are still low, and the stable profile of investment returns.
               According to the FAO, FDI could contribute to greater food security over the coming
           decades, thanks to increased productivity, technological improvement, infrastructure
           development and increases in supply-chain efficiency. The FAO estimates that additional
           investments of USD 83 billion per year are needed if developing countries’ agricultural
           sectors are to meet the food needs of 2050 (Hallam, 2009).

           Grain marketing infrastructure
                To be aligned with the likely grain production increase, industry experts forecast that
           Ukraine might need to add additional storage capacity. Although domestic consumption of
           grain is expected to stabilise or even decrease in the short-term due to the population
           decline, export infrastructure will become of critical importance. This scenario may be
           affected by a rise in the consumption of grain to feed livestock and cattle, if the dairy and
           meat industries also grow during the forecast period. However, the development of these
           industries will take some time to offset the effect of the population’s decline on the
           domestic demand for grain.
               Grain exports could become a key driver of infrastructure development and foreign
           investors have a role to play. Grain export activity is dominated by approximately ten
           companies, half of which are large, international agricultural commodity traders (Table 5.3).

           Deep processing of grain
               As the grain industry grows and develops, Ukraine could consider moving into the
           deep processing of grain. For example, the adoption of advanced cracking technologies to
           extract gluten and starch (separation process) could be developed in the food and non-food
           industries. Products might include food ingredients providing texture, flavour, and
           preservatives to the final food product (e.g. glucose, dextrose, isoglucose), along with non-
           food products such as starch for the textile and pharmaceutical industries.


92                                                  COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012
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                                 Table 5.3. Foreign companies are sizeable grain exports
                                  Top 10 exporting companies of wheat and barley, 2010-11 (9 months)

                                                                                 Export volumes                     Share of exports
          Name of the company                 Residence
                                                                              (thousands of tonnes)                       (%)

          Nibulon                             Domestic                                772.0                               25.3
          Suntrade/Bunge                      International                           306.4                               10.1
          Kernel                              Domestic                                249.5                                8.2
          UAC                                 Domestic                                181.4                                6.0
          Cargill                             International                           140.3                                4.6
          Sema/Glencore                       International                           137.0                                4.5
          Louis Dreyfus                       International                           126.4                                4.1
          Alfred C. Toepfer/ADM               International                            87.3                                2.9
          Vitalmar Agro/Nidera                International                            60.0                                2.0
          Agro trade                          Domestic                                 32.6                                1.1
          Total                                                                     2 092.9                               68.8

         Source: Investment Capital Ukraine (2010), “Sector Primer Agriculture”, Investment Capital Ukraine, Kyiv.

             Large multinational firms can raise the funds and provide the technologies needed to
         establish such facilities. Deep processing of grain to produce starches and gluten is a
         capital- and technology-intensive process. Achieving a high extraction rate of proteins and
         vitamins from the wheat grain and a more complete processing of all parts of the kernel
         requires increasingly sophisticated production technology. Research and development
         (R&D) efforts and large initial investments in complex and technologically-advanced
         equipment would be required to build the necessary deep processing capacity.
              To attract foreign investments in deep processing of grain, Ukraine has two main
         advantages. On the one hand, it has access to low-cost grain supplies, since the
         procurement of raw materials is the main component of the cost of production. In addition,
         domestic demand for starch and gluten is significant. For instance, Ukraine imports
         around 80% of its domestic consumption of gluten and is a major importer of starch and
         gluten worldwide (Figure 5.9).

                    Figure 5.9. Major importers of starch and gluten, millions of USD, 2007
           700

           600

           500

           400

           300

           200

           100

              0
                       Mexico     Indonesia       Malaysia    Brazil   Viet Nam    Philippines        India      United Arab     Ukraine
                                                                                                                  Emirates
         Source: United Nations Commodity Trade Statistics Database (2007), 2007 International Trade Statistics Yearbook, United
         Nations Statistics Division, New York.




COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012                                                                   93
III.5.   FOCUS ON THE GRAIN VALUE CHAIN



Key issues and policy barriers
           Lack of access to finance results in low input use and insufficient capital investment
                Ukrainian farmers face problems in accessing finance. Among 85 farms surveyed, 58%
           indicated that they did not have sufficient access to credit (Figure 5.10). The key problems
           with access to finance are high interest rates (cited by 76% of surveyed farms) and the
           absence of appropriate collateral (mentioned by 32% of respondents). Commercial interest
           rates typically range from 25 to 30% and banks usually expect 200 to 300% collateral,
           depending on the farm’s credit history and the perceived risk level.


                   Figure 5.10. Percentage of farmers having difficulty in obtaining credit
                                Short and long-term credit       Only short-term credit        Only long-term credit
              %
             100

              90

              80                                                                          41
              70

              60

              50

              40                                                       37

              30

              20

              10                                       22

               0
           Source: OECD (2011), Country Capability Survey, internal working document, OECD, Paris.



                Limited access to financial resources hampers both the use of inputs and the increase
           in land productivity. For example, the amount of fertilisers used per ha of agricultural land
           in 2008 was 26 kg, compared with the European Union’s average of 83 kg. The price of
           fertilisers and pesticides is a major concern for farmers, particularly since they cannot use
           the land as collateral for borrowing. The land is not willingly accepted by banks as
           collateral since it is difficult to foreclose on land in case of default. The burdensome and
           ineffective legislative framework, which does not necessarily protect creditors’ interests,
           makes financial institutions even more cautious about lending, with detrimental effects on
           small and medium-sized farmers. The lack of adequate collateral or credit history is a
           significant constraint on small farmers’ access to credit from commercial financial
           institutions. Moreover, the global financial crisis has affected the balance sheets of local
           banks, which are still burdened with non-performing assets and are unable to focus on
           new lending. The Ukrainian government has therefore intervened to provide assistance to
           the agricultural sector during the crisis, supporting for example, interest rate
           reimbursement on loans and leasing schemes.
                The difficulty of obtaining long-term loans prevents farmers from investing in fixed
           assets such as harvesting or transportation equipment, new storage facilities and processing
           units. The lack of highly efficient modern agricultural machinery, especially harvesting
           equipment, remains one of the key impediments to improving grain yields (Figure 5.11). Lack
           of financing also means that farmers don’t have sufficient on-farm storage capacity. As a
           result, they are forced to sell shortly after harvesting when prices are the lowest. Large farms
           avoid many of these problems, as they have better access to finance.

94                                                            COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012
                                                                                               III.5.   FOCUS ON THE GRAIN VALUE CHAIN



                   Figure 5.11. Limited access to long-term loans results in very low use
                                         of agricultural machinery
                                   2008 tractor use in selected countries, tractors/thousands of ha
           300


           250


           200


           150


           100


            50


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         Source: FAOStat (2011), FAO Statistical Databases, http://faostat.fao.org, accessed 15 September 2011.


         Non-completion of land reform and moratorium on land transactions
              The process of land reform started in 1990 when private farms were allowed. The pace
         of reform was rather slow and there are still significant changes to be made in order to
         make Ukraine’s agricultural sector more competitive on a global scale. Around 72% of
         Ukraine’s arable land was privatised during the land reform, while the remainder is owned
         by the state. Private owners received their land following the restructuring of state and
         collective farms after the collapse of the Soviet Union. Trading of agricultural land is
         currently restricted by a moratorium included in the Land Code, although non-agricultural
         land can be sold.
             Ukrainian agricultural firms adapted themselves to this context by forming their own
         land banks. They purchased small firms that had consolidated land by signing lease
         contracts with individual small landowners. The average length of a lease contract is
         7 years, while every 10 000 ha of bundled leases consists of approximately 2 000 individual
         contracts. Agricultural producers are unable to purchase the land that they lease. The
         moratorium probably benefits companies that are already present in Ukraine, since it
         restrains potential domestic and foreign investors.

         Quality standards are still an important issue
              The quality standards for grain products are currently not aligned with those of other
         markets, impeding the full exploitation of the grain sector’s growth potential on an
         international scale. The lack of equipment combined with limited use of fertilisers make the
         seeds more sensitive to weather conditions and parasitic diseases. Controls are inefficient
         and compliance procedures are often arbitrary as they are not applied in a transparent way.
         Responsibility for food control is fragmented across several ministries, with a multiplication
         of competencies and a lack of co-ordination. Private players bear most of the costs of
         compliance in performing the necessary tests and laboratory procedures.
                 The legislative framework does not enforce strict controls over product safety and quality
         and has not been particularly helpful in promoting convergence with trading partners’

COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012                                                           95
III.5.   FOCUS ON THE GRAIN VALUE CHAIN




                  Box 5.3. Challenges faced by the current system of warehouse receipts
                                                 for grain
                The introduction in 2002 of a system of warehouse receipts for grain was in part aimed
              at improving access to private credit resources by allowing grain producers to use grain as
              collateral for loans, or to sell, trade or use the receipts for delivery against financial
              instruments such as futures contracts. However, the system still faces a number of
              challenges that continue to limit farmers’ access to credit by undermining the trust of the
              financial institutions in the system, including:

              Lack of coherence in the legal framework
                Different laws give contradicting rules with regard to the rights, liabilities and
              responsibilities of each party to the single and double warehouse receipt (producer,
              warehouse, bank, etc.).

              Inadequate monitoring system
                Although private and independent mechanisms for verifying the quality and quantity of
              stored commodities exist, these mechanisms are costly for grain owners. In addition,
              verifying agents often have limited access to the state-owned storage facilities.

              No reliable performance guarantees
                Holders of warehouse receipts do not receive adequate compensation if the stored goods
              do not match in quantity or quality with what is specified on the receipt (due to either
              negligence or fraud).

              Ineffective futures exchange market
                Agricultural market operators cannot hedge effectively against price fluctuations using
              futures contracts due to the absence of a well-developed futures exchange. Although the
              government established an Agricultural Exchange, the latter cannot be considered an
              exchange in the traditional sense of the word. Rather, it constitutes a focal point for
              registering the Agrarian Fund’s contracts. The Agricultural Exchange’s activities are thus
              largely determined by the Agrarian Fund. Under these conditions, the exchange fails to
              attract private investors by limiting the liquidity of exchange contracts.
              Source: FAO/EBRD (2010), “Ukraine: Grain Sector Review and Public Private Policy Dialogue”, Report Series,
              No. 15, December 2010.




           standards, despite the incentives provided by accession to the WTO and the possibility of a free
           trade agreement with the EU. For instance, in 2008, the government approved the Plan of
           Priority Measures to meet Ukraine’s commitment within the WTO membership framework,
           which specifies tasks for ministries and agencies. However, there has not been any significant
           progress on a new legislative framework for quality standards and controls.

           Transportation and storage infrastructures are still a bottleneck and increase costs
                The competitiveness of Ukraine’s grain sector to a certain extent depends on the
           available storage and transportation infrastructure. In spite of significant improvements,
           the grain sector is still characterised by high post-harvest losses and high transaction
           costs. This results in low farm-gate prices and discourages further investment in
           agribusiness. Large farms that do not own elevators run the risk of losing crop quality or
           being compelled to sell their harvest at unfavourable prices. Improved infrastructure could
           reduce transportation and marketing costs, increase competition and attract further
           investment into agribusiness.


96                                                          COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012
                                                                                            III.5.   FOCUS ON THE GRAIN VALUE CHAIN



               Exports of grains to global markets are hampered by the logistics and transport
         infrastructure, including roads, railways, storage and drying and port capacities. Roads in
         Ukraine do not have spare capacity to handle increased truck traffic. Transportation by rail
         is limited by the lack of specialised rolling stock. Ukraine’s storage capacity (approximately
         30 million tonnes) is more or less sufficient to meet normal demand, but problems might
         arise in peak years. In the medium term, the capacity of Ukraine’s ports could limit the
         growth of exports of agricultural products (Figure 5.12).


                    Figure 5.12. Cargo handling volume is near to maximum capacity
                                           of Ukrainian ports
                                           Capacity                                 Cargo handling volume
           35

                     30
           30
                           28

           25

           20
                                           16   15.8
                                                                15    14.8
           15

           10
                                                                                      6.5   6.4
            5
                                                                                                            2.5      2.2
            0
                      Odessa               Mariupol              Ilychevsk             Nikolaev                Berdjansk
         Source: OECD (2010), Ukraine Sector Competitiveness Review, internal working document, OECD, Paris.



             Ukrainian ports continue to receive public and private investment and can currently
         handle around 24-26 million tonnes of grain exports per year, which is sufficient to
         accommodate Ukrainian, Russian and Kazakh grain exports. However this leaves little
         scope to meet higher demand, especially at peak times in the summer.

         State regulation of grain trade flows is detrimental to private investment
              Public interventions, such as grain export quotas, increase uncertainty in the market.
         For instance, rising food prices coupled with a poor harvest resulted in the imposition of
         export quotas by the government in 2006. The quotas for wheat, barley, maize and rye
         exports remained in force until 2008. As a result, grain exports dropped from 13.2 million
         tonnes in the 2005-06 marketing year to 3.7 million tonnes in 2007-08. The quotas policy
         implemented in 2010-11 resulted in lower revenues in the grain sector, but its impact on food
         price rises is uncertain (OECD, 2009). Activity on the domestic market was limited, and the
         execution of export contracts that had already been negotiated and signed was impeded.
         Processors encountered difficulties in purchasing inputs at prices that allowed them to make
         their products (flour, bread) and sell them at government-controlled prices (Box 5.4).
              Ukrainian farmers suffered considerable losses as a result of the increase in the spread
         between export prices and ex-warehouse prices for grain following the introduction of the
         quotas. In 2010-11, losses to Ukrainian agriculture were estimated by the private sector at
         over USD 1 billion. The negative impact on investment and liquidity in the agricultural
         sector still needs to be precisely estimated. Grain producers usually react to decreasing
         profitability by reducing investment. The restrictions may also be discouraging foreign

COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012                                                        97
III.5.   FOCUS ON THE GRAIN VALUE CHAIN




                                   Box 5.4. The 2010-11 grain export restrictions
                Grain export restrictions were implemented in Ukraine in the second half of 2010. The
              restrictions started with burdensome State Customs measures applied in ports of loading
              mainly for wheat exports in August-September 2010. Subsequently, official export quotas
              came into force on 19 October 2010 and remained in place until 30 June 2011.
                In late July 2010, additional grain testing was required by the State Customs Service at
              points of export. The official government objective for such measures was the accuracy and
              compliance with contract terms of each corresponding shipment, and the prevention of
              unregistered or grey market deals at a time when there were concerns over possible food
              grain shortages. This resulted in delays of cargo for up to 8 weeks. The restrictions applied
              mainly to wheat shipments, but other grains were also tested and delayed from time to time.
                 On 18 October 2010, the Cabinet of Ministers of Ukraine signed Resolution #938 effective
              immediately setting export quotas for wheat, barley, corn, buckwheat and rye. Export
              license applications required certification of grain quantities that the applicant had at its
              disposal; these were issued by the Ministry of Agrarian Policy and Food. Lack of clarity and
              non-transparency characterised the process of quota distribution.
                In December 2010, the Cabinet of Ministers of Ukraine signed Resolution #1 182 changing
              the original export quota legislation. The new regulation extended the duration of the grain
              export quota regime until the end of March 2011 and increased the quantities of grain
              allowed. Similar to the previous round of quota distribution, market players reported unfair
              treatment and lack of transparency in the procedures. A majority of the grain export quota
              was awarded to Khlib Investbud, a trading division of a larger state-run enterprise, the State
              Food and Grain Corporation of Ukraine. As in the previous distribution, international and
              domestic grain trade representatives received either small shares or no share at all.
                On 2 April 2011, the Cabinet of Ministers of Ukraine signed Resolution #337 again extending
              the duration of grain export quotas until the end June 2011. This legislation increased the
              quantity of corn exports and left quantities of other grains unchanged. The grain export
              restrictions were lifted in May 2011 and replaced by custom duties on exports in June 2011.
                There appears to be an intention to maintain the role of Khlib Investbud, with government
              quotas or without them. On 16 March 2011, it was announced that Khlib Investbud had
              started a forward contracts campaign for the 2011 crop and intended to purchase
              786 000 metric tonnes (mt) of wheat, 99 000 mt of rye, and 10 000 mt of buckwheat. Khlib
              Investbud was contracted by the Agrarian Fund to conduct state purchases of grains for the
              State Intervention Fund. According to the top management of Khlib Investbud, the
              company was signing forward contracts with Ukrainian farmers with the disbursement of
              payment as follows: 50% of contract value paid on signing; 20% paid just before the
              harvest; and the remaining 30% paid after the harvest.
                This scheme was aimed at providing farmers with the financing they need for the spring
              planting campaign. The Government of Ukraine put the Agrarian Fund (AF) in charge of
              providing agricultural producers with inputs (mostly fertilisers and fuel) at discounted
              prices. AF would provide a 10-15% discount on ammonium nitrate fertiliser and about 6.7%
              on fuel. These inputs were to be supplied by Ukraine’s largest fertiliser and fuel producers.
              Source: USDA (2011), “Ukraine: Grain and Feed Annual”, USDA Foreign Agricultural Service, Washington, DC,
              April 2011.



           investors, with some threatening to reconsider Ukrainian projects. The EBRD has also
           warned that the risks related to investing in Ukraine are increasing. In addition, the IMF
           required an improvement in grain market conditions and greater market transparency as


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         a condition for the release of the next tranche of IMF funds. Moreover, the recent grain
         trade restrictions could lead to WTO challenges.

         Support measures distort production and trade
              Producer support, measured using the Producer Support Estimate (PSE), was 7% in the
         period 2008-10, compared with 10% in 2005-07 (OECD, 2009; OECD, 2011).1 The share of this
         categorised as “most distorting” was 84% of the total in 2008-10. Payments based on
         commodity output (market price support, payments based on output) and payments based
         on input use (based on variable input use) accounted for around 70% of Ukraine’s PSE
         in 2010. Other market price support measures are also used, such as tariff protection, non-
         tariff regulation, direct state purchases and sales of agricultural and food products.
             Frequent changes in policies have an adverse effect on agricultural performance. For
         example, the list of commodities covered by state price regulations is updated frequently
         (EBRD/FAO, 2010), with a resulting lack of clarity and coherence ultimately affecting producers.
         Secondly, rules are not always transparent and unified, giving room for misunderstandings
         and contributing to an ineffective application of the interventions. The high involvement of the
         administration puts an additional burden on the activity of private companies.
              Another measure which has caused important distortions is the cancellation of VAT
         refunds for exporters, hurting the profitability of exporting companies and in particular
         that of small and medium-sized enterprises, which are unable to hedge themselves against
         these sudden changes in regulations. Even for companies that are still entitled to receive a
         VAT refund, the reimbursement procedures are burdensome and lengthy. There is a high
         level of arbitration and ineffective application of the measures, which is ultimately
         beneficial to a few oligopolistic players while interfering with the development of a
         competitive private sector.

Policy recommendations
         Improving access to finance
              Broadening access to finance could be achieved by various means. One option would be
         the more widespread use of credit guarantee schemes, with a guarantee agency standing
         ready to reimburse lenders if the borrower fails to repay a loan, therefore assuming part of
         the risk of lending to famers.2 The sponsors could be international financial institutions,
         private investors or public agencies. In the case of bankruptcy, the sponsor would repay the
         amount of the loan covered by the guarantee, usually between 50 and 80%. Credit guarantee
         funds have become a fairly common practice in OECD countries, with Japan establishing its
         fund in 1931, followed by the Netherlands and Germany in 1951 and 1954, respectively. Since
         the 1990s, transition economies have started developing these instruments, with some
         success stories such as in the case of the Czech Republic. However, credit guarantee funds
         are not significantly developed in Ukraine yet. The OECD experience proves that this
         mechanism could support access to finance, especially for creditworthy SMEs.
            Another option could be the development of co-operative banks, which could channel
         community deposits to farmers in a more efficient way. Co-operatives could share
         equipment costs and pool assets to support organised services for their members. The Law
         “On Banks and Banking” of 2000 introduced the co-operative legal form in Ukraine. In 2002,
         the Law “On Credit Unions” established credit unions. Nevertheless, co-operative banks
         have not developed to a significant extent and those that do exist suffered during the


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III.5.   FOCUS ON THE GRAIN VALUE CHAIN



           financial crisis. In addition, the costs of establishment remain significant and there is a
           lack of structure at a national level. As a result, these institutions are much less common
           than in many other countries with strong agricultural sectors.
              Access to agricultural equipment and working capital could be improved through the
           support of leasing services. During the financial crisis the government allocated
           UAH 120 million to a leasing programme meant to support the purchasing of “domestically
           produced machinery and equipment for the agro industrial complex”.3 However, without detailed
           data, it is too early to assess the success and impact of this scheme. Agricultural machinery
           accounted for 13.2% of the total value of leasing contracts signed in the first quarter of 2011, for
           a value of UAH 168 billion, according to the Ukrainian Union of Lessors. Given the demand to
           replenish ageing agricultural and processing equipment, leasing clearly has considerable
           potential to provide farmers with reasonably priced and modern equipment. The Draft Law on
           State Budget for 2012 plans to further increase the leasing programme for farmers.
               Supply chain financing and receivables financing could be used to let other value-
           chain players fund working capital requirements or use account receivables as collateral
           for lending. Warehouse receipt programmes have been adopted since the late 1990s in
           Bulgaria and Kazakhstan and since 2002 in Ukraine, with the support of the EBRD and
           USAID. This mechanism allows farmers to store some of their harvest in a licensed
           warehouse and use it as collateral.
               The agricultural insurance market is still underdeveloped in Ukraine, as the sector is
           considered highly risky due to high exposure to weather variations and price volatility.
           Only 3.4% of cultivated area was covered by insurance contracts in 2007, according to the
           SSCU. Agricultural insurance could be pivotal to the modernisation of the grain sector,
           providing access to credit and encouraging best farming practices (IFC, 2010).
                The creation of a commodity futures market would enable commercial producers and
           consumers to offset the risk of adverse future price movements in the commodities they are
           trading. From a farmer’s perspective, the risk of price variation for both inputs (e.g. fertiliser)
           and outputs (e.g. grain) could be neutralised. An example of the multiple benefits associated
           with a futures market can be seen through the establishment in 2003 of the Indian Multi
           Commodity Exchange. This has grown to be the world’s sixth-largest commodities exchange:
           it enables participants along the agricultural supply chain to optimise their risk exposure. It
           reduces transaction costs to farmers who would otherwise have to trade through middle-
           men, improving price information through collation of national spot prices on an electronic
           database. A commodity futures market could also help to raise quality standards at the farm
           level by specifying standards as part of contracts.

           Completing the land reform
                Completion of the land reform could help to improve competitiveness and increase
           awareness of local opportunities among foreign investors. This would require further
           reforms, such as the unification and digitalisation of the cadastre system, and the end of
           the moratorium on land sales. According to the World Bank (2011), 95.8% of land owners
           have received state deeds proving their rights. However, there is no operational land
           cadastre yet, although it has been in development since 2004. A reliable cadastre system
           would constitute a guarantee underpinning real estate transactions and provide a reliable
           basis for negotiating long-term credit (Kozlowski, 1997). Its establishment could help to
           attract FDI, develop the real estate and land markets, improve access to finance for



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         businesses and improve the protection of ownership rights. It will also allow efficient
         farmers to expand and poor farmers to exit the market.
               The land administration system needs to be reorganised with appropriate institutions,
         avoiding the current overlapping of responsibilities. From a private business perspective,
         rules are a prerequisite but their predictability in the medium term is even more important
         to ensure visibility.

         Removing restrictions to grain trade
              Restrictions on the export of grain, including quotas, tariffs and other barriers,
         urgently need to be removed. Export duties can have a particularly negative effect on FDI
         and on trade liberalisation. In the first quarter of 2011, the Ukrainian government
         announced plans to scrap the grain export quotas set in 2010. However, in March 2011, it
         extended quotas for another three months. The quotas were finally removed in May 2011,
         but, in June 2011, were replaced by customs duties on grain exports. The unpredictability of
         these changes clearly affects the activities of farmers and traders.
              The design of an efficient and sustainable VAT refund system is another urgent
         priority. The problem has been extensively analysed by international organisations and
         academia, but there is a lack of commitment to address the issue and restore the
         transparency in the system (Legeida, 2002).

         Improving transport and storage infrastructure
             The current subsidy structure is inefficient and does not encourage farmers to
         innovate or follow best practices. Subsidies should be gradually phased out, with the cost
         savings being diverted into an infrastructure development programme.
             A 2010 FAO/EBRD programme report suggests several priorities for public infrastructure.
         The road system is in need of improvement in order to provide efficient access to ports.
         Railways also have scope for increased efficiency; for example there is a need for
         substantial investment in additional grain carriers to increase capacity. The current
         capacity of the country’s port infrastructure is sufficient to meet short-term demand
         requirements, thus increasing investment here should not be prioritised. Public
         infrastructure improvements provide dependable and low-cost connectivity in the national
         market, connecting producers with multiple purchasers. This increases competition,
         reducing regional monopsonies, and boosts farm profits, which in turn can act as a catalyst
         for private investment.
              At the farm level a rural development programme should be set up that actively
         includes the private sector, local authorities and communities in a bid to co-ordinate
         improvements in infrastructure. One such improvement could be a machinery pool that
         allows farmers to group together to share the cost and use of heavy machinery, which may
         not be justified on a smaller-scale farm. A marketing co-operative could co-ordinate farmers’
         efforts to sell grain to processors. It could also help to ease transportation problems
         through methods such as shared trucking systems. Further, this could link farmers to the
         market who may currently be excluded as a result of the prohibitive costs to processors of
         collecting grain from individual producers. Competitive grant programmes could also be
         introduced to co-finance farm investments.




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III.5.   FOCUS ON THE GRAIN VALUE CHAIN



           Notes
            1. See Note 1, Chapter 4.
            2. Legeida, N. (2002), OECD Glossary of Statistical Terms. “VAT Refund Crisis in Ukraine: Causes, Risks
               and Solutions”, Institute of Economic Research and Policy Consulting, www.ier.com.ua/files/
               publications/Policy_papers/German_advisory_group/2002/Q18_eng.pdf, Kyiv.
            3. The Cabinet’s Resolution dated 28 July 2010, No. 648, “On Adopting the Procedure for Use in 2010 of
               the Means of the Stabilisation Fund, Aimed at Purchase of Pedigree Heifers and Cows, Home-Made
               Machinery and Equipment for the Agro-Industrial Complex and Their Further Sale to Agricultural
               Enterprises on the Terms of Financial Leasing”.



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              http://sintalagriculture.com/uploads/files/BG.pdf, accessed 15 March 2010.
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              No. 15, December 2010.
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               2009.
           Investment Capital Ukraine (2010), “Sector Primer Agriculture”, Investment Capital Ukraine, Kyiv,
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           Hallam, D. (2009), “International Investments in Agricultural Production”, Paper presented at the
              Expert Meeting on “How to Feed the World in 2050”, FAO, Rome, 24-26 June.
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               Conceptual Framework for Agri Insurance Development in Ukraine”, White Paper, Washington, DC.
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              Technical Seminar: “Private and Public Sector Co-operation in National Land Tenure Development
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           Krugman, P. (1987), “The Narrow Moving Band, the Dutch Disease, and the Competitive Consequences
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           Lall, S. (1990), Building Industrial Competitiveness in Developing Countries, OECD, Paris.
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              Research and Policy Consulting, Kyiv.
           Lissitsa, A. (2010), “The Emergence of Large Scale Agricultural Production in Ukraine: Lessons and
               Perspectives”, Paper presented at the Annual Bank Conference on Land Policy and Administration,
               Washington, DC, 26-27 April.
           OECD (2009), Agricultural Policies in Emerging Economies, OECD, Paris.
           OECD (2010), Ukraine Sector Competitiveness Review, internal working document, OECD, Paris.
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           OECD (2011), Country Capability Survey, internal working document, OECD, Paris.
           OECD/FAO (2009), OECD-FAO Agricultural Outlook 2009-2018, OECD, Paris.
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           OECD/FAO (2011), OECD-FAO Agricultural Outlook 2011-2020, OECD, Paris.
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              www.ukrstat.gov.ua, accessed 30 September 2011.
           United Nations Commodity Trade Statistics Database (2007), 2007 International Trade Statistics Yearbook,
              United Nations Statistics Division, New York.




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         USDA (2004), Ukraine: Agricultural Overview, USDA Production Estimate and Crop Assessment Division,
            Washington, DC.
         USDA (2011), Global Food Markets: International Consumer and Retail Trends, USDA Economic Research
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            Research Service, Washington, DC.
         USDA (2011), Ukraine: Grain and Feed Annual, USDA Foreign Agricultural Service, Washington, DC,
            April 2011.
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           Washington, DC.
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Competitiveness and Private Sector Development: Ukraine 2011
Sector Competitiveness Strategy
© OECD 2012




                                                    Chapter 6




              Focus on the dairy value chain


         This chapter provides an in-depth analysis of the dairy value chain in Ukraine.
         Examining the demand and supply sides, it explains why the dairy value chain is
         promising for private domestic and foreign investors given domestic and global
         trends. It identifies the role that foreign investors could play, for instance in
         increasing productivity along the whole value chain. It also presents key issues and
         policy barriers hindering competitiveness in the sector and proposes a prioritised list
         of policy recommendations.




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Summary
                The value-chain of the dairy sector comprises four main steps: input supplies, raw milk
           production, milk processing (using chilling, pasteurisation, homogenisation and other
           technologies), and distribution and retail. On the demand side, the global dairy market is
           expected to follow a similar path to other food products. Emerging economies are forecast to
           lead the increase in consumption of dairy products. This trend is driven by population growth
           and rising per capita incomes. It can also be expected that consumers’ preferences in these
           countries will increasingly move in the direction of more varied, healthier and safer products.
           The increase in demand and the reorientation of the mix of products will drive prices up,
           improve profitability and increase investments in the sector. On the supply side, the dairy
           sector has been undergoing globalisation and consolidation at all levels of the value chain.
           Concentration has been observed in processing and in production. Integration has been
           observed at production level, where independent milk producers tend to integrate forward.
                Ukraine is traditionally a dairy producer, although its herd sizes and output have been
           decreasing since independence. Production costs in the sector are comparable to those of New
           Zealand, and significantly lower than other Eurasian countries. The domestic market is
           expected to grow strongly in the coming years. Finally, Ukraine enjoys proximity to a number
           of large or developing markets, such as the EU, Russia and the CIS countries.
                Meanwhile the sector faces a number of challenges, mainly related to the structure of
           supply and output. The quality standards of milk for food production do not match those
           of the EU, and even the highest-quality Ukrainian milk is not exportable to Western Europe.
           The production of raw milk is still scattered, with 80% of production coming from
           households that own fewer than five cows. As a result, the level of investment in the sector
           is low, and does not allow for technological upgrades or for access to skilled human
           resources, like veterinary services and management capabilities. Finally, the milk yield,
           although improving, is still less than 50% of that in other producing countries. The
           medium-to-long-term strategy for the dairy sector in Ukraine could be built around several
           priorities: improving both the quality and productivity of raw milk production; targeting
           geographic markets, starting with the domestic market moving on to the CIS countries,
           and finally to the EU; and attracting major foreign investors to the dairy processing sector.
                Implementation of this strategy would require overcoming several identified policy
           barriers. Milk quality standards would need to be raised to meet WTO commitments and
           EU standards. Improving access to finance and better matching of available human capital
           with companies’ needs are also urgent requirements. Better access to finance would allow
           an increase in the number of cows per household, in order to reduce the number of contact
           points for processors and facilitate the implementation of better quality standards.
           A number of approaches are possible, including supporting micro-finance institutions,
           introducing supply-chain financing or designing efficient credit guarantee schemes. Other
           options include strengthening co-operative banks, which can provide funding to milk
           producers and processors at lower interest rates than commercial banks.


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               The recommended priority policy improvement is the supply of human capital
         (e.g. university education, vocational and educational training (VET), and extension centres
         for farmers) to be tailored to the practices of effective animal husbandry. Veterinarians
         currently perform basic operations, but are not sufficiently trained to ensure proper
         monitoring of a herd’s health and to optimise the birth cycle. A public-private dialogue
         should be fostered between the relevant government bodies and the players in the industry
         to understand the sector’s actual needs. The curricula of the veterinary training institutions
         should be updated to include technical topics such as scientific feeding and herd
         monitoring. VET programmes should provide a substantial amount of practical training in
         the workplace. Agricultural extension centres in rural areas could provide households and
         small farmers with training courses focusing on feeding efficiency, financial literacy
         programs, marketing activities and management skills.

Sub-sector definition and segmentation
             The dairy sector is a major part of the global food chain. It covers operations from raw
         milk production at dairy farms to processing it into a wide variety of products such as milk,
         yogurt, cheese, butter, condensed milk, milk powder and ice cream using chilling,
         pasteurisation, homogenisation and other technologies. Derivatives such as buttermilk
         and whey are by-products of milk processing.
             Global production of milk in 2009 reached over 696 million tonnes, of which
         580 million tonnes were cow’s milk (Figure 6.1). The remaining 116 million tonnes (16.7% of
         the total) were accounted for by buffalo, goat and sheep milk, which enjoy a considerable
         level of consumption in some nations (e.g. India and Pakistan), but account for a small
         share of consumption in most other countries. Even though the share of cow’s milk in total
         production declined from 84.9% in 1998 to 83.4% in 2008, it remains the main product of
         the dairy sector (FAOSTAT, 2011).

                         Figure 6.1. Cow’s milk dominates the global raw milk output
                                   Global raw milk production volume and structure, million tonnes

                                                  Cow milk                              Other milk
           800

           700
                                                                                                          110     116     116
           600                                                                  104       107
                                                              97      100
                                         92       94
                   87         89
           500

           400

           300                                                                                            570     579     580
                                                                      527       543       559
                   483       490        498      510         518
           200

           100

             0
                  1999      2000        2001     2002        2003    2004      2005       2006            2007   2008    2009

         Source: FAOSTAT (2011), FAO Statistical Databases, http://faostat.fao.org, accessed 15 September 2011.


             Global milk production has been growing steadily during the past decade, driven by
         higher demand due to growing population and increasing disposable incomes. Over the
         decade 1999-2009, global milk output rose by over 22%.


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III.6.   FOCUS ON THE DAIRY VALUE CHAIN



               Activities along the dairy value-chain can be grouped into the following segments: input
           supplies, raw milk production, milk processing, and distribution and retail (Figure 6.2).


                                             Figure 6.2. The dairy value chain


                         Farm inputs             Raw milk production              Milk processing         Distribution and retail



              Feed suppliers               Commercial farms              Primary processing         Supermarkets
                                                                                                    Shops
              Veterinary services          Dairy co-operatives           Secondary processing
                                                                                                    Food services
              Genetics (breeding)          Individual farms              Deep processing            Exports

           Source: OECD (2010), Ukraine Sector Competitiveness Review, internal working document, OECD, Paris.



                The farm inputs segment of the value chain covers operations that provide dairy farms
           with essential supplies such as feed, breeding stock, veterinary services and medicine,
           fertilisers, farm machinery, equipment and technologies.
               The raw milk production segment includes all types of raw milk producers irrespective of
           their size, from large-scale commercial farms with a dairy specialisation to dairy co-
           operatives and smallholder (individual) farms. Dairy farm operations span from calving
           and cattle-raising through to milking. Milk production is the basis of the dairy sector as raw
           milk is the main ingredient for all other products of the dairy value chain.
                The milk processing segment covers operations involved in the transformation of raw
           milk into a wide variety of dairy products, either for consumers or to be used as inputs in
           other industries. According to the degree and type of processing the segment can be
           further subdivided into primary, secondary and deep processing stages. The first stage
           involves cleaning, standardisation and homogenisation of milk, resulting in liquid milk
           and cream. Processed milk ready for consumption is the output of the secondary stage,
           which involves pasteurising, sterilising, skimming and homogenisation. The deep
           processing stage covers production of the entire range of dairy products including cheese,
           whey, yogurt, butter, condensed milk, ice-cream, milk powder, casein, and lactose.
               At the distribution and retailing level dairy products are delivered to consumers via a
           range of channels including modern retailers, other shops and restaurants. Dairy products
           and ingredients are also supplied to food-processing, pharmaceutical and other industries.

Global trends
           Increasing world consumption of dairy products with fastest pace 
           in developing countries
                The global demand for dairy products is expected to grow further with an annual
           growth rate averaging 1.9% until 2019 (OECD/FAO, 2010). The large and mature dairy
           markets in developed countries in Europe and the United States will see little growth as
           their per capita consumption is already very high. On the other hand, many developing
           economies in Asia, the Middle East and Africa, where per capita consumption is much
           lower and domestic production capacities are unable to meet domestic demand, will
           become the main sources of consumption growth for the global dairy sector (Figure 6.3).
           Dairy demand in developing countries will be driven by increasing incomes and population
           growth, as well as by changing preferences and new diet patterns, all of which are further
           encouraged by further urbanisation, economic growth and development.

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                           Figure 6.3. World consumption growth of dairy products driven
                                               by non-OECD countries
                                                        OECD                          Non-OECD
          Million tonnes
              25



             20



             15



             10



              5



              0
                   2007-09      2019             2007-09    2019                2007-09    2019                   2007-09   2019
                         Butter                        Cheese                          SMP                              WMP
         Source: OECD/FAO (2010), Agricultural Outlook 2010-2019, OECD Publishing and FAO, Paris.


         Consumption of processed products in non-OECD countries will drive dairy 
         sector growth
              As rising income leads to more diversified demand in developing countries,
         consumers in those markets should become increasingly willing to replace fresh fluid milk
         with pasteurised, UHT or reconstituted milk. This trend will be further supported by the
         growth in dairy marketing and expanding retailing channels in developing countries
         (USDA, 2010). This will gear the sector towards higher value-added dairy production. Rising
         supply potential will enable future production growth and improved domestic marketing
         linkages, placing producing countries in a more competitive position.
              According to recent projections produced by OECD/FAO (2010) the value of the global
         dairy market will increase to reach USD 392 billion by 2019. Compared with 2005, the value
         of processed dairy products (milk powder, butter and cheese) will increase by 74.4% by 2019
         and will reach USD 150 billion, while milk will grow by 14.1% during this period (Figure 6.4).

                   Figure 6.4. World dairy production value and structure, recent trends
                                           and forecasts, 2005-19
                                  Milk                  Cheese                    Butter                      Milk powder
           450

           400

           350

           300
                                                                                                              243
           250
                                                                       199
           200                     213
           150

           100                                                                                                 85
                                                                       74
            50                     52
                                                                       31                                      37
                                   18
             0                     16                                  21                                      28
                                  2005                                2010                                    2019

         Source: FAOStat (2011), FAO Statistical Databases, http://faostat.fao.org, accessed 15 September 2011.

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III.6.   FOCUS ON THE DAIRY VALUE CHAIN



                After decreasing during the global crisis, trade in dairy products should increase, mainly
           for cheese and whole milk powder, driven by the fast-growing demand in developing
           countries. While New Zealand is expected to remain the leading exporter (one third of global
           exports), its long-term capacity to satisfy the demand from importing countries will not be
           sufficient as its global milk output share is less than 2.5%. This opens room for other exporters,
           such as Brazil, which is expected to further increase its presence on foreign markets.
                On the import side, the Russian Federation and middle-eastern countries are expected
           to remain the most significant importers of butter. The Russian Federation will still be the
           largest importer of cheese and imports are expected to grow by 2% per year over the next
           decade (Figure 6.5).


                              Figure 6.5. Key importers of selected dairy products globally
            CAGR Imports of cheese, 2020 over the avreage 2008-10 (%)              CAGR Imports of WMP, 2020 over the average 2008-10 (%)
            8                                                                      2.5
                     China                                                                                                        China
            7                                                                      2.0

            6                                                                      1.5
                                                                                                         Russia
                                                                                   1.0       United States
            5
                              Mexico                                               0.5              Mexico
                                                                                                                                 Algeria
            4
                                                                                   0.0
            3                           United States
                                                                                  –0.5
            2                                                   Russia
                                                Japan                             –1.0
                              Saudi Arabia
            1                                                                                                     Saudi Arabia
                                                                                  –1.5
                    Algeria
            0                                                                     –2.0
                0       50    100      150      200     250     300 350                  0          50        100        150      200       250
                                    Imports of cheese, 2008-10 (th tonnes)                                    Imports of WMP, 2008-10 (th tonnes)
           Source: OECD/FAO (2011), Agricultural Outlook 2011-2020, OECD Publishing and FAO, Paris.



           World dairy price trends should prompt a supply response from investors
               On average, world market dairy prices in real terms are expected to stay 15-40% higher
           when compared to the decade preceding the 2007-08 peak (OECD/FAO, 2010). This will
           prompt supplying countries to invest, expand and restructure their production units to meet
           market needs. Rising supply potential will enable future production growth and improved
           domestic marketing linkages, placing these countries in a stronger competitive position.
           However, uncertainty remains regarding the volatility around this future trend (Figure 6.6).

Sources of competitiveness

           A highly fragmented production segment which involves households 
           and small farmers
                The dairy sector is an important component of the rural economy in Ukraine, providing
           employment and income in an environment of weak social security and scarce job
           opportunities. Dairy farming in Ukraine includes a broad range of farms: from households
           with one or two cows selling raw fresh milk via village collecting stations – which provide a
           significant income for vulnerable groups – up to large corporate farms, some of which have
           already made significant investments and control thousands of hectares (Figure 6.7).




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                    Figure 6.6. Annual dairy, food and meat price indices, 2002-04 = 100
                 Cheese imports in 2008-10 (thousand tonnes); projected average annual growth of cheese imports
                                                      2020 over 2008-10 (%)

                                         Food price index               Meat price index                   Dairy price index

           210

           190

           170

           150

           130

           110

            90

            70

            50
                 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

         Source: OECD/FAO (2011), Agricultural Outlook 2011-2020, OECD Publishing and FAO, Paris.


                     Figure 6.7. Millions of cows producing milk in Ukraine, 1990-2006
                                                    Households                              Dairy farms
            9

            8
                     2.2
            7

            6                     2.9

            5

            4

                     6.2                          3.2
            3                                                    3.3
                                                                               3.2
                                  4.6                                                      3.0                  2.8
            2                                                                                                                  2.7

            1                                     1.7             1.4          1.1         0.9                  0.9            0.8
            0
                    1990          1995          2001             2002         2003         2004                2005            2006

         Source: SSCU (2011), State Statistics Service of Ukraine website, www.ukrstat.gov.ua, accessed 30 September 2011.


              Ukraine witnessed a significant decline in milk production during the 1990s:
         between 1990 and 2001 the number of cows fell by 40 per cent (SSSU, 2011). Yields also fell
         in the early 1990s although they subsequently recovered and, since 2000 (Figure 6.8), the
         whole dairy sector has been one of the most dynamic branches of the Ukrainian
         agribusiness sector, producing around 4% of total national output (Nivievskin, 2008).
              The Ukrainian dairy supply chain involves a significant number of individual households,
         resulting in a high fragmentation at the production level. This affects the profitability of dairy
         farming, as small herds are considered to be economically inefficient. Households’ bargaining
         power is low and there is a high level of idling of production facilities. Technological upgrading
         has been hampered by lack of investment at the farm level.
              After the production phase, milk collection is rather heterogeneous: for households with
         one or two cows it is organised by milk collecting entrepreneurs without a proper contract;
         for bigger enterprises it is organised by either dairy processors or by local authorities or

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                   Figure 6.8. Milk yield, tonnes of fluid milk per cow per year, 1990-2006
                                                   Households                             Dairy farms
              8

              7

              6

              5                                                                                                      3.9
                                                                                                        3.6
                     2.7
              4                                                                           3.4
                                                 3.1            3.2         3.2
              3                    2.7

              2
                     3.0                                                                                             3.2
                                                                                                        2.9
              1                                  2.1            2.2          2.1          2.5
                                   1.9

              0
                     1990         1995          2001            2002        2003         2004           2005        2006

           Source: SSCU (2011), State Statistics Service of Ukraine website, www.ukrstat.gov.ua, accessed 30 September 2011.

           co-operatives. In 2010, around 60% of the raw milk collected for processing came from
           household farmers. For processors, the presence of small farmers represents higher
           transaction costs, depending on whether co-operatives aggregate the output (Reardon et al.,
           2009). Milk collecting points in rural areas are too numerous and widespread as a result of the
           dispersion of households. Contractual links between producers and dairy processors are
           weak. At the same time, processors have strong bargaining power. For example, a change in
           the subsidy system introduced in January 2011 was passed on to producers through a
           reduction of the price processors pay for raw milk of around 12% on a quarterly basis, from
           UAH 3.02 per kilo in the last three months of 2010 to UAH 2.64 in the first quarter of 2011.
              There are some big international players in the processing segment, such as Lactalis and
           Danone, two French dairy groups, and Wimm-Bill-Dann (WBD), a Russian food and dairy
           group. However, the shortage of high quality raw milk is a problem for international players: for
           example, in 2010 Danone collected less than 1% of the milk in Ukraine, due to its low quality.

           Cost-competitiveness of raw milk production
                  Raw milk production in Ukraine is relatively inexpensive due to low input and labour
           costs. Feed is a key driver of milk production costs, accounting for around 60%, and
           Ukrainian farms mostly produce their own feed. Ukraine’s production costs in the
           period 2007-08 were only slightly higher than those estimated in New Zealand and
           significantly lower than those estimated for Kazakhstan, Germany, or France (Figure 6.9) by
           the International Farm Comparison Network. However, competitiveness is undermined by
           the need to improve the quality of products and adhere to international standards.

           Access to fast-growing markets, high domestic demand and advantageous
           geographic position
                According to the most recent FAO-OECD forecasts, the expected growth of dairy
           product consumption in Ukraine is promising (OECD/FAO, 2010). This growth process will
           be driven by the increase of GDP per capita and the purchase by customers of higher-value-
           added products. This will involve the development of all price segments from low priced
           traditional products to the medium and premium segments, along with the introduction of
           new products and product categories. Whole milk powder and cheese are expected to grow
           at an average annual growth rate of 6.9 and 5.3% respectively over 2010-19. In addition to

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                               Figure 6.9. Cost of milk production in selected countries,
                                              US dollars per 100 kg, 2007
                             Depreciation                    Labour costs                      Material costs (feeding) and miscellaneous
           50

           45            5
           40                                  4
                         7
           35
                                              14                    1
           30
                                                                    4                     4
           25
                                                                                          7                    1
           20
                                                                                                                                     1
                        35                                                                                     6
           15                                                                                                                        6
                                              25                    26
           10                                                                             19
                                                                                                               15                    12
            5

            0
                     France                 Germany              Thailand             Kazakhstan            Ukraine              New Zealand
         Source: International Farm Comparsion Network (2009), Dairy Report 2009, www.ifcnnetwork.org/en/news/2009/09/
         pressrelease_dairy-report_2009.php, accessed 15 April 2009; Author’s calculations based on estimates provided by
         Milkiland Ukraine (2009), corporate website www.milkiland.com/en, accessed 15 April 2009.

         the growing domestic market, there will also be increasing opportunities for exports of
         processed-goods (Figures 6.10 and 6.11). Ukrainian dairy producers and foreign investors in
         the dairy industry could take advantage of the favourable geographic position of the
         country. In 2005, 66% of Ukrainian dairy products were exported to Russia. But the Russian
         market also poses risks. For example, the 2006 Russian import ban on dairy products from
         Ukraine caused a decrease in this share to 32% and had an extremely adverse impact on
         cheese and butter producers in Ukraine (Figure 6.12).

                 Figure 6.10. Domestic demand for processed dairy products is expected
                                to increase by 30% over the coming decade
                        Consumption index of selected dairy products in Ukraine, past trends and forecasts,
                                                   100 = consumption in 2005

                                                        Cheese                                      Whole milk powder
           350

           300

           250

           200

           150

           100

            50

             0
                 2005     2006      2007    2008      2009   2010       2011   2012    2013    2014     2015       2016   2017     2018     2019



              Therefore, to minimise such risks Ukraine should diversify its export structure to
         include other markets, such as Central Asia, the Caucasus, Asia, and the Middle East. CIS
         countries, as well as the Middle-East, remain the most promising regions for Ukrainian dairy
         products, especially for whole milk powder and cheese. This process is already underway.

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                     Figure 6.11. The Ukrainian dairy industry exports significant volumes
                                               of its production
                                   Dairy consumption/export ratio of Ukraine, thousands of tonnes, 2009

                                           Exports                       Consumption                       Imports
             350

             300

             250

             200

             150

             100

              50

               0
                               Cheese                      Butter                 Whole milk powder         Skim milk powder

           Source: OECD/FAO (2011), Agricultural Outlook 2011-2020, OECD Publishing and FAO, Paris.


                         Figure 6.12. CIS countries and Middle-East already key importers
                                            of Ukrainian dairy products
                                                Export structure of Ukraine dairy products, 2007

                             Russia
                            Algeria
                        Kazakhstan
                              Japan
                              China
                           Moldova
                            Georgia
                        Azerbaidjan
                             Turkey
              United Arab Emirates
                              Syria
                   Rest of the world

                                       0             5       10             15           20           25          30           35
                                                                                                                               %
           Source: State Statistics Service of Ukraine (SSCU), (2008), website, www.ukrstat.gov.ua, accessed 15 June 2008.


                The export possibilities for dairy products are currently limited to developing countries,
           for quality reasons. In the EU, a close and sizeable market, Ukraine exports dairy products for
           non-human consumption. Exporting to the EU is a medium to long-term opportunity that
           Ukrainian producers could take advantage of, but quality issues need to be tackled first.

The role of foreign investors in the dairy sector
                The trend towards concentration is already visible in the processing sector. The
           growing power of suppliers and buyers has triggered pressures to improve efficiency and
           has resulted in increasing concentration at the global level. The 20 largest dairy processors
           account for the majority of dairy market sales in the world. Their sales amounted to
           USD 172 billion in 2009, with the top six accounting for nearly 67% of this (Table 6.1).




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                                      Table 6.1. Turnover of the largest global dairy
                                               processing companies, 2009
                          Company                     Country                    Turnover, USD billion

                          Nestlé                      Switzerland                        27.2
                          Danone                      France                             15.7
                          Lactalis                    France                             13.7
                          Friesland Campina           Netherlands                        13.7
                          Fonterra                    New Zealand                        12.0
                          Dean Foods                  United States                      11.8
                          Dairy Farmers of Am.        United States                      10.8
                          Arla Foods                  Denmark/Sweden                     10.1
                          Kraft Foods                 Unites States                       7.5
                          Unilever                    Netherlands                         6.6
                          Parmalat                    Italy                               5.4
                          Saputo                      Canada                              5.3
                          Bongrain                    France                              5.2
                          Meji Dairies                Japan                               4.7
                          Morinaga Milk Ind.          Japan                               4.3
                          Land O’ Lakes               United States                       3.7
                          Nordmilch                   Germany                             3.7
                          Schreiber Foods             United States                       3.7
                          Mengniu                     China                               3.7
                          Muller                      Germany                             3.4

                         Source: Rabobank (2010), Rabobank Dairy Top 20, Press Room Rabobank Group,
                         corporate website www.pressroomrabobank.com/publications/food__agri/rabobank_
                         dairy_top-20.html, accessed 15 June 2010.


              Some of the largest global players in the dairy industry have already invested in Ukraine,
         purchasing and modernising old dairy processing units. In general, starting from a low level
         in 2000, FDI has increased significantly in recent years, reaching USD 65.5 million in 2006.
               For example, Lactalis has been present in the market since 1996, when it acquired its
         first asset. In 2004, it purchased the Ukraine-based operations of American Food Master
         International, namely the Bilosvit dairy plant in the Cherkasy region. In 2007, Groupe
         Danone bought the Rodych Dairy Plant in the southern Ukrainian regional hub of Kherson
         and in 2006 Fromagerie Bel Group bought the Shostka City Milk Plant in the Sumy Region.
             There has been an important debate in the literature on the impact of FDI on the local
         producer base. Some argue that FDI has had a negative effect on small local farmers by
         excluding those that can’t comply with high quality standards (Farina and Reardon, 2000;
         Reardon et al., 1999). Others ascribe the negative impact on farmers to the fact that foreign
         investors prefer to deal with larger suppliers in order to minimise transaction costs
         (Runsten and Key, 1996). On the other hand, Dries and Swinnen (2004) found evidence of
         positive vertical and horizontal spill-over effects of foreign investment on the Polish dairy
         production sector, leading to significant quality improvements by small local suppliers,
         better access to finance and increased investment. These spill-over effects occur in three
         phases: first, foreign investors control output quality and provide incentives through the
         provision of inputs, credit and technology. At a second stage, domestic processors start
         copying the most successful vertical integration strategies. The evidence from the Polish
         dairy market shows that five years after the introduction of FDI in the sector there were no
         longer any significant differences in the way local and foreign firms sourced their supplies.




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           Attraction of FDI into the dairy processing sector
                The experiences of other regional economies suggest that FDI could have a positive
           impact on the dairy sector in Ukraine. Although FDI can place small or marginal producers
           under pressure as some struggle to meet the new, higher quality standards demanded by
           processors, the negative direct effects on the industry as a whole are generally offset by the
           positive impact of spillovers such as technology transfer, improved skills and better
           management. Critics of FDI suggest that the establishment of foreign processing capacity
           leads to consolidation of the supplier base, with some smaller suppliers in particular
           unable to meet the higher quality demands of newly-established foreign-owned
           processors. However, evidence from the earlier experiences of the dairy sectors of Poland
           and Hungary suggests that these negative direct effects are relatively small (Gorton and
           Guba, 2001; Dries and Swinnen, 2004). Moreover, they are offset by positive indirect effects,
           including better access to financing (including from the processors themselves), higher
           investment and improvements in quality.
                In Poland’s case, foreign investments in processing companies resulted in new
           contracts with suppliers that demanded higher quality standards and consistent supplies,
           but in return offered help with management training, better access to credit, technology
           and skills transfers, and better access to raw material inputs. These included programmes
           that provided producers either with direct access to feed for livestock or with the necessary
           inputs (such as seed and fertiliser) for producers to grow their own feed. On the financing
           side, foreign investors offered leasing contracts for equipment and livestock, along with
           either direct loans or guarantees as collateral for commercial bank loans. Encouraged by
           the example of foreign-owned processors, domestic firms subsequently also began to
           adopt similar strategies, leading to productivity improvements across the industry. The
           quality of milk produced, even by small local suppliers, also improved significantly. These
           experiences suggest that a strategy of encouraging foreign investment in the dairy industry
           could produce similar benefits in Ukraine.

Key issues and policy barriers
           Shortages of human capital
                There is a shortage of the key technical skills required to both improve productivity in
           the dairy sector and to raise milk quality to the highest international standards.
               According to the OECD Country Capability Survey two-thirds of the dairy farmers
           surveyed highlighted problems in recruiting veterinarians, due to a lack of supply of these
           professional skills, especially in rural areas (Figure 6.13). Even when specialists are
           available, their technical skills might not be aligned to international best practices. For
           example, breeding plays an important role in the improvement of herds and currently
           there is a lack of knowledge of scientific feeding and herd monitoring techniques. Feeding
           needs to be balanced, ensuring sufficient protein intakes, and tailored to the birth cycle of
           the herds. Inadequate feeding usually leads to a diet rich in carbohydrates, which is
           detrimental to the herd’s health.
              Veterinarians currently perform basic operations, but are not well enough trained to
           ensure proper monitoring of the herd’s health and to optimise the birth cycle.
           Improvement of veterinary skills would strongly benefit private dairy farmers in Ukraine.
           At the same time, veterinary and health inspectorates in the public health and monitoring
           bodies need to modernise their regulation, streamlining their frequently lengthy



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                     Figure 6.13. Workforce skills are seen as an area for improvement
                                   where government action is called on
                                  “What do you think should be done to improve the annual milk yield?”




       Access skills and know-how about breeding                                                                                  67




                    Access better quality feeding                                                                      53




                                            Other                                  26



                                                     0        10         20            30         40              50        60    70       80
                                                                                                                                           %
                                          “What are the areas for improvement in milk quality?”


                      Technology and equipment                                                                                           75


                                        Expertise                                                                 47


                                 Quality of inputs                                                                47


                     Milk collection and transport                                24


                  Better stick to processor needs                                 24


                                            Other                  10


            83 dairy farms were surveyed             0        10         20            30         40              50        60    70       80
                                                                                                                                           %




       More than 2/3 of the farms surveyed pointed out skills improvement as key to higher milk yield


Source: Calculations based on OECD (2011), Country Capability Survey, internal working document, OECD, Paris.

         inspections. Outdated rules need to be replaced with updated animal health management
         practices. Public sector organissations could disseminate information, providing
         guidelines and appropriate training in the desired practices.
             The Ukrainian education system focuses on scientific subjects without providing
         sound management and business administration curricula. There is a need to improve
         accounting, finance and management skills, in order to develop a business and
         entrepreneurial mindset. At the moment, dairy farmers lack technical skills in fields such
         as operations management, finance and risk management, and expertise in business
         planning and product promotion.




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           Outdated and excessive dairy safety regulation is ineffective and burdensome
                Excessive requirements for permits, certifications and standards, prescribed testing
           methods that are not aligned with international guidelines, and overlapping inspections
           from different agencies constitute a significant burden to the dairy sector, estimated at
           approximately 23% of annual turnover (IFC, 2009). Nevertheless, the current system does not
           overcome a major problem as it does not align with safety and quality standards accepted in
           major developed-country markets. Dairy producers have to comply with more than a
           hundred different testing methods, but only 37% of these are in line with international
           standards (IFC, 2009). Moreover, the system lacks effective enforcement mechanisms. This
           limits dairy sector exports mainly to other CIS and developing country markets. Exports to
           the wealthy western European markets are presently concentrated on low-value-added
           products such as casein, dry milk powder and other intermediate products. Improvements in
           safety standards would open up significant new markets for higher-value-added exports
           such as milk, cream and cheese, boosting profitability for producers and processors.
                Certifications and standards are mandatory but are not WTO compliant or aligned
           with international standards. They impose strict guidelines for product specifications,
           which limit technical innovation without achieving the goal of producing exportable, safe
           final products. Rigid rules and sanitary norms often refer to outdated Soviet Union
           standards. Despite their complexity they do not ensure a high level of safety. Compliance
           is enforced by multiple institutions, which lack communication and co-ordination,
           creating a duplication of procedures and inefficiency.
                Entrepreneurs surveyed in the OECD Country Capability Survey conducted in 2011
           reported that their dairy products were reviewed and certified for export to the EU, but that
           state veterinary standards were not, therefore they could not trade with the EU market
           (Figure 6.14). A review of best practices suggests that the harmonisation of regulations towards
           the EU voluntary compliance system would significantly reduce costs to both government and
           producers whilst increasing the access of Ukrainian products to the EU market.

           Milk quality standards: design and enforcement
                Under the Ukrainian standard, raw milk is sorted into three quality grades: extra
           grade, Category I and Category II, while in the EU there is only one grade for raw milk,
           which is of higher quality than Ukrainian extra grade milk (Table 6.2).* Ukraine households’
           milk output is usually Category II, which is not used by the food processing industry in
           the EU and the USA. The situation is better at large dairy farms, since they deliver mainly
           extra grade and Category I milk. Because of these low food safety and quality standards,
           Ukraine’s dairy industry can’t enter large Western European markets.
                Moreover, enforcement and monitoring of standards is questionable. Milk quality is
           rarely controlled or monitored at the collecting points or at the processing plants. Some
           processors are, however, taking steps to improve standards, by paying higher prices to
           farms producing higher quality milk. Nonetheless the strong seasonal pattern of milk
           production and the subsequent scarcity of raw milk in autumn and winter encourage
           processors to pay higher prices for any category of milk at certain times of the year.



           * The main piece of legislation is the Law of Ukraine No. 1870-IV “On Milk and Dairy Products produce”
             adopted on 24 June 2004, which sets up the institutions ensuring quality and safety of milk and dairy
             products along the whole dairy value chain, including production, transportation, processing,
             storing and marketing, exports and imports.

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                         Figure 6.14. Quality of state controls and regulation are debated


                  Control systems could be improved –                                  Regulation can lack effectiveness
                  especially veterinary and sanitary controls




      • Design of control systems debated
                      Ex: sending an animal to the veterinary service             “I have some old cows that produce
                      instead of having it checked on the farm                    very little milk. I would like to slaughter
                                                                                  them and replace them with younger,
      • Implementation even more key                                              more productive ones. But if I want to do so,
                                                                                  I need special authorization, because under
                      “We have all the papers in order, it makes us easier        local policy, it is not allowed to slaughter
                      to check and thus we are much more controlled               milking cows”
                      than less organized producers” Foreign milk
                      processor in Ukraine




                                                                                               Foreign milk producer in Ukraine

                 “We were reviewed and certified for export to
                 the EU, but state veterinary services were not.
                 As a result, we could not export.”




                    Large Ukrainian milk processor

Source: OECD (2011), Country Capability Survey, internal working document, OECD, Paris.



                 Box 6.1. Duplication of procedures and inefficiency in enforcing standards
                Overlapping institutions and lack of co-ordination in enforcing safety standards is
             illustrated by an IFC study conducted in 2009. The study concluded that on average a
             typical milk processing value chain (“from farm to fork”) needs to:
             ●    comply with up to 120 permits, authorisations, and other regulatory requirements;
             ●    comply on average with up to 50 mandatory standards for each dairy product;
             ●    comply with up to 51 orders and mandatory guidelines from the Ministry of Health Care
                  and other supervision agencies for each dairy product;
             ●    comply with around 110 prescribed testing methods, in spite of the fact that 63 per cent
                  of them are not in line with international standards;
             ●    receive repeated and overlapping inspections from several inspecting agencies.
             Source: International Finance Corporation (2009), Reforming Food Safety Policy in Ukraine: Proposals for Policy
             Makers, IFC, Washington, DC.



             Poor enforcement of standards also hampers the shift towards higher value-added
         products. Many products that do not meet mandatory standards are still sold in the
         market, undermining consumer confidence in the sector as a whole.

         Fragmentation in raw milk production has a negative impact on quality, 
         efficiency and productivity
             The weight of households’ in total raw milk output and the presence of widespread
         and numerous collection points are two significant challenges for the development of the
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               Table 6.2. Quality standards for raw cow milk for food production in Ukraine
                                                 and the EU
                                                                                                           Ukraine
                                                                     EU
                                                                                   Extra grade            Category I         Category II

            Plate count 30 degrees Celsius (‘000 per ml)             100                300                500               500
            Somatic cell count (‘000 per ml)                         400                400                600               800

           Source: Nivievskin, O. and S. von Cramon-Taubadel (2008), “The Determinants of Dairy Farming Competitiveness in
           Ukraine”, 12th Congress of the European Association of Agricultural Economists, Ghent.


           sector and the entire dairy value chain. Productivity of cows is very low in Ukraine by
           Western standards. The average productivity in the United Kingdom, for example, is about
           7 tonnes per cow per year; in Israel it is about 11-12 tonnes. In Ukraine, even for large
           modern farms, milk yield approximates 2.9 tonnes per cow. Reasons include the very low
           level of investments (both private and public), the poor condition of facilities, high taxation
           of inputs and the lack of cattle breeding skills.
                The large share of households in raw milk production adds costs to the value chain,
           making Ukrainian dairy products less competitive on the global market. Households
           cannot capture economies of scale in production. A recent study shows that in Ukraine,
           productivity grows as herd size increases, making large-scale production more
           advantageous, on average (Nivievskin and von Cramon-Taubadel, 2008). For example,
           increasing the average size of households’ herds from one to five cows would allow them
           to attract financial and technical support from dairy processors (Figure 6.15).

                              Figure 6.15. Milk yields in Ukraine’s large dairy farms are half
                                              of the European Union average
                                           Annual milk yield comparison, tonnes of milk per cow, 2006
             12


             10


               8


               6
                         11

               4                         8.2
                                                           7
                                                                       6.1          6
                                                                                                   5                 4.5
               2
                                                                                                                                 2.9

               0
                       Israel         Denmark      United Kingdom     EU25        France         Greece             Poland    Ukraine –
                                                                                                                             large dairy
                                                                                                                                farms
           Source: Nivievskin, O. and S. von Cramon-Taubadel (2008), “The Determinants of Dairy Farming Competitiveness in
           Ukraine”, 12th Congress of the European Association of Agricultural Economists, Ghent.


                The high fragmentation of production significantly increases the cost of milk
           collection, since most households own only one or two cows. Most household farms sell to
           dairy logistics or milk collecting firms, which are typically small-scale entrepreneurs. The
           prevalence of households in raw milk production also has a negative impact on the quality
           and safety of milk. Raw milk supplied to processors is often of poor and inconsistent
           quality. Milk collection and cooling facilities are not widespread or up to date. For instance,


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          milk is first supplied to special collecting points in rural areas, where milk from different
          origins is mixed together without any preliminary quality tests.

          Lack of financing affects the level of investments and therefore productivity
              Small and medium-sized farms face problems accessing finance due to the high cost
          of borrowing. Therefore, they have limited resources to finance investment in capital
          equipment, other inputs and specific training.
               According to the OECD Country Capability Survey conducted in 2011, more than 75%
          of the farmers surveyed indicated that access to credit is a barrier to the development of
          their business (Figure 6.16). The key reasons quoted by the respondents were the high level
          of interest rates (82% of responses), with annual rates typically in the 20-30% range. The
          lack of collateral was considered a barrier by 26% of respondents. More than half of the
          farmers surveyed (51%) assessed the milking equipment in use as technically “outdated”.
          Increasing herd size was perceived by 53% of respondents as a necessary investment
          during the next five years, while 40% of the panel planned to either upgrade their existing
          equipment or fully re-equip. Technology and equipment were indicated by 75% of the
          surveyed farmers as areas for improvement, followed by “expertise”.


       Figure 6.16. Lack of financing affects the level of investments and therefore productivity
                                              Are you currently receiving sufficient access to finance?
                                                                      Yes                No



                                                                                   24%
                   ~75% of farms indicated                                                                  80 % of respondents cited
                   lack of access to credit                                                                 interest rate as a key
                   (short and long-term)                                                                    reason for limited access
                   as an issue                                              76%                             to finance


                                                              83 dairy farms were surveyed


                  On short-term or long-term credit?                                            What are the key reasons for such difficulties?

  %         Long-term        Short-term         Short and long-term                %
 100                                                                              100
                                              26                                   90
  80                                                                               80
                                                                                   70
  60                               33                                              60
                                                                                                      82
                                                                                   50
  40                                                                               40
                                                                                   30
  20                    41                                                         20
                                                                                   10                                                   26
   0                                                                                0
                                                                                              High interest rates            No appropriate collateral

Source: OECD (2011), Country Capability Survey, internal working document, OECD, Paris.


               The fragmentation of raw milk production impedes access to the credit market and
          deters necessary investment. In Ukraine, the distribution of milk yields varies depending
          on the size of dairy farms (Nivievskyi, 2008). Smaller herds of 10 to 100 cows have an
          average yield of 1.7 tonnes of milk per cow, while in herds with more than 700 cows the
          yield averages 6 tonnes per cow. Also, dairy intermediaries or processors are less willing to
          provide financial, technical or logistical support to households with one or two cows. The

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III.6.   FOCUS ON THE DAIRY VALUE CHAIN



           financial crisis has negatively affected an already fragile situation, as small and medium-
           sized farmers have witnessed a sharp contraction in the credit market combined with the
           devaluation of the currency.

           Imperfect information and price heterogeneity affect farmers’ profitability
                The dairy industry in Ukraine is dominated by small, disconnected players without access
           to information or bargaining power. This renders farming profits uncertain and low. Since
           independence, farmers’ prices have been lower than international prices with considerable
           disparities between producers (Sauer et al., 2011). Processors are generally local monopolies,
           created during the soviet era, and continue to dominate pricing for their specific region.
                The creation of a nation-wide integrated market information system could increase
           producers’ information, thereby encouraging competition between processors, reducing
           disparities in regional prices, and increasing profit and investment at farm level. Further,
           such an information system could be extended to share research, techniques, industry
           forecasts and other information relevant for optimising farm-level decisions.

           Taxation of inputs via tariff and non-tariff import barriers
              Imports of inputs, such as feed, seeds, agrichemicals or technologically-advanced
           machinery are limited by both tariff and non-tariff barriers.
               The liberalisation of the current non-tariff measures would be beneficial, in particular
           in the machine building sector as higher imports would ensure technological
           modernisation and therefore productivity gains. A study undertaken by Movchan and
           Shporttyuk (2010), found that non-tariff protectionism in Ukraine increased in the
           period 1996-2006, peaking in 1999 with the introduction of minimum customs values and
           a rise in the number of products subject to licensing. Non-tariff measures are still high in
           four sectors of the Ukrainian economy, including the food industry and machine building.
           During the first two years of WTO membership, Ukraine has met its obligations with
           respect to reductions in import duties. On joining in 2008, Ukraine committed to “bind” its
           import tariffs. In particular, it joined a series of sectoral arrangements for import duty rate
           reductions, including one covering agricultural equipment (Kobouta et al., 2010). However,
           in 2008 the Ukrainian parliament approved a law introducing a temporary surcharge of 13%
           on the import duty on several products. This was in contravention of WTO rules and
           Ukraine was obliged to abolish the 13% surcharge in September 2009. The manoeuvre did
           not send a positive image of the country to international partners, as it was clear that the
           surcharge was an attempt to restrict imports despite WTO commitments. Imports in the
           machine building sector (including machinery, equipment and vehicles) dropped from
           USD 17.8 billion in the first ten months of the first WTO membership year, to
           USD 8.2 billion in the first ten months of the second membership year.

Policy recommendations
                Ukraine has considerable opportunities to improve the competitiveness of its dairy
           sector. A major issue preventing long-term investments in the industry is the uncertainty
           regarding land ownership, which has already been discussed in previous sections.
           Investments in dairy production have a long pay-back period and the uncertainties related
           to land ownership raise the risks involved. In addition to the policies identified earlier in
           the field of land tenure and land reform (see Chapters 4 and 5), a number of sector-specific
           recommendations would be beneficial.


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          Human capacity building policies would have a positive impact on productivity
               Human capacity building programmes are recommended to fill the skills gap between
          the competences provided by the Ukrainian educational system and the practical needs of
          the dairy industry, notably in the fields of veterinary medicine, feed efficiency, animal
          husbandry skills and management. A long-term and focused commitment by policy
          makers to develop human skills and social capital could have an important effect on the
          improvement of milk quality and on the development of the dairy sector.
               Specific action could target initial agricultural education, fostering public-private dialogue
          between the relevant government bodies and industry players to understand the sector’s
          actual needs (Figure 6.17). For example, the curricula of veterinary courses could be revised and
          updated with current business practices including technical topics such as scientific feeding,
          herd monitoring and optimisation of birth cycles. Animal husbandry skills should be
          harmonised with international and EU standards. Secondly, in order to raise the exposure of
          professors and students to international standards, linkage and exchange programmes could
          be introduced. Internships of veterinary students within dairy companies might also improve
          training. This would also facilitate the recruiting process for veterinarians and reduce the
          hiring cost to farmers. Thirdly, tertiary and university education curricula need to be integrated
          with organisation and management foundation courses. Problem solving and leadership skills
          need to be taught to facilitate entrepreneurship.


            Figure 6.17. A summary of policy options to enhance initial and VET education
     Key issues in the Ukrainian educational system                                  A series of potential solutions

                                                                                         Organisational reform
                                                            •   Increased autonomy for universities
                 Unadapted organisation                     •   Possibly bringing education and research closer
                                                            •   Convergence towards the Bologna process
                                                            •   New management (tools, people)


                                                                                       Private sector involvement
         Irrelevance of programmes and training
                                                            • Permanent and ad hoc forums for public-private dialogue
                                                            • Review of curriculum, course revision
                     Lack of funding                        • Reform of VET framework and trainings



                                                                                         International exposure
        Isolation from international best practice          • For students: partnerships, exchanges, linkage programmes
                                                            • For faculty: publications in int’l reviews, exchanges

Source: OECD (2010), Ukraine Sector Competitiveness Review, internal working document, OECD, Paris.


               The quality of the upper-secondary and post-secondary vocational education and
          training (VET) system needs to be improved, developing a close link between job-specific
          requirements and relevant training. Currently, Ukraine offers a certain amount of VET in
          schools but very little post-secondary, non-tertiary training (OECD, 2011). VET programmes
          should provide a substantial amount of practical training in the workplace.
               Ukraine has no plans to implement a national system of continuing education and
          training (CET), but legislation does give employees the right to paid training provided by
          employers. CET could provide privately-financed training to dairy farmers. Agricultural
          extension centres in rural areas could be targeted, as they support and assist households
          and small farmers (Figure 6.18).

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III.6.    FOCUS ON THE DAIRY VALUE CHAIN



                         Figure 6.18. Extension programmes are an example of a policy option
                                              to develop producers’ skills
                         Extension programmes:                                                                                                 Who does what:

                    Non-formal continued education                                                                                different funding and operational models
                                                                                                                                            FUNDING OF TRAINING

 Role: disseminating information and advice through the transfer                                                                 Public                       Private
 and exchange of practical information:
         – Promoting knowledge and skills.




                                                                                                              Public
         – Promoting attitudes and aspirations.                                                                         Deconcentrated/decentralized     Fee-based State
                                                                                                                        State training                   programme




                                                                                       DELIVERY OF TRAINING
         – Reinforcing the local community.
         – Some programmes may include financing schemes.

                                                                                                                        State-support to farmers
 Financing of extension programmes is varied:                                                                         who decide to contract with
         – Public (state and/or local authorities).                                                                     extension service providers
                                                                                                                                                         All-private programme,




                                                                                                              Private
         – Private (training participants and/or other supply chain members).                                                                            e.g. commercialization
                                                                                                                                                         programme
 Scope: technical as well as business skills:                                                                         State contracting with private
                                                                                                                        players to provide extension
         – Intervention of experts.                                                                                     services to farmers
         – Knowledge sharing between producers.

Source: OECD (2010), Ukraine Sector Competitiveness Review, internal working document, OECD, Paris.


               Improving safety regulations and streamlining administrative controls
                    Dairy safety regulations, standards and certifications need to be simplified, while
               administrative controls and processes should be streamlined. This will increase the
               efficiency of the system and reduce the compliance costs for private firms. The move
               towards a free trade agreement with the EU will probably accelerate this process. Priority
               should therefore be given to the harmonisation of standards, certification, and food safety
               regulations with international and EU best practice.
                   Recent international experience suggests that an overhaul of the current system of
               excessive regulation and overlapping responsibilities would yield significant benefits. The
               establishment of a single regulatory authority responsible for food control and safety
               issues would mark a significant step forward. A redesigned food control system should
               take account of EU legislation and practice, and should include the scrapping of the
               existing mandatory certification system, which imposes burdens but provides few
               benefits. A new system should also not differentiate between domestically-produced and
               imported products, which would further simplify compliance procedures. The current
               system is a complex mixture of mandatory quality specifications, technical regulations
               and safety standards. In order to comply with WTO requirements and EU practice, this
               approach should be replaced with a system of mandatory technical regulations but
               voluntary standards. Moreover, a number of different pieces of existing legislation deal
               with food-related issues, creating confusing and sometimes contradictory requirements.
               Food should be removed from the provisions of most of these laws in favour of more
               specific legislation designed to comply with WTO rules. There is also a need to update
               regulations regarding the use of food additives, flavourings, pesticides and other
               contaminants, including limits on permitted levels and rules regarding the types of food in
               which such additives can be used.
                      A recent study drawing lessons from international experience (IFC, 2011) suggests
               that, although the introduction of food safety management systems would involve short-
               term costs for producers and processors, it would provide net benefits over the medium


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         term. IFC estimates suggest a payback period for food safety investments of around one to
         two years, and notes that some Ukrainian producers in the dairy sector have experienced
         shorter payback periods following the introduction of more rigorous food safety systems.
         Start-up costs are typically more than recouped through higher revenues as a result of
         access to new markets, lower wastage, better management and a rise in the attractiveness
         of the business to investors.

         Strengthening the role of producer co-operatives
              The prevalence of small-scale producers results in high costs of collection and
         transportation and difficulties in quality control. Experience in other countries suggests
         that the development of producer co-operatives can be a successful means of overcoming
         these problems. Co-operatives can act as collection centres for milk, provide members with
         common access to shared cooling and initial processing equipment, provide shared storage
         facilities, allow a greater degree of quality control, organise transport services and provide
         a range of other services for members. Also, the strongest argument in favour of developing
         the co-operative structure is the ability of collective organisations to provide greater
         bargaining power in dealing with milk processors and, as a result, to obtain better prices for
         members. By improving quality and consistency, reducing costs and improving
         management, co-operatives can increase the returns to small-scale farmers, and thus
         encourage producers to increase herd sizes and output. The establishment of centralised
         facilities for initial treatment and storage allows the costs of quality improvements, which
         would be beyond the financial reach of individual small producers, to be shared.
              In Asia, for example, development of the dairy sector in recent decades has in a number
         of cases involved the development of a tiered structure of co-operatives, with local-level or
         primary co-operatives providing basic collection, storage and transport services, while
         secondary- or tertiary-level federations of co-operatives provide marketing, training,
         bargaining, standardisation and other functions across a wider geographical area, or even at
         national level. In some cases, governments have provided representatives on the boards of
         directors of local co-operatives, with the remainder being elected from among local producers.
         Government representatives, often with expert knowledge such as veterinary skills, can act to
         guide local management, at least in the early stages of development of the co-operative.
             There are a number of other areas in which governments can assist in the
         development of co-operative structures. These might include providing information and
         simplifying the task of establishing a co-operative, for example by making available
         standardised legal agreements and recommended management structures. Expert advice
         could be provided by local or regional government departments responsible for veterinary
         services or regulatory issues. The provision of grants or low-cost credits to cover start-up
         expenses and provide initial investments in shared facilities would also help to encourage
         the development of co-operatives. Specialised training courses in management, animal
         husbandry and other relevant skills would increase the chances of success. The
         government could also appoint regional or national-level federations to represent local
         co-operatives. These would be able to offer marketing and training services, set quality
         standards and negotiate on behalf of smaller co-operatives.

         Improving access to credit
             Several solutions could support the enhancement of access to finance. They include:
         microfinance, co-operative banks, credit guarantee schemes, and supply chain linkages.


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III.6.    FOCUS ON THE DAIRY VALUE CHAIN



                   Microfinance programmes support mainly informal activities with a low return and
              limited market demand. They could provide lending specifically targeted to the needs of
              households, small farmers and dairy producers, allowing them to purchase higher quality
              inputs, upgrade working capital and increase the size of herds. Reaching critical mass, with
              at least 5 cows, is considered essential in order to attract the interest of dairy processors
              and benefit from their assistance schemes.
                  At the moment few micro finance institutions are active in Ukraine, with a loan
              portfolio of only USD 268 million in 2009. ProCredit Bank is the biggest player, with
              25 500 active borrowers in 2009, according to the Microfinance Information Exchange. New
              microfinance schemes could be encouraged to promote dairy businesses, following the
              example of other emerging markets where well designed microfinance services
              contributed to increased incomes and stronger employment generation.
                   Thanks to their proximity to customers, co-operative banks could play an important
              role in local and regional financing, pooling resources from their members and channelling
              personal savings to provide mutual credits. Co-operatives could provide funding to milk
              producers at a lower interest rate, compared to those of commercial banks.
                   Credit guarantee schemes could alleviate the high collateral requirements requested by
              financial institutions and reduce information asymmetries between banks and small and
              medium-sized farmers who do not have a long credit history and are unable to provide
              information on their creditworthiness (Figure 6.19). Three aspects need to be monitored to
              ensure the desired results: i) regulation and supervision; ii) the role and involvement of the
              private sector; and finally iii) the appropriate design of credit guarantee schemes (OECD, 2010).


Figure 6.19. Credit guarantee schemes are a way to foster access to finance for mid-size farmers
         A way to bridge the gap between SMEs and banks                                      A mechanism creating a win-win situation
          Purpose: help small, credit-worthy companies which
         might otherwise fail access financing of working capital
         or investment due to lack of collateral or of credit history.                                       Bank loan
          Mechanism: a guarantee against default of the SME is                     SMEs                                                Banks
         issued by a sponsor to the lending bank:
              – In the vast majority of cases, the SME reimburses
              the loan and has only paid a small guarantee commission                   Guarantee           Guarantee
              to the sponsor.                                                           commission           Scheme               Guarantee
              – In case the SME defaults, the sponsor pays out all or a                 (fee)
              portion of the loan, usually 50-80%, to the lending bank.
                                                                                                     Counter Guarantee Financial Support
         Several types of sponsors can be considered
                                                                                     State           Legal environment and framework
          State budget, private investors, international financial
         institutions.

                                                                                      Establishing a guarantee system in transitioning economies
                                                                                       requires political support and budgetary State involvement

Source: England’s Financial Service Authority (2005), “A Framework for Guarantee Schemes in the EU”, a discussion paper, London;
European Training Foundation (2010), Labour Market Needs and Employability: Trends and Challenges in Armenia, Azerbajan, Belarus, Georgia,
Republic of Moldova and Ukraine, ETF, Turin.


                   The introduction of supply chain linkages could encourage lending to weaker players
              in the value chain, such as small and medium-sized farmers, by milk processors
              (Figure 6.20). Risk could be shared between farmers and processors, with one side
              providing funding, technology and know-how in return for a reliable supply of milk. This
              would raise the market participation of smaller farmers and strengthen co-operation
              between different players across the value chain, aligning their interests and requirements
              in terms of volume, quality and security of supply. Such linkages would reinforce the
              loyalty of farmers and encourage long-term commercial relationships (Wilner, 2000).


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                          Figure 6.20. Supply chain financing brings the financial
                          means of large or foreign firms to small-scale producers
                                                   Two examples of supply-chain financing schemes
                               • Guarantee on loans by the supplier
                                                        Processor


                                                                                          Sales

                                                 Guarantee                                            Farm


                                                                                Loan

                                                          Bank


                               • Direct loan from the processor to buy inputs

                                                        Processor

                                                                                  Sales

                                                                                                      Farm

                                                                                  Proceeds                         Inputs


                                                             Bank                                 Input Supplier

                                                                                 Advance payment
                         Source: Professor Swinnen, OECD Agribusiness Workshop, 14-15 October 2009, Paris.


         Evidence from the Asian financial crisis of the late 1990s suggests that, during periods of
         collapse in bank credit, supply chain financing compensated for the lack of funding in the
         system (Love et al., 2007) especially for short term financing. A recent example of supply
         chain financing in Ukraine is a project worth EUR 2 million in low rate credits for dairy
         producers initiated in 2011 by Danone, a French food-products multinational, and Index-
         Bank, a universal bank owned by the French Credit Agricole group. Index Bank will provide
         loans at an annual rate of 16-19% to famers and producers supplying milk to Danone. The
         French food group will reimburse farmers for up to half of the interest charges. The funding
         will be channelled to projects aiming at increasing herd sizes, renovating equipment, and
         improving milk quality (US Ukraine Business Council, 2011).



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Competitiveness and Private Sector Development: Ukraine 2011
Sector Competitiveness Strategy
© OECD 2012




                                                    Chapter 7




         Energy-efficiency and renewable
        technologies: Focus on production
           of energy based on biomass


         This chapter provides an in-depth analysis of biomass heat and power generation in
         Ukraine. Examining the demand and supply sides, it explains why the biomass value
         chain is promising for private domestic and foreign investors given domestic and
         global trends. It identifies the role that foreign investors could play along the value
         chain, for instance in producing heat and power or in the designing and engineering
         of plants. It also presents key issues and policy barriers hindering competitiveness in
         the sector and proposes a prioritised list of policy recommendations.




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Summary
                Energy efficiency technologies include several applications along the energy value
           chain, steps including production, transmission and distribution, and industrial and
           residential consumption. Within energy production, the use of alternative (non-fossil)
           sources of energy has emerged as one of the most interesting sectoral case studies for
           Ukraine. In particular, heat and power production based on biomass was identified as a
           pilot sub-sector. The sub-sector covers a whole range of activities from the collection of
           residues and wastes, through their processing, transportation and storage, to their
           combustion in order to produce heating and electricity. Finally, the distribution of the
           produced energy is considered as well.
               The use of biomass for production of energy has been pioneered by the US and the
           Nordic countries, such as Denmark, Finland and Sweden, for small-scale heating and for
           industrial use. Starting in the 1980s, biomass has also been increasingly used for district
           heating. In 2006, about 10% of global primary energy demand was met by energy from
           biomass (OECD, 2010). Power and heat production based on wastes and biomass has
           become increasingly profitable and private sector driven, due to the increase in prices of
           other traditional sources of energy.
                Experiences in several OECD countries, including Sweden and Poland, show that
           governments can take several steps to stimulate the establishment of a biomass-based
           energy production sector. On the demand side, a government strategy that stimulates
           awareness and quick adoption of this alternative energy, including but not limited to tax
           policy, allows for the necessary investments and organisational measures that in turn
           stimulate the development of the sector. On the supply side, the development of an easily
           accessible distribution infrastructure (electricity grid, district heating network) seems to be
           a key factor for the development of this market. The organisation and regulation of the
           whole value chain is also a facilitator. For example, the creation of a market for agricultural
           residues, the establishment of organisations of biomass producers and of equipment
           manufacturers, and promotional activities to increase awareness are all factors that have
           allowed for development of this sector.
               Ukraine has high potential for energy efficiency technologies as its energy efficiency is
           only one third of the average for industrialised countries. This reflects a combination of: a
           bias towards energy-intensive industries, such as cast iron, steel, cement and chemicals;
           the use of out-dated technologies, both in industries and in energy transit infrastructures;
           and low energy prices. Ukraine’s abundant agricultural waste and increasingly expensive
           fossil energy could be the basis for the future development of energy production based on
           biomass. Biomass resources are widely and conveniently available from a sizeable
           agricultural and forestry sector. The economic potential of crop wastes has been estimated
           by the National Academy of Sciences of Ukraine at 14 million tonnes of coal equivalent per
           year (around 60% of Ukraine’s measured heat production). The planned convergence of
           natural gas import prices to Western European levels, agreed by the government with the


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         IMF under the stand-by arrangement, should further increase the attractiveness of
         renewable energy sources.
             However, administrative barriers substantially limit investment opportunities in the
         sector, and a national plan defining the role and objectives of biomass in the energy
         landscape is still lacking. One of the consequences is limited communication and low
         awareness among farmers, industrial companies and utilities about the possible use of
         biomass. Development is also held back by the lack of access to capital for most players,
         indebtedness of local utilities and arrears in payments by consumers. As a result, today
         fossil fuel-based boilers and combined heat and power plants still dominate the market
         and produce more than 80% of heat supply in Ukraine.
               A strategy for this sector could be based on attracting:
         ●   domestic and foreign utilities in rural and peri-urban areas;
         ●   biomass-related equipment production companies and services;
         ●   investors in agriculture and forestry, who might be interested in the sale of by-products
             and waste-streams as a means of diversifying or complementing their core activities.
             The suggested priority area for reform in this sector is investment policy and
         promotion. Administrative hurdles to investments in the field should be lifted. Specifically,
         focus should be on streamlining the administrative processes (e.g. permits), implementing
         a single-window approach for investors, and creating a pre-approval process for green
         tariffs. A sector-specific plan should be defined by the government, spelling out a long-
         term strategy for development of biomass-based energy production, and a mid-term action
         plan including, for example, support mechanisms, R&D and infrastructure investments,
         and specific measurable targets (e.g. biomass as a percentage of total energy production).
         Other areas for reform are related to the overall energy sector, including alignment of
         prices, market regulation, solution of the payment arrears problem and privatisation.

Why focus on production of energy based on biomass
         The need for energy efficiency
              Ukraine has high potential for energy efficiency technologies as its energy efficiency is
         one third of the average for industrialised countries (Figure 7.1). This reflects a combination
         of a bias towards energy-intensive industries, such as cast iron, steel, cement and
         chemicals, the use of out-dated technologies, both in industries and in energy transit
         infrastructures, and low energy prices.
              Within the energy sector, key sectors with the potential to improve energy efficiency
         and develop alternative sources were identified. Traditional technologies for energy
         production, alternative technologies, and the transmission and distribution system were
         all evaluated (Figure 7.2).

         Traditional energy production, transmission and distribution activities 
         are still dominated by state ownership
              Natural gas production, transportation and distribution activities are dominated by
         the state-owned sector. Gas usage and losses in the transportation and distribution
         systems are higher than in equivalent OECD countries. There is a need to reduce
         operational costs and to modernise distribution infrastructures: for example, more than
         8 billion cubic meters of gas are spent each year in the transport system, representing a
         cost of more than USD 1.5 billion.


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                                 Figure 7.1. Energy intensity, a cross country comparison
                                        Tonnes of oil equivalent per thousand USD of value-added, 2006
            0.50

             0.45

             0.40

            0.35

            0.30

            0.25

            0.20

             0.15

             0.10

             0.05

               0
                      OECD-Europe           World        Poland        Czech Republic            Belarus          Russia             Ukraine

           Source: International Energy Agency (IEA) (2006), Energy Policy Review Ukraine, IEA, Paris.


                               Figure 7.2. Opportunities to reduce energy-intensity
                        and to develop alternative sources of energy along the value chain

                    Traditional and alternative                                                              Industrial and residential
                                                          Transmission and distribution
                        energy production                                                                          consumption


               Improving the energy efficiency            Reducing network losses                          Reducing the energy-intensiveness
               of traditional productions                                                                  of the industry
               Gas production                             Distribution of gas and gas products             Metallurgy
               Oil production                             Distribution of oil and oil products
               Coal production                            Transmission and distribution
                                                          of electrical power
               Heat and power production based
               on nuclear, gas, oil, coal, large hydro                                                     Reducing the commercial, public
                                                          Heat distribution                                and individual energy consumption
                                                                                                           Buildings technologies – insulating
               Leveraging alternative sources
                                                                                                           materials, appliances to monitor
               of energy
                                                                                                           and regulate heating consumption
               Energy production based on biomass,                                                         Transportation sector –
               wind, small hydropower, geothermal                                                          automotive industry
               energy, sun energy

Source: OECD (2010), Ukraine Sector Competitiveness Review, internal working document, OECD, Paris.


                Natural gas extraction, transportation and distribution are still heavily regulated and
           controlled by the government. Naftogaz Ukraine, a company fully owned by the state,
           dominates the gas value chain in Ukraine (Figure 7.3). The government has direct access to
           reserves and infrastructure, pricing and tariff setting, import and export transactions.
           Moreover, administrative procedures for granting exploration and production licences are
           cumbersome for foreign investors (IEA-OECD). A new gas law was passed in August 2010
           giving access to the distribution network to potential gas producers, but it remains to be
           seen whether implementation will prove effective.
                There are also substantial opportunities for improving energy efficiency in oil
           production, distribution and refining activities. Unlike oil refining and distribution, which
           are controlled by powerful private domestic and Russian players, oil production is fully
           owned by the state. State-owned Naftogaz dominates exploration and production, as well
           as the main oil pipelines (Figure 7.4). Oil exploration and production equipment is old and


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           Figure 7.3. Naftogaz (100% owned by the state) dominates the gas-value-chain
                                           in Ukraine

                 UPSTREAM                                     MIDDLESTREAM                                               DOWNSTREAM

                Exploration and
                  production                        Transmission                  Processing                        Distribution and trade


                                               Monopoly through                One major player                  Full ownership of the pipes,
            > 92% of the production
                                                2 subsidiaries                in gas processing                   shares in a majority of the
                                                                                                                    42 privatised regional
                                                                                                                   distribution companies


         Source: International Energy Agency (IEA) (2006), Energy Policy Review Ukraine, IEA, Paris; OECD (2010), Ukraine Sector
         Competitiveness Review, internal working document, OECD, Paris.


               Figure 7.4. State-owned Naftogaz dominates exploration and production,
                                   as well as the main oil pipelines

                 UPSTREAM                                     MIDDLESTREAM                                               DOWNSTREAM

                Exploration and
                  production                        Transmission                   Refining                         Distribution and trade


            > 95% of the E&P is due             State monopoly                Private and foreign               Private and foreign (Russian)
               to state controlled                  through                  (Russian) companies                  companies control most
                  companies –                    Ukrtransnafta                own the 6 refineries                     filling stations
              Naftogaz of Ukraine                                           with some state shares
                   (Ukrnafta,                                                                                     State-owned companies –
              Chornomornaftgas),                                                                                 Ukrnafta, Naftogaz – have a
                Nadra of Ukraine                                                                                 share of the oil retail market

         Source: International Energy Agency (IEA) (2006), Energy Policy Review Ukraine, IEA, Paris; OECD (2010), Ukraine Sector
         Competitiveness Review, internal working document, OECD, Paris.


         inefficient and requires upgrades. Oil refining technologies are also outdated. The depth of
         processing varies between 47 and 70% in Ukraine, while it reaches 90% in OECD countries.
             Worn-out and inefficient coal production equipment provides opportunities for
         improving the efficiency of coal mine operations, especially in state-owned mines. Further
         efficiencies can be achieved by utilising coal-bed methane, which is currently wasted. The
         state owns over 150 coal mines producing only half of the volume of coal, which is primarily
         used for power plants (Table 7.1). The other half is produced by 30 more competitive private
         mines, primarily producing coking coal for metallurgy. State-owned coal production in
         Ukraine is currently unprofitable and needs financial support from the government.


                                  Table 7.1. The distribution of Ukraine’s coal mines
                                             Features of State-owned and Private-owned mines

                                                                   Ukraine’s coal sector

                                      State-owned                                                              Private

                                      > 150 mines                                                           < 30 mines
                            Mainly coal for power plants                                             Mainly coking coal mines
                          Half of Ukraine’s coal production                                       Half of Ukraine’s coal production

         Source: International Energy Agency (IEA) (2006), Energy Policy Review Ukraine, IEA, Paris.




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                Mining and geological conditions in Ukraine’s mines make profitable coal extraction
           difficult. Average coal prices are below short-term production costs because of rapidly
           increasing prices of mining equipment and operating costs. Thus, in order to support
           production the government is forced to provide subsidies. Privatisation of state-owned coal
           mines is a possibility in the medium-term, but would raise political risks due to the
           possibility of redundancies and associated social issues.
                The efficiency of power plants needs to increase. Ukraines thermal power plants tend
           to be quite inefficient due to excess capacity and age. The average load factors for thermal
           power plants are very low, measuring just 28% in 2004 compared to 70% in 1990.
                The nuclear and large-hydro power generation sectors are not open to private and foreign
           investment. To a large extent, state ownership still prevails in power generation, with 100%
           state ownership of nuclear facilities, 85% ownership of thermal stations and 99% ownership of
           hydropower plants. Privatisations of thermal power assets might happen in the coming years,
           according to the economic reform plan of the president, but the timeline remains unclear.
                The electricity market is highly regulated with wholesale prices for nuclear and hydro
           generation set by NERC, a special agency that regulates energy prices and tariffs. At the
           moment, regulated tariffs are still not high enough to cover depreciation or re-investment
           in power system assets. There are also opportunities for improving efficiency in the power
           transmission and distribution sector. The losses of electricity during transmission and
           distribution in Ukraine amount to about 15% (8% in 1990), compared to 6% in the OECD
           countries. According to Ukraine’s State Agency for Energy Efficiency and Energy Savings, at
           the beginning of 2011 the actual technical loss of electricity in the grid dropped to 10.7% of
           the overall electricity supply. Currently, power transmission is fully controlled by the state,
           while distribution activity is shared between private and public ownership (Figure 7.5). One
           domestic private investor has a significant degree of control over the market, owning up to
           75% of shares in ten distribution companies, which may make it difficult to build a level-
           playing field for potential newcomers.


                        Figure 7.5. State and private ownership of power transmission
                                     and distribution assets until mid-2011

                                    Transmission                                          Distribution and supply

                   Ukrenergo is a 100% state-owned company                14 oblenergos are state-controlled
                                                                           7 oblenergos are partly state-owned
                                                                           6 oblenergos are fully controlled by the private sector
                                                                           3 independent suppliers are owned by private
                                                                             industrial companies

           Source: International Energy Agency (IEA) (2006), Energy Policy Review Ukraine, IEA, Paris; OECD (2010), Ukraine Sector
           Competitiveness Review, internal working document, OECD, Paris.



                However, there are a couple of successful case studies. The distribution companies
           owned by foreign investors have a very good track of record of reducing losses from electric
           power lines. AES, a US company, has been making large investments in its distribution
           lines and billing systems, totalling around USD 80 million during 2003-09.




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         Alternative sources were selected with a focus on production of energy based 
         on biomass
              The dominant presence of the state in most existing energy sub-sectors, high
         administrative barriers to entry in most markets, and consultations with stakeholders led
         to the final selection of alternative sources of energy. The low level of state ownership and
         relatively lower barriers to entry were the key reasons for such a choice.
              Production of energy, and in particular of heat and power, based on biomass was
         selected as a pilot sub-sector on the assumption that gas prices will continue to increase as
         expected by the government. In the initial stages, government intervention in this sector
         would be required to define a strategy and launch some pilot projects; however, the
         economic viability of the biomass sector is sustainable without major government
         subsidies. This was a key selection factor, as private players would not be interested in a
         sector highly dependent on uncertain public subsidies.
              Ukraine’s abundant agricultural by-products and the rise in fossil energy prices are the
         two elements that are likely to drive the future development of energy production based on
         biomass. Biomass waste and residues are widely and conveniently available from the
         sizeable agriculture and forestry sectors. Straw, manure and wood are especially promising
         as primary biomass sources of heating. The economic potential of crop wastes has been
         estimated by the National Academy of Sciences of Ukraine at 14 million tonnes of coal
         equivalent per year. Thus, the use of primary agricultural residue could partly satisfy
         increasing heat consumption needs and replace traditional heat production systems. At
         present, fossil fuel-based boilers and combined heat and power plants still produce more
         than 70% of the heat and power supply. With natural gas prices expected to increase further
         as a result of the price reform in the internal market, the use of natural gas for production of
         heat and power will become very expensive. Global prices for other fossil fuels, such as oil
         and coal, are also expected to rise in future. In contrast, renewable sources of energy, such as
         hydropower, geothermal, wind and solar energy and biomass energy, are nearly limitless.
         Generation of energy from renewable sources avoids damaging the climate and environment
         by eliminating emissions or, in the case of biomass, by recycling the carbon.

Sector definition and segmentation
             The OECD (2010) defines biomass as “any organic material of plant and animal origin,
         derived from agricultural and forestry production and resulting by-products, and from
         industrial and urban wastes, used as feedstock for producing bio-energy and other non-food
         applications”. Biomass involves different technological processes and areas of application.
         Energy generation from biomass is very flexible in terms of production scale. The size of
         production facilities can be matched to the needs and requirements of consumers and can
         range from private small-scale installations to industrial multi-megawatt operations.
             The biomass and waste energy production value chain includes three stages: fuel supply;
         production; and the sale of heat, hot water or electrical power. The supply stage includes
         collection of various types of agricultural and municipal residues, their transportation,
         processing and preparation, and transportation and storage at the power generation facility
         (Figure 7.6). Biomass potential of crop origin is not addressed in this study.*



         * This kind of study would require an assessment of the potential adverse effects on arable land
           fertility or food prices.

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                                       Figure 7.6. Biomass residue supply chain for energy production
                                                             Biomass supply                                                Production          Sale
                             Collection                            Processing                                                 Combustion-
                             of residus                                or                                                      production       Sale of heat
                                                 Transport                               Transport               Storage                        or hot water
                            and wastes                             preparation                                                  of heat or
                                                                                                                                hot water


                        Agricultural             Truck              Pressing            Truck                 Tank             Burning         Own use
                        by-products
   TYPICAL OPTIONS




                          Forestry                                                                                           Gasification      District
                        by-products             Tractor              Drying             Tractor             Storehouse
                                                                                                                             and burning       heating


                         Municipal           Conveyor belt           Mixing          Conveyor belt             Silo                          Rural heating
                        by-products



                                                                                                               Pile                           Industrial
                                                                                                                                               heating
   PRODUCTS




                                          RESIDUES AND WASTES
                                                                                                     FUEL
                                                                                                                                  HEAT OR HOT WATER

Source: OECD (2010), Ukraine Sector Competitiveness Review, internal working document, OECD, Paris.


                            Heating and combined heat and power plants (CHP) can use different types of
                       biomass, including hay, grass, peat, and wood as well as waste. Industrial heating systems
                       are usually based on waste generated by their own production processes and may include
                       paper, manure, wood waste and other materials. The use of traditional stoves and open
                       fireplaces is on the decline as it has very low energy efficiency of 20-25%. Modern biomass
                       boilers provide much higher efficiency in the 70-80% range. They also offer relatively clean
                       combustion and can use different types of fuel, such as wood logs or pellets.
                            Biomass can also be used along with coal in co-firing systems for either power
                       production or for heat and CHP production (Table 7.2). Requiring moderate initial
                       investments, this option could be considered in the near term as it uses existing facilities
                       that require only minor modifications. It is the most competitive option for using biomass
                       in power generation (IEA, 2007). Several OECD countries, including Australia, Denmark,
                       Finland, the UK and the US, have successfully promoted co-firing, and this has proven to be
                       a key initial step in encouraging the development of a biomass market as well as improving
                       the necessary technical expertise.

Global trends
                       Renewable sources of energy play an increasingly important role and biomass 
                       is amongst the most dynamic segments
                            Renewable energy sources are playing an increasingly important role in meeting
                       energy needs across the world. Not only do they reduce dependence on fossil fuels but they
                       also help to protect the environment by reducing greenhouse gas emissions, create new
                       jobs and contribute to economic development.
                             Rapid development of the emerging economies, especially China and India, will drive
                       future demand for all types of energy sources. Rising prices of fuel and energy for the end
                       consumer, high carbon emission penalties and environmental protection policies will



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                                                      Table 7.2. Energy uses of biomass
Scale                       Use                                             Type of heating       Features

Small scale heating and     Traditional stoves and open fireplaces          Individual heating    Often low level of efficiency 20-25%
hot water applications,
                            Modern biomass boilers                          Individual heating    Energy efficiency around 70-80%
capacity < 1 MW/th
                                                                                                  Relatively clean combustion
                                                                                                  Larger installation used for heating of flats
Large scale applications    Biomass fired CHP plants for district heating   Power and heat        Fuels are hay, grass, peat, wood
                                                                                                  Interesting alternative in the modernisation of DH grids
                            Biomass boilers for district heating            District heating      An alternative in converting coal fired DH plants
                                                                                                  Smaller installations used for block heating
                            Industrial heating biomass boilers              Industrial heating    Fuels are waste products coming from the production process:
                                                                                                  paper, sawmills, manure from cattle farms
                                                                                                  Larger installations might be used for small scale DH
                            Co-firing                                       Power and heat        Moderate additional investment required
                                                                                                  Efficiencies up to 45% is the most cost-effective biomass use 
                                                                                                  for power generation

Source: Van Holsteijn en Kemna (VHK) (2002), “Heat from Renewable Energy Sources”, The RES-H Initiative and related Directives, VHK.,
No. 332, the Netherlands.


           partially restrain energy demand growth. At the same time, these developments will
           stimulate the growth of renewable energy, and biomass in particular. In OECD countries
           energy supply from biomass increased 7.8 Exajoule (EJ) in 2006 from 5.5 EJ in 1990. The
           share of energy produced from renewable sources in the world total energy supply equalled
           12.4% in 2007 (Figure 7.7) with energy generated from renewable combustible and waste
           materials accounting for 9.6% of the total.

                          Figure 7.7. Structure of the global total primary energy supply, 2007

              Natural gas, 20.9%
                                                                                    Non-renewable waste, 0.2%

                                                                                    Nuclear, 5.9%
                                                                                                                  Hydro, 2.2%


                           Oil, 34%
                                                                                                                  Renewable
                                                                                                                 combustibles
                                                                                                                and waste, 9.6%



                                                                                    Coal, 26.4%                   Other1, 0.6%




           Source: IEA (2009), World Energy Statistics, IEA, Paris.


                Looking at the application of biomass for production of energy, different forms of
           biomass are used for different purposes across sectors. According to available data, about
           25% of biomass was used for generation of heat and power, about 30% in the residential
           sector and about 46% in industrial applications in 2006. At the same time, liquid biomass is
           largely used for the production of fuel for the transport sector and biogas consumption is
           concentrated in the heat and power generation sector (OECD, 2010).
               Although the availability of data on the renewable sector is still rather limited, the
           majority of biomass in non-OECD countries is still used in the residential sector, while
           OECD economies have the leading position in the application of biomass for energy


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           production. Generation of heat and electricity from both liquid and solid biomass has been
           increasing steadily for the past 2-3 decades.
               There is a wide variation in the use of renewable sources both among developed and
           developing countries. Among the OECD countries, more than 75% of energy consumed in
           Iceland comes from renewable sources, while in Korea it is only 1%.
               Renewable combustibles and waste account for over 77% of the total renewable energy
           supply, 72% of which is generated from solid biomass and charcoal (Figure 7.8). The share
           of energy produced from biomass in the OECD countries has been higher than energy
           produced from other renewable sources since 2003.

                    Figure 7.8. Structure of world renewable energy sources supply, 2007

                                                                                                                   Liquid biomass,
                                                                                                                   2.40%
                   Wind, 1.00%
                                                                                                                   Renewable MW,
                                                                                                                   0.90%

                                                                                               Solid
                  Hydro 17.70%                                                               biomass/
                                                                                             charcoal,
                                                                                              72.90%
              Solar, tide, 0.60%
             Geothermal, 3.30%


                     Renewable                                                                                     Gas from biomass,
               combustibles and                                                                                    1.10%
                 waste, 77.30%

           Source: IEA, (2007), “Biomass for Power Generation and CHP”, IEA Energy Technology Essentials, Paris.




                     Box 7.1. The case of biomass adoption in district heating in Sweden
                The use of biomass in Sweden increased by 88% between 1980 and 2002. During this
              period biomass application increased considerably and reached 14% of the total energy
              produced in the country. The application of biomass in district heating increased
              substantially and in 2002 about 43% of district heating was based on biomass.
                The existence of a large forest industry and well developed district heating systems
              provided a good organisational basis for the biomass expansion. The growth of the sector
              was assisted further by the existence of structures that could handle products from the
              forestry sector and strong and stable demand from the district heating systems.
                Higher demand for biomass has in turn led to reduced production costs as new methods
              and technical solutions for biomass were continuously introduced during the last decade.
              Heat production plants benefitted from the growth of the biomass market and the
              emergence of new suppliers.
              Source: Bengt Johansson (2001), “Biomass in Sweden – Historic Development and Future Potential Under New
              Policy Regimes”, Energy and Environmental Systems Studies, Lund.




           Proximity of resources and stability of supply are key to ensuring profitability 
           of a biomass project
                One key success factor at the supply stage is related to the intrinsic physical
           characteristics of biomass. The low energy density of biomass means that a considerably
           larger volume is required to generate the same amount of energy compared to fossil fuels.
           High moisture content increases the weight of fuel and raises the cost of transportation.

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         Biomass fuels in their raw form are typically consumed on site or transported over short
         distances, within a 50-80 km radius as a maximum, depending on transportation costs. As a
         result, collection and transportation represent a major cost for suppliers of biomass material.
              Key success factors for the expansion of the biomass sector include the creation of a
         reliable supply and stable market conditions. In order to operate biomass-based power plants
         efficiently, operators require a stable supply of fuel throughout the year as well as clear and
         predictable prices. In many cases the lack of raw materials is the key barrier. Lack of feedstock
         for the production of wood pellets in many EU countries has led to a reduction in production
         volumes during the last few years. However, lack of raw materials should not be a problem for
         countries with large agricultural, forestry and wood processing sectors. Rather, governments
         have to facilitate the development of suppliers, perhaps by means of demonstration projects.
         Also, in order to overcome the seasonality of biomass supply, appropriate storage facilities for
         feedstock have to be built, requiring high initial investments.
              Key success factors for profitability at the next stage are related to the distribution
         costs of heat and power generated from biomass (Figure 7.9). The required investment in
         distribution should be minimised as heat distribution or electrical power transmission and
         distribution networks should be present prior to the installation of a bio-heat plant.
         However, some investment in better insulation in the network and other energy-saving
         measures might be necessary in order to reduce losses of heat during transmission and to
         improve efficiency of distribution. There may also be a need to invest in connections to the
         national electricity grid.

                               Figure 7.9. Key success factors for a bio-energy project

                       Biomass supply                      Production of heat/power                           Sale


               Biomass fuels must typically be        Supplies of biomass must be stable      The heat or electrical power network
              consumed on-site or transported             to ensure stability of heat         should exist prior to the installation
                  on short distances only                    or power production                     of a bio-energy plant



                  Biomass has a low energy              High utilization rate will ensure       Investments in energy networks
                          density                         stability of heat production         distribution should be minimized
                                                         and shorter pay-back period


                 A significantly larger volume        Existence of market instruments, i.e.     Distribution costs should not be
            of biomass fuel is required to generate    long-term contracts with farmers,       higher than fossil-fuel based heat
             the same energy as a smaller volume      ensure stable biomass supplies with            and power production
                         of fossil fuel                clarity and predictability of prices


                The costs of fuel collection and       Storage capabilities near the plant
             transportation can quickly outweigh       allow to overcome the seasonality
                     the value of the fuel                   of the biomass supply


         Source: Hurstboiler (2010), Corporate website www.hurstboiler.com, accessed 15 June 2010.


Sources of competitiveness
         Biomass resources are widely available in Ukraine
             Ukraine’s agricultural sector is a rich source of biomass, including straw from grain
         crops and rapeseed, residues from the production of corn for grain, residues from the
         production of sunflowers, secondary agricultural residues (sunflower and rice husks, sugar
         bagasse), wood residues, and peat (Table 7.3).


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                      Table 7.3. Straw, wood, husk and manure as primary biomass sources
                                            are promising in Ukraine
            Biomass
            residue      Origin                                                                   Final use
            source

            Straw        To conserve humus for soil fertility, straw is left on the field        The straw surplus can be used as fuel in small straw-fired boilers
                         after harvesting if it is not needed for livestock.                     and in straw-fired district heating plants.
                         But this is not mandatory in a well-planned crop rotation.
            Wood         Sawmills, pulpmills, and other wood processing industries                Residues can be made into wood-chips or pellets to fire boilers.
                         generate bark, sawdust, wood chips and other residues.
                                                                                                  The energy produced can help to meet the heating needs of the
                                                                                                  wood industry or be sold to wood-fired district heating plants 
                                                                                                  or Combined Heat and Power plants.
            Manure       National cattle and swine herds of approximately 17 million              The manure can be used in biogas plants to provide heat in
                         animals.                                                                 small-sized plants for households, villages or in modern plants
                                                                                                  supplying thousands of people.
                         Animal manures are typically disposed of through application            The resulting sludge at the end of the process could be used as
                         to farmlands as organic fertilisers.                                     fertiliser since the nitrogen and phosphorous content is not lost.

           Source: Institute for Economic Research and Policy Consulting (2007), “Bioenergy Production in Ukraine: The
           Competitiveness of Crops and Other Raw Materials from Agriculture and Forestry”, Policy Paper, No. 11, Institute for
           Economic Research and Policy Consulting, Kyiv.


                In terms of regional distribution, all regions except the western part of the country and
           the Crimean peninsula have high economic potential for development of energy generation
           based on agricultural residues. This primarily correlates with production of wheat and
           sunflowers, which are the primary sources of agricultural residues, however it is also
           influenced by other factors, such as the quality of the soil and the region’s climate.
               According to the National Academy of Science of Ukraine, the economic potential of
           crop wastes is estimated at 14 million tonnes of coal equivalent per year. For example, this
           would imply that primary agricultural residues could potentially replace more than half of
           the measured fossil fuel consumption for heating (Figure 7.10 and Box 7.2). Ukrainian
           government experts estimate that up to 1.4 million cubic meters of wood, 1.1 million of
           cubic mters of wooden waste and 3.8 million cubic meters of firewood could be annually
           used for energy purposes.

           Biomass residue use is cost competitive for production of heat and power
                Wide availability of biomass resources further ensures a cost advantage, mainly due to the
           low cost of raw materials, labour and transportation. For example, under certain assumptions,
           heat produced with straw-based boilers is 67% cheaper than using a gas-fired unit (Figure 7.11).


                     Figure 7.10. Economic potential of biomass sources in 2008, breakdown
                       by type of agricultural residue, millions of tonnes of coal equivalent
                Residues from sunflower                                                                                                                 4.48

             Residues from corn for grain                                                                                                           4.31

                            Straw of wheat                                                          2.17

                    Straw of other rapeseed                                                       2.06

                            Straw of barley                         0.83

               Straw of other grain crops              0.30

                                               0           1          1           2           2            3          3          4          4          5         5

           Source: Institute of Engineering Thermophysics – National Academy of Science in Ukraine (2010), BEE FP7 Project, Kyiv.

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                                  Box 7.2. Assessing the biomass potential of a country:
                                        From “theoretical” to “economic” potential
            Theoretical potential
              The overall maximum amount of biomass which can be considered theoretically
            available for bio-energy production within fundamental bio-physical limits.

            Technical potential
              The fraction of the theoretical potential which is available under the existing techno-
            structural framework conditions and with the current technological possibilities, taking
            into account competition with other land uses (food, feed, fibre production), ecological and
            other-non-technical constraints.

            Economic potential
             The share of the technical potential which meets criteria of economic profitability
            within the given framework conditions.
            Source: Zhelyezna, T. and V. Leznova, (2008), Presentation of the EC FP7 Project “Biomass Energy Europe”,
            Presentation at the 4th International Conference on Biomass for Energy, 22-24 September 2008, Kyiv.




                     Figure 7.11. Production costs of heat by straw-based boilers are lower
                                            than by gas-fired boilers
             Operational costs of heat production, using a 600 kW boiler, natural gas vs straw-wheat crop residue,
                                                      ‘000 hyrvnias, 2007

                                  Purchase of electrical power                Other operational costs                      Labor costs
                                  Technical maintenance                       Fuel purchase
           400
                                                10
           350                                  15
                                                25
           300                                  26


           250

           200
                                               293                                                                5
           150                                                                                                   13
                                                                                                                 25
           100                                                                                                   26
                                                                                                                 90
             0
                                            Gas-based                                                        Straw-based
                                              heater                                                            heater

                                                                     Gas-based heater                                Straw-based heater

           Number of utilisation days                                                    Half a year – 4 272 hours
           Fuel quantity needed                                      293 000 m3 of gas                               746 tonnes of straw
           Energy density                                              35 MJ per m3                                   16 MJ per tonne
           Fuel price                                            1 000 grivnas for 1 000 m3                      120 grivnas per tonne
           Electrical power consumed                                    25 000 kWh                                      13 000 kWh

           Total annual heat production                                                        2 204 Gkcal

         Note: Amortisation costs are not included.
         Source: Zhovmir, N. et al. (2007), “Al’ternativnoe teplosnabzhenie za schet ispol’zovanija solomy” (Alternative Heat
         Supply Through Use of Straw), Kommunal’noe khozjaystvo, No. 8, pp. 24-27, December.




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                Similarly, as Ukraine has considerable forest resources and a large wood processing sector,
           it can also use wood for heat generation. Wood-fired boilers for heat and hot water supply
           require a low upfront investment and ensure a 3-year simple pay-back period (Figure 7.13). For
           example the operation of a 6.0 MWh hot water boiler plant on wood biomass can generate
           operating profits of around 50% of annual heat sales revenues (Figure 7.12).


               Figure 7.12. Operating costs and profits of a hot water boiler based on wood
                         biomass for supply of a middle-size city, thousands EUR
                          Operating profit         Labor cost         Maintenance cost         Power cost       Wood-based fuel cost
             600

                                                                                                          283
             500


             400


             300
                                                                                          14
                                                                             18
                                                                44
             200


             100                             199


               0
           Source: Scientific Engineering Centre “Biomass” et al. (2004), Ukraine: Market Potential for District Heating Projects in the
           Ukraine and their Modernisation with Austrian Technology, The Austrian Energy Agency, Wien.


            Figure 7.13. Net cash-flow plan in the five first years of the project, thousands EUR
              400
                       Initial investment             283                    283                    283                  283
              200

                   0

             -200

             -400

             -600

             -800            -760

            -1 000
                             Year 0                 Year 1                  Year 2                 Year 3               Year 4
           Note: The technical, environmental and economic assumptions are the following: 6.0 MWh hot water boiler plant
           operating on wood biomass; availability of wood wastes and residues due to neighbouring forests; distance of
           transportation of wood and residues is no more than 10 km to obtain reasonable cost of wood biomass; existing hot
           water distribution network to households and companies; tariffs on the supplied heat – 4.03 EUR/GJ; heat supplied to
           the customers – 138 240 GJ; distribution losses – 20%; fuel consumption – 26 667 tonnes/year; cost of fuel (including
           transportation and processing) – 7.45 Euro/tonne.
           Source: Scientific Engineering Centre “Biomass” et al. (2004), Ukraine: Market Potential for District Heating Projects in the
           Ukraine and their Modernisation with Austrian Technology, The Austrian Energy Agency, Wien.




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         Increasing prices of natural gas in Ukraine should make biomass an even more
         attractive fuel to utilities
             With the vast majority of heat and power produced from fossil fuels, natural gas is the
         primary source of energy in Ukraine. Ukraine depends on imports for the majority of its
         energy supplies, including natural gas and oil (Figure 7.14); domestic production of gas
         meets only 25% of total demand.


                   Figure 7.14. Fuel used for power and heat production in Ukraine, 2006
                          Combined heat and power plants                                       Heat-only boilers


                               Coal, 6%

             Heavy fuel oil,
                      16%                                                    Coal, 32%



                                                                                                                   Natural gas,
                                                                                                                   55%


                                                    Natural gas, 78%
                                                                              Heavy fuel oil
                                                                              (mazut), 13%




         Source: International Energy Agency (IEA) (2006), Energy Policy Review Ukraine, IEA, Paris; OECD (2010), Ukraine Sector
         Competitiveness Review, internal working document, OECD, Paris.



              The growing cost of fossil fuels, especially oil and gas, should pave the way for using
         alternative fuels in power and heat production. As a result of the current gas reform,
         monitored by the International Monetary Fund, natural gas will become increasingly
         expensive in Ukraine and will gradually rise to reflect the current market price of the fuel
         after decades of subsidised prices. The IMF’s requirements for gas prices include:
         ●   gradually bringing domestic gas prices to import-parity;
         ●   50% domestic gas price increases for households and utility companies were
             implemented on 13 July 2010, effective 1 August 2010, with the next billing period;
         ●   a further 50% increase was planned in 1 April 2011, with semi-annual increases thereafter
             until import parity is reached for all categories of consumers, with automatic adjustment
             mechanism planned thereafter; however, in 2011 due to the gas price negotiations
             between the Russian Federation and Ukraine, the gas price increase was delayed;
         ●   most of the industrial prices are already at market levels, and preferential tariffs for
             various industries have been eliminated.
             According to World Bank estimates, prices of natural gas might increase by more than
         400% from 2009 until 2017 in Ukraine (Figure 7.15).

The role of foreign investors in the biomass value chain
             Ukraine offers a number of opportunities for foreign direct investment along the entire
         value chain of biomass-based heat and power generation, including supply of waste to utility
         companies, production of biomass burning equipment, design and construction of biomass-
         based heat and power utilities, and conversion of fossil fuel units to biomass (Figure 7.16).




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                  Figure 7.15. Price of natural gas for utilities in Ukraine, past trends according
                                                to IMF requirements

            2 500



            2 000
                                                                     + 125%
                                                                                                                            
            1 500



            1 000



               500



                           0
                                     End of 2008                Mid 2010            2nd quarter of 2011              2014                      2017

           Source: International Monetary Fund (2010), Country Report, No. 10/262, Country Report Series, International Monetary
           Fund, Washington, DC.


                                   Figure 7.16. Potential opportunities for FDI along the value-chain

                                       Biomass                                Production of heat and power                                        Sale
                                        supply



                                             Supplying             Supplying            Designing and            Construction            Owning and
                                           the agriculture      the equipments           engineering              of the heat         operating the heat
                                               wastes             for a heat or          the heat or             or CHP plant           or CHP plant,
                                                               CHP plant project          CHP plant                                   distributing heat



                                Large grain or         Boiler manufacturers   Engineering, procurement                      Utilities companies
             PRIVATE PLAYERS




                                sunflower                                     and construction companies                    producing heat or
             TO BE INVOLVED




                                                       Other equipments
                                producers                                                                                   electrical power
                                                       (heat exchangers)
                                Large cattle raising   manufacturers
                                farms
                                Wood producers
                                or processors




                                Acquisition of grain   Partial or total       Partial or total acquisition                  Privatisation of district
                                or cattle farms or     acquisition            of EPC companies with transfer of skills      heating companies and
                 POSSIBLE FDI




                                forestry companies     of a boiler            and technologies in biomass based heat        further conversion
                                with further effort    manufacturer with      and power utilities                           of fossil-fuel units
                                on sales of wastes     further focus on                                                     to biomass-based units
                                to utilities           biomass
                                companies              technologies
                                                       and equipments



           Source: OECD (2010), Ukraine Sector Competitiveness Review, internal working document, OECD, Paris.




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Key issues and policy barriers
         Regulatory framework and administrative complexity limit access 
         to utilities companies
              Private actors operating in Ukraine face an over-regulated and highly complex
         administrative and legislative framework, which limits private and foreign access to utilities
         companies. According to the Enterprise Surveys conducted by the World Bank (World Bank,
         2009), in 2008 the major constraints on investment in the country were political instability,
         high tax rates, endemic corruption, practices in the informal sector, and access to finance.
         According to the survey’s respondents, 31.8% of firms expected to have to pay officials
         informally to get things done, compared with an average of 23.5% in Eastern Europe and
         Central Asia. Nearly 60% of the firms surveyed expected to give gifts in order to obtain
         construction permits, twice as many as the eastern and central European average. On



                       Box 7.3. Example of foreign direct investment by AlterEnergyGroup
              Foreign investor overview: Swiss renewable utility company with its first operating asset
            located in the small city of Smela in Cherkassy.
              Investment characteristics: Full conversion in 2008-09 of a gas-fired CHP to a wood-fired
            CHP; Capacity – 10 MW/th and 2.5 MW/el; forest of Cherkassy ensures low-cost and
            stability of supply.
               Amount of investment – 1 million euro.
              Rationale for investment: “Ukraine was chosen due to the poor state of its existing power
            generating infrastructure, heavy reliance on imported and domestic hydrocarbon energy
            sources, abundance of vastly underutilised alternative energy sources, and lack of
            competitive barriers to entry”.

                                               Company structure and activities

                                                                        Corporate level



                                          JugEnergoPromTrans                                  SmelaEnergoPromTrans

                                Core focus is in power plant                        Legal entity for the Smela
                                engineering and construction as a contract          biomass based cogeneration
                                service provider with experience                    power plant located in Smela,
                                in electric power and water                         Cherkassy
                                heating systems



                                The JEP acquisition allows AEG                      The pilot biomass CHP is the first
                                to control the engineering,                         commercial wood biomass CHP
                                procurement, and construction (EPC)                 operating in Ukraine and proved that
                                of power generation projects                        foreign Direct Investment is
                                without incurring high cost                         viable in this specific sector
                                third-party EPC contracts



                          Designing and                                                            Utility’s ownership operations –
                                                      Procurement              Construction
                           engineering                                                             prod. and sale of heat and power


            Source: AlterEnergyGroup (2010), Corporate internet site, www.alterenergygroup.com/content/home.php?lang=en,
            accessed 15 June 2010.




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           average, 2.1 days were spent meeting Ukrainian tax officials, compared with an average of
           1.6 days in Eastern Europe and Central Asia. Another interesting indicator is the number of
           days required to obtain a construction-related permit, which was 135.6 days in Ukraine
           compared with 79.6 days in the region. The IFC, the private sector arm of the World Bank
           group, estimates that in 2008 private firms and entrepreneurs spent USD 1.55 billion on
           complying with permits, inspections and technical regulations (IFC, 2009).
                Although these issues have been highlighted for some time and there has been a
           commitment by different governments to simplify procedures, barriers have still not been
           removed. According to the World Economic Forum Global Competitiveness Index 2010-11,
           the country dropped by seven positions to 89th (or by five positions in a constant sample)
           as a result of the weak institutional framework and the lack of competition in the market
           for goods and services.
                In the renewable energy sector a support scheme based on feed-in tariffs for electricity
           produced from renewable resources was introduced in 2008 and then modified in 2009.
           The tariff path is fixed until 2029 at a level that is linked to conventional energy prices with
           an additional guarantee against exchange rate fluctuations, as the calculation contains a
           floor for prices expressed in euro. However, the business community observed that there is
           a lack of clarity of certain provisions in the green tariff law (Box 7.4). The changes in the tax
           code in introduced several tax benefits in favour of renewable energy companies, such as a
           reduction of taxes on land used for the construction of renewable energy facilities and an
           exemption from corporate tax of sales of power generated by renewable sources, available
           until January 2021 (OECD, 2011). But apart from these measures, there are few incentives
           for existing companies operating in the energy sector to reduce the consumption of natural
           gas and switch to biomass.



                               Box 7.4. The application of feed-in tariff regulations
                The business community has raised some issues related to the application of feed-in
              tariff regulations, notably the costs of connecting renewable energy facilities to the grid
              and the lack of clarity of certain provisions in the green tariff law. It considers in particular
              that the investment risk of renewable projects could be mitigated if access to green tariffs
              were guaranteed when the relevant building permits are issued, not only after the plants
              start producing electricity (International Chamber of Commerce-Ukraine, 2010). However,
              such modifications would probably increase considerably the risks for the state and the
              grid operators given frequent delays in the finalisation of renewable energy projects.
              Source: OECD (2011), “Investment Policy Reviews: Ukraine 2011”, OECD Investment Policy Reviews, OECD, Paris.




           Biomass sector is not promoted enough as an area for foreign investment
                Despite the synergies and potential that the biomass sector could provide, there is a
           lack of promotion of alternative sources of energy generally and, more specifically, of
           biomass. The absence of a clear promotion and communication strategy on the topic
           affects both the development of the local biomass market and the attraction of foreign
           investors. The level of public and corporate awareness of the key features of the biomass
           sector is generally low. According to the OECD Country Capabilities Survey, 43% of the utility
           companies interviewed reported a medium perception of public interest in biomass energy
           production, while 45% of them assessed the interest as being either low (around 22%) or very



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         low (around 22%). A significant proportion of the surveyed firms suggested that there is a
         need to raise the level of awareness both among utility companies (63% of respondents) and
         among end-consumers (43% of respondents) (Figure 7.17). Investing in the sector would
         mean taking advantage of the vast natural asset base and transforming it though technology
         and innovation into a new green industry. The process would create new jobs, develop
         capabilities and help to reduce Ukraine’s dependence on natural gas and other sources of
         energy. All these elements need to be combined into a clear promotion strategy on energy
         efficiency and green growth, targeting the business sector and end-consumers.

             Figure 7.17. Lack of public support and awareness for the biomass industry
                                            was pointed out

                                    QUESTION ASKED           Very low                            22

                                                                  Low                            22

           45% of the            How do you assess           Medium                                                      43
          respondents assessed    public interest about
          as low or very low      the possibility of using       High                 11
          the public interest     biomass for energy
          for biomass sector      production?                Very high       3             40 utilities companies were surveyed
          in Ukraine
                                                                         0       10        20          30          40             50
                                                                                                                                  %

         Source: OECD (2011), Country Capability Survey, internal working document, OECD, Paris.

              In 2009, the Ukrainian government drafted, with the assistance of the Dutch
         government, an Action Plan for the Biomass Sector that highlights the lack of effective
         communication and information exchange between ministries, agencies and other
         institutional stakeholders as well as among potential consumers of biomass energy.
         Overall, the actual understanding of issues related to the sustainability of renewable
         energies remains poor. Workshops and training courses on regulation, financing,
         standards, sustainability and certification in the sector have been sporadically organised,
         mainly thanks to the support of international donors, such as the Dutch government.
         Interestingly, the potential of the Ukrainian biomass sector is seen as an important goal for
         the development of the country more by foreign counterparts than at the national level.

         Power and heat payment arrears
              The distribution of power and heat is perceived as a social service in Ukraine, with
         subsequent free-riding behaviour by final consumers who are not forced to pay their bills
         in full and can accumulate large arrears (Figure 7.18). Disconnection from the power and
         heat supply is not common and often delayed, mainly for cultural and social reasons.
         According to the Ministry of Fuel and Energy the average level of payment for heating
         services amounted to only 60% of the total due in 2008, with big regional disparities (e.g. it
         was only 36% in the Luhanska oblast compared with 93% in the Odesska oblast).
             The toleration of energy sector payment arrears is common in other former-Soviet
         Union countries. Evidence suggests that it has declined in some of the energy-importing
         countries, such as Armenia, Kyrgyz Republic and Ukraine, while it has risen in energy-rich
         countries such as Azerbaijan and Russia (Petri and Taube, 2003). This quasi-fiscal activity has
         hidden costs that have created inefficiencies and distorted the power and heat market.
         Firstly, there is an incentive to over consumption and waste, such that resources are not
         allocated in an efficient way. Secondly, these cumulative debts have a negative, even if not
         direct, impact on the budget deficit. Thirdly, they create cross-subsidisation between oblasts,

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               Figure 7.18. Payment arrears also need to be solved to allow for investment
                              The case of heat payment arrears in Ukraine, end of August 2008




   •


   •




   •



   •




Source: Centre for Social and Economic Economic Research Ukraine (CASE) (2008), Ukrainian Heating Sector Review, www.case-
ukraine.com.ua/u/publications/5a6fa8e6557b434db34f03aee0e6e9e9.pdf, accessed 20 October 2008.

           where the complying regions are actually taking the burden and subsidising those that do
           not comply. Finally, they are detrimental to the restructuring and upgrading of the whole
           sector, as private or foreign investors would not have an incentive to intervene in an
           uncompetitive market where the current players are accumulating debts and the
           profitability of their activities is at risk. For instance, according to the Country Capabilities
           Survey in Ukraine conducted by the OECD in 2011, 58% of the firms interviewed identified the
           lack of visibility regarding future profits as a major hurdle to foreign investment in the sector.

           Natural gas, heat and electrical power prices are still subsidised
                The subsidies that are keeping energy prices at artificially low levels are preventing
           investments in renewable energy. Despite the recent increase in the price of natural gas,
           Ukrainian households still enjoy subsidised energy prices, which have typically been
           artificially below international levels. Prices tend to cover only operating costs, instead of
           long run marginal costs. For example, at the beginning of 2011 the import price for natural
           gas (including VAT) stood at around UAH 2000 per thousand while consumers paid an
           average of UAH 911 per thousand. The IEA estimates that in 2009 the level of energy
           subsidies in Ukraine was equivalent to some 4.7% of the country’s GDP, i.e. around twice the
           levels observed in Russia and Kazakhstan (IEA, 2010). This has hampered both efficiency
           and investment, minimising competition (IEA, 2006). One of the consequences of the
           current pricing scheme has been chronic under-investment in building, maintenance, and
           upgrades of all energy infrastructures, including pipelines and the electricity grid.
                The Economic Reform Programme for 2010-14 envisages a gradual increase of gas
           prices and aims at achieving a liberalisation of the energy industry. Energy sector reforms
           are facing political resistance, but until the era of subsidies and cheap energy comes to an
           end, other alternative, more efficient energy sources that are not subsidised will struggle to

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         be competitive. For instance, the bailout granted in July 2010 by the IMF is conditional on
         structural reforms including a realignment of energy prices with market fundamentals.

         State ownership of power and heat production assets
              The participation of private actors could bring in much-needed investment in the
         biomass sector, reduce the costs of processes and upgrade service quality. There is a lack of
         funding to replace fossil fuel-based boilers with biomass-fired equipment. Private
         investors could play a key role in the provision of funds as they have the ability to raise
         financing on capital markets. However, most of the old facilities are currently owned by the
         state, the regions or the municipalities. Public authorities perceive the production of power
         and heat as a social service and do not generally link it to market dynamics.
               The size of the state-owned enterprises in the energy sector prevents the entry and exit
         of new players, limiting its modernisation and growth. As a result the private sector has not
         had the chance to be particularly involved so far. Due to the protracted lack of government
         investment, the rate of depreciation of existing capital assets has already reached 70% on
         average and the presence of obsolete equipment raises the inefficiency of current processes.
         There is therefore an urgent need to modernise or replace existing assets.

Policy recommendations
         Streamline administrative processes, including a single-window approach 
         and pre-approval for green tariffs
              The licensing, permit and administrative processes need to be streamlined to make
         them transparent, more predictable and competitive. A “single-window” system for setting
         up alternative energy activities should be considered. The single-window would provide
         information on administrative forms, procedures, approvals, clearances and permissions,
         reporting, filing, payments and compliances. An electronic system would be advisable, so
         that different players do not need to visit different physical locations anymore, minimising
         costs. Drawing from the OECD experience, the most advanced single-window systems, such
         as the one implemented in Korea, also connect entrepreneurs with financial intermediaries,
         insurance companies, and ICT specialists to facilitate their operations. The single-window
         approach would improve governance and minimise the opportunities for corruption.

         Align energy costs to market prices, as promised to the IMF
              The distortions caused by the mismatch between domestic and market energy prices
         need to be removed with a high priority. The government is already committed to
         implementing semi-annual increases in gas prices and the process of aligning energy
         prices with international levels needs to continue. Industrial prices are already at market
         levels, while consumers still enjoy subsidised tariffs. The upward pressures on prices will
         give consumers a better understanding of what their energy consumption is worth to the
         economy as a whole, and hence, a stronger incentive to use energy in a more efficient way.
         The process could also divert attention towards other alternative sources of energy.
              To protect the poorest segments of the population from sharp rises in energy costs
         several welfare mechanisms could be introduced. A targeted welfare approach would be
         more effective than subsidising energy prices for all consumers. Special cash transfers,
         such as energy vouchers, would be relatively good in terms of targeting, but they would
         require some degree of administration and co-ordination. Other options such as lifeline
         tariffs where the lowest block of consumption is charged at a lower price would be simpler
         to administer but would require a reliable metering system. The relevant stakeholders

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           need to perform a transparent cost-benefit analysis and select the combination of
           measures that they would like to adopt in order to offset the impact of the energy price
           rises. This step is particularly important to ensure that the most vulnerable part of the
           population does not suffer the greatest losses and ultimately to ensure political stability.

           Draft a national action plan for the production of energy from biomass, 
           including demonstration projects and possible green tariffs for heating
                A national strategic plan for the biomass sector needs to be drafted, with clear targets
           for the short and the long terms and key performance indicators to keep track of the work in
           progress. Some demonstration projects showing the integration of both supply and use are
           recommended to draw attention to the sector and raise awareness of its relevant features.
           The experience drawn from international case studies could be also used as a reference for
           the implementation of a reliable supply chain. An indication of alternative green tariffs for
           heating could also be provided in order to support investors in their investment decisions
           through a clear projection of their future revenues and profitability. Predictability of income
           streams is an important element that investors consider in their business plans; at the
           moment there is no long-term certainty about the income flows for private players and the
           national strategic plan could support foreign and domestic investors in this direction.
               In 2006, the Energy Strategy of Ukraine to 2030 was approved, in an attempt to
           formulate a policy strategy for the country. In the baseline scenario presented in the report,
           power generation by other renewable sources is expected to increase at an average growth
           rate of 16% per year, from 51 million kilowatt hour in 2005 to 2.1 billion kilowatt hour
           in 2030. The funding required to finance the alternative energy sources for power
           generation was estimated to be UAH 7.1 billion in the period 2006-30. Unfortunately, the
           report has not been followed by a phase of structural reforms and the implementation of
           new alternative energy sources has stalled.
               In 2009, the government of the Netherlands supported its Ukrainian counterparts in
           the preparation of the Biomass Action Plan for Ukraine, outlining a general strategy for bio-
           energy development in the country, defining the current barriers and suggesting concrete
           solutions to solve existing issues within a defined time frame. The analysis already
           conducted could be a framework to support and realise a strategic plan. Politicians have the
           opportunity to overcome inertia and internal disputes, to build an ambitious project that
           could have an important impact on the country. The national action plan should also
           include a communication and promotion campaign, to increase the awareness of the
           biomass sector’s potential among the business community and end consumers.
               Poland could be taken as a good case study of a country which has been attempting to
           reduce its dependence on fossil fuels, particularly its use of coal for the generation of more
           than 90% of its electricity (Figure 7.19). As part of this effort, the Polish government set
           targets for the use of renewable energy as a percentage of total energy use. The latest
           targets, set in 2009 in line with EU directive 2009/28/EC, call for an increase in Poland’s use
           of renewable energy to 15% of total energy consumption by 2020. The government
           subsequently introduced a further target of 20% by 2030 in its strategy document “Poland’s
           energy policy to 2030”, released in November 2009. This longer term strategy also includes
           a target for a 10% share of bio-fuels in the transport fuel market by 2020. In 2009, renewables
           accounted for 6.6% of gross energy consumption, mostly biomass, although much of this
           was used for heat rather than electricity generation.



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                          Figure 7.19. The quick adoption of biomass in Poland has made it
                                      a key element in the renewables landscape
                                    Electricity production from renewables in Poland (GWh), 2005-09

                                    Wind                    Biogas                    Biomass                     Hydro

        9 000
                                                                                                                     1 034
        8 000
                                                                                                                      295
        7 000                                                                                   806
                                                                                                221                           Biomass in 2009
        6 000                                                           472                                                   57% of electricity
                                                                        162                                                   production from
          5 000
 Biomass in 2005                                 257                                                                 4 863    renewables
 36% of electricity         105                  117
          4 000             135                                                                                               3.9% of total
 production                                                                                     3 267                         electricity production
                                                                       2 343
 from renewables
          3 000            1 345                1 818
 1.1% of total
          2 production
 electricity000

        1 000              2 176                2 030                  2 253                    2 153                2 376

             0
                           2005                 2006                   2007                     2008                  2009

Source: International Energy Agency (IEA) (2011), Energy Policies of IEA countries, Poland Review, IEA, Paris; Poland’s Ministry of Economy (2010),
“Energy Policy of Poland until 2030”, Presentation delivered by Martin Korolec on 22 September 2010.


               The government’s strategy for encouraging the use of renewable energy has included
          both regulation and market mechanisms. The 2005 energy law introduced an obligation on
          electricity distributors to purchase all of the electricity generated from renewable sources
          that is offered to them, and to give this electricity priority access to the national grid.
          Moreover, the government introduced a system of green certificates’ setting quotas for the
          use of renewable energy and imposing charges on distribution companies not meeting
          these quotas. In addition, electricity generated from renewable sources and fuels
          containing bio-components (including transport fuels containing additives such as
          ethanol) are either exempt from or subject to lower rates of excise duty. Also, since 2006
          farmers have been permitted to produce bio-fuels for their own use, subject only to
          minimum quality requirements, without paying excise duty. The government also provides
          grants and preferential credits for renewable energy investments through the National
          Fund for Environmental Protection and Water Management and relevant regional funds,
          partly financed by EU support. These mechanisms are expected to result in further
          significant increases in bio-energy production and use.

          Increase privatisations of energy production and distribution assets to trigger private
          investment in infrastructures
               The state-owned enterprises dominating the energy arena need to go through a phase of
          privatisation. The past experience shows that the control exerted by the long chain of state-
          owned enterprises is detrimental to the efficient, profitable and sustainable functioning of the
          energy market. In the medium- to long-term the whole system, if not reformed properly, will
          become unaffordable with unfavourable consequences in terms of energy security and direct
          financial effects on the Ukrainian debt burden. A transparent and competitive process of
          privatisation of the energy generation and distribution companies should be implemented.
          In 2010, the Ukrainian Minister of Energy and Coal announced a plan to privatise two power
          generating companies and around five regional power distribution companies in 2011. Then in
          June 2011, the government announced the privatisation by the autumn of 2011 of two power


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III.7.   ENERGY-EFFICIENCY AND RENEWABLE TECHNOLOGIES: FOCUS ON PRODUCTION OF ENERGY BASED ON BIOMASS




                     Box 7.5. The role of private and foreign investment in the Russian
                                             privatisation reforms
                 Prior to the reforms, the Russian power sector was controlled by RAO UES, the state-owned
              holding company that controlled, but did not fully own, 72 vertically integrated local power
              companies (oblenergos) accounting for 70% of Russia’s electricity generation. In practical terms,
              it owned all of the transmission and distribution networks in the country (Solanko, 2011).
                The scope of the reform of the energy sector was ambitious and could not be financed
              only with public funds. Therefore it was clear that the reforms needed to provide an
              attractive environment for private investments, in order to mobilise private and foreign
              funds. The World Bank’s standard model for reform was followed, including the following
              points (Besant-Jones, 2006):
              ●   Corporatise power sector enterprises.
              ●   Unbundle, meaning disaggregating the total electric service provided by a power utility
                  into its basic components.
              ●   Create an autonomous, transparent regulator.
              ●   Privatise the generators and distributors.
              ●   Develop power markets.
              ●   Streamline the role of the government.
                Private and foreign investments in wholesale and territorial generation companies
              totalled USD 21.5 billion in 2007, including the investments of three major international
              players, Fortum, Eon and Enel.



           plants and nine power distribution companies worth around USD 760 million at current
           market prices. Ukraine has the opportunity to raise funds, which could help the budget deficit,
           while at the same time attracting private and foreign investment, which could help the
           modernisation of the energy infrastructure.

           Review of payment mechanisms and market regulation institutions
               The energy payment mechanisms need to be redesigned as current tariffs do not cover
           the real costs of energy supply. Payment collection should be enforced by a dedicated
           market regulation institution. The regulation should provide incentives for cost reduction
           and savings. The strengthening of payment discipline will have a positive effect on budget
           revenues and will also improve energy utilisation efficiency.
                The co-ordination of enforcement activities should be done at the national level, with
           a clear and transparent legal framework and strong enforcement standards across all the
           oblasts. It could be advisable to support the implementation of meter readings in both
           industrial and residential buildings and to implement tight controls, linked to fines and
           sanctions. Currently, local authorities play an important role in determining whether
           customers in arrears are disconnected. However, the set of rules that determines the
           disconnection of non-compliant consumers needs to be set at a national level and enforced
           through systematic and targeted controls.

           Solve existing payment arrears
                The enforcement of payment collection will have a positive effect on payment arrears:
           if end consumers pay the full cost of the energy, generation and distribution companies


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         will not accumulate arrears. The problem of payment arrears could also be tackled with the
         introduction of guarantee schemes by intermediaries. The debt spiral starts with the
         arrears consumers owe to regional power distributors (oblenergos). As a result, the
         oblenergos do not have enough resources to pay for the power purchased or to maintain
         and upgrade the distribution network and other assets. The oblenergos pile up debts
         towards Energorynok, the state company selling power to the oblenergos. At the beginning
         of 2006, consumers owed UAH 10 529 million to oblenergos. Distribution companies’ debt
         towards Energorynok was UAH 15 962 million. In the same period, Energorynok’s liabilities
         to Ukrenergo, the state company which owns and operates the transmission grid, were
         UAH 18 323 million (Tsarenko, 2007).
               Prospective investors need to receive a signal that the chain of existing payment arrears
         has come to an end. In June 2010, the Ukrainian parliament passed a law going in the opposite
         direction, which wrote off UAH 24 billion of debts owed by energy companies to the state
         budget. The write off, if not followed by a restructuring of the payment system, would give a
         further incentive to keep the vicious cycle of payment arrears in place, with harsh
         consequences for the government’s budget and for the outlook for the Ukrainian energy sector.



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156                                                         COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012
Competitiveness and Private Sector Development: Ukraine 2011
Sector Competitiveness Strategy
© OECD 2012




                                                    Chapter 8




   Machinery and transport equipment:
        Focus on civilian aircraft
             manufacturing


         This chapter provides an in-depth analysis of the civilian aircraft manufacturing
         sector in Ukraine. Examining the demand and supply sides, it explains why the
         civilian aircraft value chain could be promising for private domestic and foreign
         investors given domestic and global trends. It identifies the role that foreign
         investors could play along the value chain. It also presents key issues and policy
         barriers hindering competitiveness in the sector and proposes a prioritised list of
         policy recommendations.




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Summary
                The aircraft manufacturing sector is part of the aerospace industry and covers the design,
           production, maintenance, repair and overhaul of military, civilian passenger, dual-purpose
           (cargo) transport aircraft and helicopters. This study only includes civilian commercial aircraft
           manufacturing, excluding military aircraft, business aviation and helicopters.
                Building an aircraft requires design, engineering, manufacturing and assembly of
           hundreds of thousands of parts with different levels of sophistication. Suppliers can be
           divided into four tiers, depending on their role in the production supply chain: tier-1
           suppliers act as system integrators; tier-2 suppliers act as suppliers to tier-1 suppliers and
           usually manufacture sub-systems and complex components; tier-3 suppliers manufacture
           system elements and components; tier-4 suppliers provide raw materials and other parts.
           Maintenance, repair and overhaul (MRO) services take part after the sale of the aircraft but
           are a key component of the value chain: the acquisition cost of a new aircraft accounts for
           only 20-40% of its lifetime direct operating cost, which is also driven by total time on the
           ground, fuel efficiency and other factors. The aircraft value chain is coordinated by an
           original equipment manufacturer (OEM), which acts as lead designer, final assembler and
           main provider of MRO services.
                World sales of civilian aircraft are estimated at circa 33 000 units, at a total cost of
           USD 4 trillion, over 2011-30. About 75% of sales will be made up of passenger aircraft with
           more than 100 seats, while cargo planes will only account for 6% of sales volume. The
           aircraft manufacturing sector is global, as manufacturing offers large economies of scale
           and because client airlines demand MRO at a global level.
                On the demand side, sector trends are largely determined by the needs of airlines.
           Aircraft demand is expected to remain high over the next 20 years. About 80% of global
           demand for aircraft until 2030 will be located in OECD countries and the Asia Pacific region.
           In OECD countries, the volume of air travel is not expected to increase considerably but
           many airlines will replace outdated, inefficient airliners. In the Asia Pacific region, high
           demand will primarily be driven by growth in passenger travel and cargo transportation.
              On the supply side, increased competition seems the main trend. Currently, four OEMs
           dominate the passenger aircraft market. Two of them, Airbus and Boeing, are leaders in the
           middle and large size segments; two others, Bombardier and Embraer, are leaders in the small
           size segment. Competition is expected to intensify in the coming ten years, with new players
           in all major segments. Technology will remain key to competing effectively, especially
           regarding fuel and CO2 efficiency. Two other important differentiating factors are expected to
           be the quality and reach of MRO services and the ability to finance capital-intensive
           programmes through government support, bank lending and risk-sharing partnerships.
               Ukraine is one of the few countries in the world able to produce modern aircraft.
           Traditionally active in military aircraft production as part of the Soviet military-industrial
           complex, Ukraine has also developed specific capabilities in the segments included in the
           scope of this publication. Antonov, the main Ukrainian aircraft manufacturer, is the

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         designer and manufacturer of the largest operating cargo aircraft in the world, the An-225
         Mriya. More recently, it has also been involved in the civilian passenger segment, launching
         the An-148 family of regional jets.
              The Ukrainian aircraft industry is recognised, thanks to the country’s historical presence
         in the sector, its engineering skills and capabilities, and its relative cost competitiveness.
         Ukraine inherited a significant part of the former USSR’s capabilities in the aerospace sector,
         starting with Antonov. It is now a state-owned company, operating under public law and
         tightly supervised by the defence agency. The country’s education system produces a
         significant number of well-qualified and skilled aerospace scientists and engineers.
         Ukrainian aircraft are known for their ability to use unpaved airfields and flexibility of
         operations. As a result, Ukraine seems to have potential to compete efficiently, at least in
         some segments, on global markets. However, several challenges exist for the civilian aircraft
         industry in Ukraine. First, obsolete governance and closed investment policies prevent the
         implementation of an optimal business strategy based on global best practice. Second,
         Ukrainian aircraft manufacturers are still not able to provide efficient MRO around the world.
         Third, Ukrainian manufacturers face a financing challenge, due to the size of their market,
         the tight government budget and a lack of advanced financing schemes for manufacturers
         and customers. As a result of all these challenges, the majority of demand for Ukrainian
         products is currently concentrated in Ukraine and other CIS countries.
              An industrial strategy for the Ukrainian aircraft manufacturing sector should leverage
         existing capabilities under economic and political constraints. Investment in Ukraine could
         be attracted under three options, which could be seen either as strategic alternatives or as
         successive steps in a long-term industry development plan, resources allowing:
         ●   Long-term option: developing OEM (Antonov) and tier-1 suppliers. This option would
             mean revamping the OEM, reinforcing MRO, building partnerships and enhancing
             financing capabilities. This is an ambitious option, which would require considerable
             resources and involvement from both the government and the private sector.
         ●   Medium-term option: developing high-end tier-2 and tier-3 suppliers. In this option,
             focus could be put on design capabilities or equally on design and manufacturing.
         ●   Short-term option: focusing on low-end tier-2 and tier-3 components, both basic design
             and manufacturing.
              Implementing any of the above options requires several reforms. The most urgent one
         involves the sector’s governance and investment policy. The sector is closed to foreign
         investment and would gain considerably from increased openness. At the moment, the
         governance of the civilian and military aircraft sectors in Ukraine is unified. The military
         aerospace sector is closely protected and controlled, and the same level of protection and
         control applies to the civilian aircraft sector. It does not allow for interactions with foreign
         investors or industrial partners, unless approved at ministerial level or higher, which
         virtually eliminates all opportunities to implement a business-centred industrial policy.
         A reorganisation of the supervision of the sector was announced in 2010. It is necessary to
         translate this announcement into a new governance system with separate branches for the
         military and civilian sectors. The civilian aircraft manufacturing part of Antonov could
         become a corporation and be allowed to interact with global suppliers and partners. This
         would enable closer partnerships and would help solve financing issues. Once this has been
         done, increased investment promotion could take place to leverage these improvements.



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               The second area for improved competitiveness is human capital. Workforce skills are
           essential to remain competitive in this high value-added sector. To preserve and enhance
           workforce skills, action could be taken on initial, vocational and continuing education.
               Other actions from government are needed. More specifically, a review of state support
           could be undertaken to tailor the magnitude and type of support awarded to the industry,
           in compliance with international commitments. A new trade policy would also help the
           development of the industry, as integration in global supply chains and financing schemes
           relies on the free flow of goods and services.

Why focus on civilian aircraft manufacturing
                Machinery and transport equipment is a broad sector and includes machinery and
           equipment, electrical and optical machinery, and transport equipment. A selection process,
           in consultation with stakeholders, was needed to decide which specific sub-sector to focus
           on. Ukraine has a strong presence in several sub-sectors. The country is a major producer of
           heavy machinery and industrial equipment for industries including mining, steelmaking,
           and chemicals. Significant products also include non-numerically controlled machine tools,
           large electrical transformers and agricultural machinery. Ukraine also produces automobiles,
           railway equipment and has sizeable space and aircraft manufacturing industries.
                Mechanical equipment, electrical machinery, motor vehicles and transport equipment
           were preselected in consultation with stakeholders (Figure 8.1). The size of each sub-sector,
           through its share in total domestic output, was used as the key criterion to eliminate the
           less significant sub-sectors.


                    Figure 8.1. Four sub-sectors were identified on the basis of their share
                                       in the national domestic turnover
                                                  Machinery, electrical and optical equipment,
                                                             transport equipement


              Machinery and                                      Electrical and                          Transport
               equipment                                       optical equipment                         equipment

             Non-transport 0.45%                               Electrical
                                                                                0.71%
                                                                                                       Motor vehicles,
                                                                                                                         0.36%
             engines and                                       machinery and                           trailers and
             turbines, pumps                                   apparatus – electric                    semi-trailers
             and compressors,                                  motors, generators,                                       0.92%
             bearing and gears,                                transformers;
             valves and taps                                   insulated wires and
                             0.09%                             cables; others                          Ships and boats
             Agriculture                                                                               building and
             and forestry                                                                              repairing
             machinery –                                                     0.08%
             tractors...                                       Radio, TV,
                                                               communication                           Railway and
             Machine tools   0.05%                             equipment                               tramway
                                                                                                       locomotives and
             Domestic        0.10%                                              0.19%
                                                                                                       rolling stock
             appliances                                        Medical and
                                                               measuring
                                                               equipment                               Aircraft and
                             0.23%                                                                     spacecraft
             Other general           Furnaces, furnace
             purpose                 blasters
             machinery
                                     Lifting and handling                        Share in %
                                     equipment                                  of the Ukraine
                                                                             overall output, 2009
                                     Non-domestic
                                     cooling and
                                     ventilation equipment

           Source: Based on data provided in June 2010 by the Macro-Econolmic Division of Ukraine’s Ministry of Economy and
           Trade, State Statistics Committee Ukraine, 2010; OECD (2010), Ukraine Sector Competitiveness Review, internal working
           document, OECD, Paris.




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                 After discussions with stakeholders, the civilian aircraft industry was finally selected.
             This sub-sector ranks high in government priorities, since the country’s capabilities in
             aeronautics give it a potential competitive advantage. Moreover, the level of technology in
             the sector, as measured by the OECD technology intensity scale, is higher than in other
             industries, such as shipbuilding or railroad equipment. Finally, world demand for civilian
             aircraft and components, according to expert interviews, is expected to be very dynamic
             over the coming years, providing additional opportunities for this sub-sector (Table 8.1).

                  Table 8.1. Aircraft industry was selected as it presents specific technology
                           and capabilities in Ukraine and high government priority
                                                                                Electrical                          Other transport equipments: Shipbuilding,
                                                           Non-transport
                                                                            machinery and                             railroad equipments, aircraft industry
                                                            engines and
                                                                               apparatus:
                                                          turbines, pumps                     Motor vehicles,
                                                                           Eelectric motors,
Criteria                Sub-sector indicators            and compressors,                         trailers
                                                                               generators,                       Ship building       Aircratf         Railroad
                                                            bearing and                      and semi-trailers
                                                                             transformers;                       and repairing      industry         equipment
                                                            gears, valves
                                                                            insulated wired
                                                              and taps
                                                                          ans cables; others

Innovation              Technology intensity                    ***              ***               ***                *               ****              ***
Demand                  Expected world demand                   **                **                **                **              ****               **
Supply                  Specific domestic capabilities           *                 *                 *                *               ****               *
Government priorities   Priority level for the sector           **                 *                **                **              ****               **
                        Total                                    7                 7                 8                6                16                8

Source: OECD (2009), OECD Science, Technology and Industry Scoreboard 2009, OECD, Paris, www.sourceOECD.org/industrytade/9789264063716,
accessed 15 December 2009; OECD (2010), Ukraine Sector Competitiveness Review, internal working document, OECD, Paris.

Sector definition and segmentation
             Definition
                  The aircraft industry is part of the aerospace industry and includes companies
             involved in research, development and production of airplanes, helicopters, engines,
             guidance and control units and other parts. It also includes companies providing
             maintenance, repair and overhaul services. As part of the aerospace industry, aircraft
             manufacturing is closely linked to the defence and space industries. However, aircraft
             manufacturing can be subdivided into military and civilian aircraft manufacturing. This
             study only covers civilian aircraft manufacturing, including commercial passenger and
             freight aircraft, but excludes business aviation, military aircraft and helicopters.
                  Aircraft production is a capital- and technology-intensive process. The process of new
             aircraft development can take a number of years and require huge financial resources. The
             aircraft supply chain involves thousands of companies that can be grouped into the
             following categories (Figure 8.2):
             ●   OEMs or aircraft manufacturers, such as Airbus and Boeing, acting as designers,
                 integrators, final assemblers of the aircraft and key MRO providers (Figure 8.3).
             ●   Tier-1 suppliers act as system integrators, responsible for production and assembly of
                 major aircraft systems, including engines, avionics, wings, and undercarriage. They
                 often provide substantial MRO services as well.
             ●   Tier-2 businesses are suppliers to tier-1 companies. They manufacture sub-systems and
                 avionic components.
             ●   Tier-3 suppliers manufacture system elements and components – including grid parts,
                 mechanically engineered parts, and other components.


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Figure 8.2. The aircraft manufacturing industry ranges from components to after-sales services
                                                                                                                                                    Original                    Maintenance,
                        Fourth-tier                        Third-tier                      Second-tier                  First-tier                 Equipment
                         suppliers                         suppliers                        suppliers                   suppliers                 Manufacturers                  Repair and
                                                                                                                                                    (OEMs)                     Overhaul (MRO)
                      R/D                              R/D                          R/D                             R/D                           R/D
                      Designing                        Designing                    Designing                       Designing                     Designing
                      Procurement                      Procurement                  Procurement                     Procurement                   Procurement
                          Production                        Production                   Production                      Production                    Production
                             After sales                      After sales                   After sales                     After sales                   After sales


                   Basic elements –            System elements –               Components –                    Subsystems                     Aircraft design and           After-sales network
                   raw materials like          grid parts,                     navigation systems,             engines, avionic, pod,         final assembling              Spare parts, training,
                                                                                                                                              of subsystems
    PRODUCTS




                   steel plates or             mechanical                      avionics and                    aerostructure, power                                         mechanical support
                   plastic parts,              engineered parts,               mechatronics                    systems, landing gear,
                   software and                cheap metal parts               (e.g. hydraulics                brakes, in-flight
                   services                    low complexity                  combined with                   entertainment,
                                               components                      computerized systems)           interior
                                               (e.g. harnesses)


                                                                               ●   Bridgestone                 ●   General Electric           ●   Airbus
                                                                                                                                                                                            s,
                             r eds                                             ●   GKN Aerospace               ●   Goodrich                   ●   Boeing                           OEM r
                      H u n d li e r s
    EXAMPLES




                                                                                                                                                                                              ie
                                                                                                                                                                                   F ir s t- t s,
                           upp                               r eds                                                                                                                              r
                      of s                            H u n d li e r s         ●   Honeywell                   ●   Pratt & Whitney            ●   Bombardier
                                                                                                                                                                                   su  p p li e
                                                              p                                                                                                                                   ft
                                                      o f sup                  ●   Michelin                    ●   Rolls Royce                ●   Embraer                             A  ir c r a
                                                                                                                                                                                                     s
                                                                               ●   Siemens                     ●   Thales                                                              se  r v ic e s
                                                                                                                                                                                      com     panie
                                                                               ●   Telec



Source: OECD (2010), Ukraine Sector Competitiveness Review, internal working document, OECD, Paris.


Figure 8.3. OEMs play a key role in designing, coordinating suppliers, and assembling the final product

                                                               OEM – Airbus, Boeing, Bombardier, Embraer, Antonov, Sukhoi
   OEM




                     Engine                 Avionic                  POD            Aerostructure            Power              Landing                Brakes              In-flight             Interior
                                                                                                            systems              gear                                   entertainment



                    General                 Various              General              General               General             General               General              General              General
                   contractor              suppliers            contractor           contractor            contractor          contractor            contractor           contractor           contractor
   TIER 1




                     Design,              Electronics             Design,              Design,               Design,             Design,               Design,              Design,             Design,
                   production                  and              production           production            production          production            production           production          production
                  of key-parts,            informatic          of key-parts,        of key-parts,         of key-parts,       of key-parts,         of key-parts,        of key-parts,       of key-parts,
                  assembling              equipments           assembling           assembling            assembling          assembling            assembling           assembling          assembling



                    Various                 Various               Various              Various              Various             Various                Various              Various              Various
   TIER 2 and 3




                   suppliers               suppliers             suppliers            suppliers            suppliers           suppliers              suppliers            suppliers            suppliers
                    Engine                 Electronic            Electrical          Sections of           Electrical         Subsystems              Brackets           Softwares,         Seats, toilets,
                  subsystems             and informatic         commands,           fuselage and          subsystems          e.g. dampers          subsystems          screen, basic          oxygen
                     and                  subsystems           exhaust cone             metal                                                           and              electronic          containers,
                  components                                                         structures                                                     components                                 textiles


                                                                                       Various              Various             Various
   TIER 4




                                                                                      suppliers            suppliers           suppliers
                                                                                   Raw materials,          Electrical       Raw materials
                                                                                     seatings...          components         e.g. metals


                               HIGH-END COMPONENTS                                               MID-END COMPONENTS                                             LOW-END COMPONENTS

Source: PIPAME (2009), Étude de la Chaîne de Valeur dans l’Industrie Aéronautique, PIPAME, Paris, www.industrie.gouv.fr/p3e/etudes/aeronautique/
etudes3.php, accessed 15 September 2011.




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         ●   Tier-4 suppliers provide raw materials and other parts and components, software and
             services.
         ●   MRO providers are companies involved in the provision of maintenance, repair and overhaul
             and after-sales services and typically include OEMs, tier-1 suppliers and pure players.
               As a general rule, there is a link between the technical complexity of a task and the
         level of sub-contracting involved. Typically, high-complexity tasks are undertaken by the
         OEM or a first-tier supplier, whereas low-tech, low value-added components are
         manufactured by third or fourth-tier suppliers. However, this can vary a lot depending on
         the part of the plane concerned. As an example, even the producers of basic aero structure
         parts are usually tier 1 suppliers, as the OEM is responsible for hull assembly.
              It is also worth noting that aeronautics suppliers often have several specialities, and
         that they can be suppliers on different levels for different products. For instance, Latecoere
         produces electrical harnesses for Snecma, acting as a second-tier supplier and at the same
         time produces fuselage sections for the Airbus A380 as a first-tier supplier.

         Segmentation
             Civilian aircraft can be categorised as passenger, cargo or specialised aircraft.
         Specialised aircraft are not the focus of this study (Table 8.2).
             Although there are different ways to categorise civilian aircraft, the prevailing basis for
         segmentation is the combination of seat capacity and body width for passenger airplanes
         and cargo volume capacity for freight aircraft. Thus, commercial aircraft can be grouped
         into the following segments:


                                       Table 8.2. Segmentation of civilian aircrafts
                          Passenger aircraft                                             Cargo aircraft

                          Narrow body (single aisle) below 100 passengers             Small jet freighters
                          (often called regional jets), including turboprop and jets
                          Narrow body (single aisle) above 100 passengers              Mid-size freighters
                          Wide body (twin aisle)                                        Large freighters
                          Very large aircraft

                         Source: Airbus (2010), corporate website www.airbus.com, accessed 15 December 2010;
                         Boeing, (2010), corporate website www.boeing.com, accessed 15 December 2010.



             The narrow-body (single-aisle) aircraft with a capacity of fewer than 100 passengers is
         characterised by the shortest travel ranges. Often called regional aircraft, they have less
         than 100 seats or are able to carry less than 10 tonnes of cargo. They are primarily used by
         regional and feeder airlines. The regional aircraft market is characterised by fierce
         competition between fuel efficient turboprops and faster, more comfortable, jet engine
         aircraft. Future rising fuel costs, increased environmental constraints and airport
         congestion may render turboprops dominant in short haul flights where speed differences
         are less important. Currently, regional jets dominate the >50 passengers market, while
         turboprop aircraft dominate the <50 passengers segment and are currently expanding to
         the <70 passengers market. Industry projections for 2010-29 suggest that turboprops will
         account for the majority of aircraft in the 61-90 seat category, while demand for regional
         aircraft will move into the 90-130+ seat category. This assumes that in the smaller seat
         categories cost reductions will outweigh speed considerations.


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                The larger narrow body (single-aisle) category includes aircraft with capacities of
           between 100 and 220 passengers. These aircraft are typically operated on short- to medium-
           range routes with a maximum reach of about 3 700 miles (6 000 km). This is the largest aircraft
           segment in terms of the number of aircraft in operation. In 2009, there were 11 580 single-aisle
           aircraft in operation around the globe, representing over 60% of all jet airliners (Boeing, 2010).
                 Wide-body or twin-aisle aircraft can carry 200 to approximately 400 passengers and
           can fly more than 6 200 miles (10 000 km). These airliners are used on both medium-range
           and intercontinental flights. The very large aircraft segment includes wide-body aircraft
           capable of carrying more than 400 passengers over long distances (Table 8.3).

                                Table 8.3. Distribution of selected aircraft by segments
                                                                                                                  Wide body               Very 
Narrow body under 100 seats                               Narrow body over 100 seats
                                                                                                                  (twin-aisle) aircraft    large aircraft

Embraer E170, E175, E190, ERJ135, ERJ140, ERJ145          Airbus A318, A319, A320, A321                           Airbus A330, A340        Boeing 747
Bombardier CRJ200, CRJ700, CRJ705, CRJ900                 Boeing 737-900, 737-800, 737-700, 737-600               Boeing 767, 787          Airbus A380
Antonov An-148                                            Embraer E195
Sukhoi SuperJet 100                                       Tupolev TU-334, TU-204SM
ATR 42, ATR 72 (turboprops)

Note: This table only includes planes in operation as of 2011.
Source: Manufacturer websites; ATR website, www.atraircraft.com/products/list.html, accessed 15 December 2010; Embraer corporate
website, www.embraer.com/en-US/Pages/Home.aspx, accessed 15 December 2010; Bombardier website, www.bombardier.com, accessed
15 December 2010; Antonov website, www.antonov.com/index.html, accessed 15 December 2010; Airbus website, www.airbus.com, accessed
15 December 2010; Boeing website, www.boeing.com, accessed 15 December 2010; Sukhoi website, http://sukhoi.org/eng, accessed
15 December 2010; Tupolev website, www.tupolev.ru/english/Show.asp?SectionID=82, accessed 15 December 2010.




                                                   Box 8.1. Three distinct duopolies
                The global aircraft market is segmented, with three distinct duopolies for regional
              turboprops, regional jets and for large aircraft (Figures 8.4, 8.5 and 8.6). The European ATR
              (Alenia-EADS) and the Canadian Bombardier dominate the regional turboprop market,
              while Bombardier and Brazil’s Embraer dominate the regional jet market. On segments
              over 100 passengers, Boeing and Airbus constitute a duopoly as well.

                        Figure 8.4. Number of deliveries of regional turboprops, 2002-10
                                         Bombardier                       ATR                                Total deliveries
                 140

                 120

                 100

                 80

                 60

                 40

                 20

                   0
                         2002        2003          2004      2005         2006         2007           2008           2009           2010

              Source: Julian, F. (2011), “Le secteur des avions régionaux au-devant de grands changements”, Air et Cosmos,
              17 June, www.air-cosmos.com/home-page.html, accessed 15 July 2011.




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                                           Box 8.1. Three distinct duopolies (cont.)


                             Figure 8.5. Number of deliveries of regional jets, 2002-10
                                      Bombardier                 Embraer                       Total deliveries
              350

              300

              250

              200

              150

              100

               50

                0
                      2002       2003              2004   2005     2006      2007       2008           2009        2010

            Source: Julian, F. (2011), “Le secteur des avions régionaux au-devant de grands changements”, Air et Cosmos,
            17 June, www.air-cosmos.com/home-page.html, accessed 15 July 2011.




                 Figure 8.6. Number of deliveries of large or very large aircraft, 2002-10
                                          Boeing                 Airbus                         Total deliveries
             1 200


             1 000


               800


               600


               400


               200


                 0
                       2002       2003             2004   2005      2006      2007       2008           2009       2010

            Source: Airbus corporate website, www.airbus.com, accessed 30 August 2011; Boeing corporate website,
            www.boeing.com, accessed 30 August 2011.




Global trends
         Demand forecasts over the coming two decades are promising on every segment
              Aircraft demand depends on demand for air travel, which is itself driven by tourism,
         business travel and ultimately by increasing living standards, growth and globalisation of
         the economy. Historically, demand has shown strong growth. According to an ICAO (2010)
         report, passenger kilometres grew on average by 5.3% per annum between 1979-89, by 4.7%
         between 1989-99 and by 4.3% between 1999-2009.


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                In the past 15 years, the industry has shown high demand, with more than
           800 western-built aircraft deliveries each year since 1996. High demand for aircraft
           production has been driven by both demand for and supply of air travel. On the demand
           side, accelerated globalisation of the economy and the accession of tens of millions of
           people to middle or superior living standards, especially in the Asia Pacific region, have
           fuelled growth. On the supply side, domestic air market liberalisation, catalysed by the
           US Airline Deregulation Act of 1978, has allowed competition on price, increased route
           access and new market entrants. Domestic liberalisation trends have been reinforced by
           “Open Skies” international agreements which remove barriers to competition between
           countries, facilitating foreign partnerships and access to international routes. However
           some large markets, like India, remain tightly regulated.
                These structural changes have facilitated innovations in the industry. The low-cost
           carriers are notable new market entrants. These operators have a low cost structure
           resulting from fast turnaround times, the use of low-cost airports and timeslots, and
           provision of a “no frills” service. Alliances are airline partnership networks that reduce
           costs through the sharing of sales offices, maintenance facilities, IT systems, flight codes
           and bulk purchases. Deregulation of routes has enabled cost reduction by implementation
           of “hub and spoke” systems. Several key airports are chosen as “hubs” with many smaller
           “spoke” airports connected through the hub. This allows tailoring of aircraft size to the
           traffic flow from each “spoke” and consolidation of passengers at the hub to increase
           capacity utilisation. All of these innovations have translated into cost reductions which
           have driven down prices and contributed to strong air travel demand.
                However, this strong growth has been tempered by considerable volatility. The industry
           suffered a severe blow in 2009 when the total orders for Airbus and Boeing aircraft fell to a
           total of just above 400 from the highs of over 2 000 in 2007. As the global economy started
           showing signs of recovery from the financial crisis, net orders increased in 2010. In July 2011,
           American Airlines, with the aim of creating a new, more efficient fleet, announced the
           “largest aircraft order in history” of 460 narrow body, single aisle planes split between
           200 Boeing 737s and 260 Airbus A320s (American Airlines 2011– press release).
                According to Boeing (2011), in order to meet the growing demand for air travel, the
           fleet of commercial aircraft will grow from 14 240 passenger aircraft in 2009 to 30 000
           in 2030 (Figure 8.7). Revenue customer kilometres, a measure of volume of revenue-
           generating passengers for an airline, is forecast to increase 2.5 times, from 4 760 billion to
           more than 12 000 billion in 2030.
               Adding the expected freight aircraft demand, the world demand for new aircraft will
           be high over the coming 20 years and the market for new commercial aircraft will reach
           around 33 500 units in total, valued at USD 4 000 billion (Boeing, 2011).

           Demand is shifting to the Asia Pacific region and will be geographically 
           more diversified
                Air travel has become more diverse geographically and this trend is expected to
           continue into the future (Figure 8.8). It will result in a shift in demand from OECD to non-
           OECD countries, especially to the Asia-Pacific region. With the growth of air travel in Asia
           and other developing regions, the role of Europe and North America will continue to
           decline. Asia-Pacific, which currently accounts for 23% of the existing fleet, is expected to
           account for 37% of the forecast demand over the next 20 years (Boeing, 2011). North



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             Figure 8.7. Total expected demand for civilian aircraft by segment over 2011-30
                                      Expected demand expressed in units (left); in billions of US dollars (right)
          25 000                                                                     2 500



          20 000                                                                     2 000



          15 000                                                                     1 500



          10 000                                                                     1 000



             5 000                                                                     500



                 0                                                                       0
                         Regional          Single        Twin            Very                    Regional          Single             Twin             Very
                           jets             aisle        aisle           large                     jets             aisle             aisle            large

         Source: Boeing (2011), Current Market Outlook 2011-30, www.boeing.com/commercial/cmo, accessed 15 July 2011.


               Figure 8.8. Asia Pacific and other emerging economies will drive the growth
                                        of demand for civilian aircraft
                     Africa                     Middle East           CIS                    Africa                 CIS                         Latin America
                     Latin America              Europe                Asia Pacific           Middle East            North America                   Europe
                     North America                                                           Asia Pacific
          40 000                                                                     4 500
                                                                         1 210
                                                                         2 710
                                                                                     4 000                                                    100
          35 000                                                         1 400                                                        110
                                                                                                                                250
                                                                         3 390
                                                                                     3 500
          30 000                                                                                                          450

                                                                         8 010       3 000
          25 000                                                                                                  760
                                                                                     2 500
          20 000                680
                              1 040
                              1 140                                                  2 000                  880
                              1 150                                      13 480
          15 000
                              4 380                                                  1 500
          10 000
                              4 410                                                  1 000
                                                                                                  1 510
             5 000                                                       9 330        500
                              6 610

                0                                                                       0
                                   2010                           2030
                                current fleet                 expected fleet

         Source: Boeing (2011), corporate website www.boeing.com, accessed 15 July 2011.


         America, which accounts for 36% of the existing fleet, should see its demand share
         shrinking to 19% (Boeing, 2011).

         Competition is expected to intensify as new players are entering the market
             The growing demand for aircraft has brought about increased competition in the
         industry, which is expected to intensify in the coming years as new players are entering the
         market. The duopolies of Boeing and Airbus in the narrow body above 100 passenger and
         wide-body markets and Bombardier and Embraer in the sub-100 passenger aircraft
         segments may be challenged in the near future.
         ●    The sub-100 seats segment has already seen the delivery of the first Russo-Italian Sukhoi
              SuperJet 100 in 2011. The first delivery of the Chinese Comac ARJ21 is expected in 2011

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                                   Box 8.2. Demand dynamics for civilian aircraft
              The two components of demand
                The demand for new aircraft can be broken down into two components: replacement of
              the existing fleet and expansion of the fleet. Over the next 20 years, fleet expansion should
              account for between 50 and 60% (Boeing, 2011), which means around 17 000 new airplanes.
              Each component will be driven by specific factors.
                  The replacement of the existing fleet will be driven by:
              ●   Ageing fleets and the need to reduce operating expenses. Reduction of operational costs, such
                  as fuel, training, maintenance, repair and overhaul, leads to the replacement of older
                  aircraft with high operational costs by new models with lower running costs.
              ●   Need for larger aircraft. The need to ease airport congestion and growth on existing routes
                  adds pressure for replacement of the existing fleet by larger aircraft in each size category.
              ●   Environmental protection requirements. Increasingly demanding environmental standards
                  and consciousness will lead to the replacement of older and less efficient aircraft by
                  newer, greener planes.
                  Fleet expansion will be driven by:
              ●   Air travel demand. The growth of the global economy and increasing incomes will
                  contribute to the growth of air travel.
              ●   New low-cost carriers. The growing number of low-cost carriers will create new demand
                  for passenger travel.
              ●   Route liberalisation. Increased route liberalisation will create new airline networks,
                  increase competition, drive prices down and increase demand on those routes.

              Demand dynamics by segment over the next 20 years
                The single aisle with less than 100 passengers segment is forecast to grow. In spite of the
              high number of aircraft expected to be built, this segment will only account for about 2% of
              the total market in value. The 80 to 100 passengers sub-segment is expected to be more
              dynamic than the 30 to 50 and 50 to 80 passenger segments.
                 The single aisle with more than 100 passengers segment is expected to account for about
              23 300 new aircraft, by far the largest segment in terms of units with 48% of the total
              market. Demand will be fuelled by large emerging countries’ domestic and continental
              flights and the expansion of low cost carriers.
                The twin aisle aircraft segment will also account for around 44% of the total market in
              value. The demand in this segment is primarily driven by the need for fuel efficiency
              improvements.
                The very large aircraft segment will account for less than 1 000 units over the next
              20 years, but the high unit price makes this sector sizeable in value.
                The freighter market makes up only about 6% (or USD 250 billion) of the total future
              market for new aircraft. The majority of demand in this market will be met by conversions
              from former passenger aircraft, which is expected to meet around 70% of freighter
              demand. Growing world trade, increasing demand for transport of perishable and time-
              sensitive commodities, and the need to replace ageing airplanes will be the main drivers of
              demand.
              Source: Boeing (2011), Current Market Outlook 2011-30, www.boeing.com/commercial/cmo, accessed 15 July 2011.




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             and that of the Japanese Mitsubishi MRJ in 2013. The Ukrainian Antonov is trying to
             position itself with its An-148/158.
         ●   In the disputed 100 to 150 seat sub-segment, Boeing and Airbus are facing new
             competition from Embraer with the E-190/195 and Bombardier with the CS100 and CS300.
         ●   In the above 150 seats single-aisle segment, the Airbus-Boeing duopoly will face the Russian
             Irkut MS-21 and Chinese Comac C919, which are expected to enter the market in 2016.
              The causes behind the increased number of key global competitors, beyond the
         attraction of booming global markets, are numerous.
              Developing a strong aeronautics industry seems to have moved up the political agenda
         in several countries. In Russia, virtually all aircraft manufacturing capabilities were
         consolidated within the United Aircraft Corporation (UAC) in 2006. Renewed interest in the
         development of aeronautics in Russia was further demonstrated by UAC’s commitment to
         participate in seven new civilian and military projects in the coming years. In this regard,
         UAC expects considerable government support: “the aviation industry is one of the priority
         sectors of the Russian economy, state support […] through various federal target programs
         in 2011-20 will be aimed at intensive development of priority programs and technological
         modernisation” (UAC, 2010). In China, Comac was created in 2008 with the explicit goal of
         developing the C-919, a future competitor of the B737 and the A320 family.
             At the same time, skills development enabled other OEMs or contractors to compete
         outside of their original area of expertise. Embraer and Bombardier’s experience with
         turboprops and small jets has enabled them to consider moving up to larger capacity
         planes. Similarly, Mitsubishi Heavy Industries, a traditional high value-added partner for
         Boeing, has teamed up with Toyota to manufacture its own aircraft.

         Minimizing purchase price, operating costs and financial costs
              Over the last 30 years, operating costs have replaced technology as the key factor that
         airline companies focus on prior to the purchase of an aircraft. Global aircraft
         manufacturers have adapted their strategy and now promote a cost-effective package of
         features, instead of underlining technological evolutions in their products.
             Airline or leasing companies look first and foremost at the total cost of ownership
         (TCO) of the aircraft they might purchase. Key variables used to calculate the TCO include
         the initial purchase price of the aircraft, the aircraft’s operating costs and financing costs.
         Today, the acquisition cost of a new aircraft accounts for approximately 20-40% of the TCO.
         Among other things, operating costs include fuel consumption and maintenance costs and
         are a key factor in the purchase decision.
               As a consequence, when developing a new aircraft, a manufacturer must assess the cost
         of incorporating new technologies against the cost savings the aircraft will realise through
         those new technologies. In essence, civilian aircraft producers now use demonstrable cost-
         effectiveness as a key driver for developing and applying new technologies.
             Higher fuel prices cause higher operating costs during the aircraft lifecycle, therefore
         making fuel efficiency increasingly important in the purchasing decision (US International
         Trade Commission, 1998). In fact, fuel efficiency may have replaced pure performance as a
         key innovation driver in civilian aeronautics. The two evolutions planned for the
         Airbus A320 aircraft may reflect this shift. From 2012, new “sharklet” wingtip fences will be
         added to reduce fuel consumption by 3.5%. From 2016 on, Airbus will offer a new engine


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           option for the aircraft, known as A320neo. According to the company, this version will burn
           16% less fuel. While past improvements have focused on comfort and performance, these
           two future innovations focus purely on fuel efficiency.
               In reaction to increased customer focus on TCO, some manufacturers promote an
           integrated offering, bringing together manufacturing and MRO. In July 2011, Airbus
           announced the acquisition of Danish company Satair, a leading global distributor of spare
           parts, for a price equivalent to USD 504 million. Didier Lux, Executive Vice President of Airbus
           Customer Services, declared: “This acquisition is a logical step towards our vision to become
           one of the leading companies in integrated aftermarket services for our customers.”
                Financing costs are also coming under scrutiny. Aircraft purchases have long been
           subject to advanced financing schemes, including direct syndicated loans and operational
           or finance leasing. As for operating costs, airlines are increasingly evaluating the total cost
           of financing the plane when making purchase decisions.

           The supply chain is going global
                The aeronautics industry is becoming increasingly global. The historical business
           model was centred on vertically-integrated national supply chains, occasionally
           integrating pieces or subassemblies from foreign suppliers, themselves vertically-
           integrated locally. Multinational co-operations have taken place, especially for Airbus in
           Western Europe and more recently for Boeing in Japan. However, since the beginning of
           the 2000s, the industry has moved well beyond that stage by integrating engineering,
           manufacturing and after-sales services across multiple locations on a truly global basis.
                Reasons commonly cited to explain this drive are numerous. First and foremost, going
           truly global enables OEMs to leverage productivity, talent and cost differentials worldwide.
           The level of competition caused by new entrants and increased customer demands have
           made this approach difficult to ignore. Given the increasing weight of BRIC carriers as
           clients, globalising production may also be a way to secure access to these markets. Other
           factors, such as the opening of CIS countries, falling trade barriers and communication
           costs have also been instrumental in making such an organisation possible.
                What some called “globalisation 2.0” (AeroStrategy, 2009) has been driven by OEMs but
           also by their tier-1 suppliers. To minimise costs of development and better share risk, OEMs
           have started relying more heavily on a handful of reliable tier-1 suppliers. Much of the
           design, integration and co-ordination once only offered by OEMs are now carried out by
           tier-1 suppliers. Just as much as the OEMs, these suppliers look for the best skills and the
           lowest costs worldwide.
                The increasingly global structure of the civilian aircraft manufacturing industry is
           illustrated by the trend of foreign content observed over the last 50 years. Boeing reported
           that, apart from engines, the foreign content of the 727, launched in 1959, was less than 2%
           (US International Trade Commission, 1998). The foreign content of the 767, launched
           in 1978, varied from 10 to 26%. The 777, launched in 1990, included between 15 and 29%,
           depending on the customer’s choice of US or foreign engines. Experts speculate that for
           the 787, foreign content might run as high as 70% (Pritchard and MacPherson, 2005).
           Aircraft manufacturers look globally for high-quality, competitively-priced parts suppliers
           (US International Trade Commission, 1998). Figure 8.9 shows that Airbus also leverages a
           wide network of suppliers across the world, while performing the final assembly both in
           Europe and China.


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                                Figure 8.9. Example of Airbus A380 global supply-chain




               Aerostructure
               Raw materials
               Equipment and systems
               Propulsion systems
               Cabin
               Final assembly

         Source: Airbus (2010), corporate website, www.airbus.com, accessed 15 December 2010.


         Aircraft purchases are still influenced by political and strategic factors
              Aircraft sales are still not pure economic decisions. Even in a context of higher
         competition, higher pressure on costs and globalisation, aircraft purchases do not only
         reflect economic value. Carriers of countries with aircraft production capability are heavily
         biased towards their domestic manufacturer (Table 8.4).


                                    Table 8.4. Active fleet by carrier, Airbus vs. Boeing
          Carrier                    Boeing/MD              %               Airbus                %                  Total

          Air France                      74                29               179                  71                  253
          Lufthansa                     111                 37               238                  63                  301
          Delta Airlines                540                 77               158                  23                  698
          American Airlines             619                100                  0                  0                  619

         Note: These figures only include aircraft which can be attributed to the airline and some leased aircraft may be omitted.
         Source: Airfleets (2010), corporate website, www.airfleets.net, accessed 15 December 2010.



             However, two factors tend to make economic calculations more important than
         before. The financial constraint on carriers has increased, due to growing competition and
         higher fuel costs. Also, low cost carriers have emerged. In many countries, they are less
         connected to government than incumbent national carriers and, due to their business
         model, are more likely to purchase aircraft on purely cost-of-ownership grounds.

Sources of competitiveness
         Long tradition and existing capabilities in design and manufacturing
              Ukraine has a long tradition in designing and building aircraft, which few countries
         have. It has the capacity to manufacture modern aircraft with most of the elements of the
         production cycle, from conception to commercial production. Design capability, including
         the ability to integrate all systems and parts, has been developed over time with significant
         amounts of capital, research and development, and labour. Manufacturing infrastructures,


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           including a skilled and highly-educated labour force, aeronautical R&D facilities, aerospace
           manufacturing facilities and equipment, also already exist in Ukraine.
                 More specifically, Ukraine enjoys a strong reputation in aerodynamics, including wing
           design. Antonov (2007) revealed in a press release that it had been involved in wing design
           and wind tunnel testing of Comac’s ARJ21. Ukraine, with a sizeable metallurgy sector, is
           also competitive on basic and advanced metal parts. Finally, Ukrainian manufacturers are
           also known for turboprop engine technology.
                However, despite Antonov’s historical participation in the industry, reliability issues
           exist. Table 8.5 compares total accidents to total aircraft production for a selection of
           aircraft and shows Antonov at a clear disadvantage. This is just illustrative, as small
           production lines, especially for the An-148 and differences in the age of aircraft prevent
           comparisons from being statistically significant.


             Table 8.5. Total accidents/Total aircraft production % of key aircraft competitors
                 Aircraft model      Number of accidents        Production      % of accidents/Production        Aircraft size

            ATR 72                            12                   739                     1.6              Narrow body < 100 pax
            Embraer 190/195                    1                   100                     1.0              Narrow body < 100 pax
            Antonov An-148                     1                    12                     8.3              Narrow body < 100 pax
            Boeing 737-500                     5                   392                     1.3              Narrow body > 100 pax
            Airbus A320                       15                 4 000                     0.4              Narrow body > 100 pax
            Airbus 330                         3                   792                     0.4              Wide body/VL aircraft
            Boeing 747-400                     5                 1 381                     0.4              Wide body/VL aircraft
            Airbus A340                        3                   792                     0.4              Wide body/VL aircraft
            Antonov An-124                     4                    56                     7.1              Wide body/VL aircraft

           Source: Aircraft Crashes Record Office (2011), corporate website, www.baaa-acro.com, accessed 15 December 2010.



               The extent to which Ukraine’s aeronautical history presents an advantage in reaching
           a world-class OEM position compared to emerging nations without an aircraft
           manufacturing tradition is still open to discussion. Technological catch-up by countries
           and companies without an aircraft manufacturing tradition typically involves 3 stages, as
           described by McGuire (2011): 1) exposure to the new technology through FDI; 2) an
           understanding of the technology by domestic firms; and 3) domestic possession of
           technological expertise capable of manipulating and improving the original technology.
           However McGuire (2011) suggests that technological latecomer strategies cannot be
           employed as easily in the aerospace sector as in other industries. This is due to the huge
           variation in world aircraft demand, high capital investment requirements and long
           payback periods which discourage private investment. Further, a high international
           standard in safety certification necessitates immediate production of a high quality
           product upon entry to the market.
               China, Russia and Japan have followed different strategies to become the key new
           entrants to the OEM market. China and Russia have consolidated their scientific expertise
           of multiple competing design operations into two “national champions”, the Russian UAC
           and the Chinese AVIC. China’s large domestic market has also provided significant
           bargaining power in foreign partnerships and facilitated traditional technology catch-up in
           the form of FDI knowledge transfers. Japan has gained entry to the OEM market through a
           production partnership with Boeing, most recently by leveraging an expertise in the
           development and application of composites.


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             Despite some reduction in the Boeing/Airbus duopoly, McGuire (2011) suggests that
         the current market incumbents will be difficult to displace due to their experience in
         international safety regulation, vast innovation network and high levels of R&D
         expenditure. The implications for the Ukrainian industry and Antonov are difficult to
         gauge at this stage, as Antonov has both considerable experience and considerable issues.
              The Antonov design bureau was founded in 1946 and since then has designed and
         manufactured hundreds of aircraft of different types and classes. The rest of Ukraine’s civil
         aircraft sector consists of many enterprises, including Kyiv Aviation Plant “Aviant”,
         Zaporozhye Machine-Building Design Bureau “Progress”, SE Ivchenko-Progress, JSC “Motor
         Sich”, Kharkov State Aircraft Manufacturing Company, and privately-held Aeros, Aeroprakt,
         and Aerokopter.
             Antonov designed two of the largest cargo airplanes in the world, the An-124 Ruslan
         (Condor) and An-225 Mriya (Cossack). The An-124 is the largest serially-produced cargo
         aircraft and is capable of carrying up to 120 tonnes of cargo. The recognised competitive
         advantages of Antonov products include: quality of aerostructure design, ability to use
         unpaved airfields, and flexibility of operations.
              Ukraine’s Ivchenko-Progress and MotorSich produce a variety of aircraft engines, such
         as turbofans, (An-124’s Progress D-18T or An-148’s Progress D-436), and they also have the
         technology to produce propfan engines (Progress D-27), and turboprop engines. Other
         aircraft manufacturers equipped with Progress engines include Beriev and Tupolev.

         A favourable cost position
              Ukraine in general benefits from low labour costs. Even in Kyiv, where salaries are
         considered the highest in the country, wages are still much lower than in comparable cities
         in advanced economies: on a subset of high value-added jobs, wages in Kyiv are estimated
         to be 86% lower than in Chicago or 85% lower than in Montréal (UBS, 2010). Even compared
         to emerging economies and new EU members, wages still stand at one third of Sao Paulo’s
         and at about half of salaries in Warsaw.
              However, cost competitiveness can easily be eroded. A good way to assess competitiveness
         dynamics is to look at the evolution of relative unit labour costs, which weighs productivity
         growth against labour cost increases. From 2005 to 2008, unit labour cost increased by 22.2%
         per year on average. It then dropped by 15.1% in 2009, mainly due to the depreciation of the
         hryvnia, and moved back up by 18.6% in 2010 (Havlik, 2010).
               For these reasons, improvements in capabilities, rather than a simple reliance on cost
         competitiveness, will be necessary in order to compete successfully on global markets in
         the future.

The role of foreign investors in the civilian aircraft value chain
              The strategy for the Ukrainian aircraft manufacturing sector could leverage existing
         capabilities to design and manufacture a wide range of products, such as basic
         components, complex subsystems, and aircraft assembly. Investment in Ukraine could be
         attracted according to three strategic options:
         ●   Long term option: Developing OEM and tier-1 suppliers. This option would require
             revamping the Original Equipment Manufacturer role through reinforcement of the
             Maintenance, Repair and Overhaul service, and building capabilities to offer financial
             facilities for the purchase of aircraft.

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           ●   Medium term option: Developing high-end tier-2 and tier-3 suppliers.
           ●   Short term option: Focusing on low-end tier-2 and tier-3 components.
               Conceptually, these three options are not exclusive. However, they all require financial
           resources as well as involvement from both the government and the private sector. They can
           then be seen either as strategic alternatives or as successive steps in a long-term industry
           development plan. In such a plan, resources, networks and credibility created by short term,
           low-technology options could be used to develop longer term, more ambitious objectives.
               The first option, acting as a world-class integrator of complex aircraft products is an
           ambitious objective with high financial risk. Ukrainian companies would have to focus on
           coordinating design, production and MRO of commercial aircraft in an integrator role.
           Alternatively, as a tier-1 supplier, they could design, produce and provide MRO for high-
           complexity aircraft modules, such as engines. The advantage of such an option is that the
           commercial returns would be high. The interest for foreign investors would relate to the
           potential for further improvement of existing Ukrainian capabilities in integrating complex
           subsystems (Box 8.3). However, there are risks to this option due to the massive development



                  Box 8.3. A world-class integrator strategy – Russia’s Sukhoi Superjet 100
                 In 2000, Russia’s Sukhoi launched a project to design a 75-to-95 seat regional jet airliner.
               In 2008, the Sukhoi SuperJet 100 made its maiden flight and in 2011 it was certified to fly in
               the CIS. As of summer 2011, it is still awaiting certification to fly in the EU.
                 To develop the SuperJet 100, Sukhoi had to overcome two of the hurdles that the Ukrainian
               industry could face when trying to play a global integrator role: integration of systems and
               components from partners worldwide and development of worldwide MRO services.
                 To ensure the SSJ 100 is competitive, deep collaboration with foreign partners has taken
               place. Alenia Aeronautica, a subsidiary of Italian firm Finmecannica, is a strategic partner. It
               owns a 51% stake in SuperJet International, the MRO and global marketing entity of the
               programme. Engines are designed by PowerJet, a joint-venture between Russian manufacturer
               Saturn and French company Snecma. Other equipment manufacturers include many well-
               established names such as Thales for avionics, Goodrich for brakes, Honeywell for APU and
               Messier-Dowty for landing gear.
                 Special attention was given to delivering MRO services on a par with competitors
               Bombardier and Embraer. The SuperCare plan provides maintenance on key elements for
               a fixed rate per flight hour, transferring some of the reliability risk from the operator to
               SuperJet International. Additional modules include leasing of an on-site stock of spare
               parts and ground support equipment and tools. Services are also available, including on-
               site engineering maintenance support. MRO partners have been selected in more than
               21 locations worldwide. Main spares centres are located in Frankfurt (operated by
               Lufthansa Technik Logistik) and Moscow. Pilot training is provided in Venice and Moscow.
                 Whether such a strategy is replicable in the case of Ukraine mainly depends on whether
               the domestic industry can overcome two key differences with the Russian example: a
               small domestic market and limited financing capabilities. The future launch of Chinese
               and Japanese competing aircraft could also mean a closing window of opportunity for an
               OEM without a strong recent track record.
               Source: United Aircraft Corporation (2010), corporate website, www.uacrussia.ru/en, accessed 15 December
               2010; Sukhoi (2010), corporate website, http://sukhoi.org/eng/planes/ssj100, accessed 15 December 2010; Superjet
               International (2010), corporate website, www.superjetinternational.com, accessed 15 December 2010.




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         costs required when launching a new programme or project, while Antonov’s credibility in
         the global market may be questioned. The task would be even more challenging for Ukraine
         given the need to build and finance MRO capabilities in potential client countries. This is an
         essential yet still missing step to ensure exportability of products. It would require
         developing spare parts, storage facilities, on-site training, specialised personnel, and round-
         the-clock maintenance services. Finally, the complexity of global supply-chain management
         makes this option the highest risk-return combination.
             The second option, which entails manufacturing high-value components for foreign
         OEMs and suppliers, entails a moderate financial risk. As a supplier to foreign OEMs or
         their tier-1 suppliers, Ukrainian manufacturers would participate in designing and
         manufacturing technically advanced components (e.g. advanced aero-structure parts or
         engine components), without playing a central role as an integrator or an MRO provider.
         The advantages of this option are a relatively high return, the opportunity to leverage
         Ukraine’s capabilities in design and production of highly-engineered components, and the
         more limited commercial and financial risks, since MRO services are provided by the
         integrator. The disadvantages of this option are the barriers to entry in global supply
         chains. If the high-value manufacturer position was chosen, production processes would
         have to be adapted to conform to global practices for certification and standardisation.
              The third option examined, the production of low- to mid-tech parts for foreign
         players is a low-risk possibility with lower potential returns. As a supplier to foreign
         suppliers (i.e. as a tier-2 to tier-4 supplier), Ukrainian manufacturers would produce mid- to
         low-tech parts at an attractive cost. If it chose this option, Ukraine could take advantage of
         a strong industrial base and an existing credibility, especially with regard to metal parts.



            Box 8.4. Focusing on low-end tier-2 and tier-3 components – Romania and EADS
               Romania has historically been involved in aeronautics, even if not at the same level as
            Ukraine. Romanian aeronautics date back to the creation of Industria Aeronautică Română
            (IAR) in 1925 as a manufacturer of military aircraft for the Royal Romanian Airforce. At the end
            of the 1960s, its production shifted to helicopters and more recently to helicopter maintenance.
              Eurocopter, part of EADS, has been instrumental in this shift as a key partner to IAR.
            Eurocopter Romania was established in 2001 to provide MRO services for Eurocopter helicopters
            in the region. The company remains of modest size, with 126 employees and a 2010 turnover of
            EUR 29 million. Romania has also been active in avionics software components.
              In 2011, EADS activities in Romania were extended to production and assembly of metal
            components for Airbus aircraft. EADS subsidiary Premium Aerotec invested in a production
            facility in Ghimbav costing a total of EUR 40 million. The company aims to reach
            1 000 employees. However, based on public information, it seems that design is still fully
            located in Germany.
              This case is an example of a country using mid-to-low complexity components and
            services to establish strong ties with foreign OEMs and then build on that relationship. The
            Romanian government has expressed its plan to develop its aerospace industry further
            and EADS CEO Louis Gallois declared in July 2011: “We are determined to create a global
            excellence centre for MRO […] and integrate Eurocopter Romania in the global supply chain.”
            Source: EADS (2011), corporate website, www.eads.com/eads/int/en.html, accessed 30 August 2011; Le Monde (2011),
            “EADS ouvre sa première usine en Roumanie”, article published on 12th July 2011, www.lemonde.fr/
            economie/article/2011/07/12/eads-ouvre-sa-premiere-usine-en-roumanie_1547924_3234.html, accessed 15 July 2011.




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           Another advantage would be the possibility to work with a wide range of clients from
           Western and emerging economies (Box 8.4). However, the shortfalls of this option would be
           the rather limited value captured, direct competition for FDI with very competitive low-
           cost economies, and the limited leverage of existing engineering skills.

Key issues and policy barriers
           A small domestic market
                 Access to a large domestic market constitutes an important strategic advantage for
           civilian aircraft manufacturers. This gives the opportunity for economies of scale in both
           production and maintenance. Both Boeing and Airbus have access to sizeable domestic
           markets and this also enables countries to secure offset arrangements, offering market
           share on the domestic market in exchange for location of some of the production.
           Compared with neighbouring countries, the Ukrainian domestic market is relatively small:
           the domestic civilian fleet is a quarter of the size of the Russian fleet by number of aircraft
           (Table 8.6) and it is equivalent to 8% of the Chinese fleet or 2% of the American fleet. Under
           these conditions, access to foreign markets becomes of critical importance.


                             Table 8.6. Active fleet by country, selected countries
                                                            Number of carriers            Number of aircraft

                         Ukraine                                    16                            123
                         Russia                                     37                            495
                         China                                      41                          1 639
                         United States                             103                          6 513

                        Source: Calculations derived from Airfleets website, Airlines List Database;
                        www.airfleets.net, accessed 15 December 2010, (excluding civilian aircraft operated by
                        militaries, including civilian aircraft used by passenger carriers, freight companies and
                        businesses).



                The lack of access to a large domestic market can be overcome. For example, Embraer
           sold relatively few turboprops in Brazil and only began selling regional jets domestically
           after winning an order from carrier Azul in 2008.

           Low market share and lagging MRO network are two mutually reinforcing issues
                The most recent Ukrainian civilian aircraft, Antonov An-148, is a regional passenger jet
           with a 75 passenger capacity. The An-158 aircraft is an extended version of the An-148 with
           a higher passenger capacity of 99 seats. The first AN-148 was delivered in 2009 and at the
           end of the 2nd quarter of 2011, Antonov reported that there are 9 aircraft delivered and
           operating in Russia and Ukraine. By comparison, the world regional jet deliveries of
           Bombardier and Embraer reached 323 in 2009-10, which indicates that Antonov has less than
           3% of market share in this segment. Antonov recently reported that the total number of firm
           orders and options for the An-148 and the An-158 version has reached 150 (Antonov, 2011),
           which would correspond to approximately USD 4 billion, to be compared to a commercial
           order book backlog of approximately USD 16 billion for Bombardier or Embraer.
                On the domestic market, Ukrainian airline companies often prefer to purchase
           foreign-made aircraft, due to the costs and risks of switching to a new model that has not
           been proven reliable yet. Moreover, airline companies are willing to focus on specific
           models, due to the scale advantages in terms of staff training or spare parts procurement.
           For instance in April 2011, a Ukrainian airline company (UTair Aviation) concluded a
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                     Box 8.5. A close strategic and industrial relationship with Russia
              Formerly a key part of the Soviet military-industrial complex, the Ukrainian aeronautical
            industry has gained some independence in the last 20 years but significant strategic and
            industrial ties remain with Russia.
              The Ukrainian and the Russian civilian aircraft industries are interconnected. For
            production of the An-148, on top of the Kyiv assembly line, much of the assembly is made
            at the VASO factory in Voronezh, Russia. A majority stake in the factory is owned by state
            conglomerate UAC through Ilyushin. Russia also represents the bulk of orders for Antonov
            planes. The first customer for the An-148 was Rossiya, a Russian carrier. Russian carriers
            account for more than 40% of orders for An-148 aircraft.
              The relationship between Antonov and UAC has seen some recent developments, the
            exact reach of which is still unclear. In October 2010, an agreement was signed between
            UAC, Antonov and Russian bank VneshEkonomBank (VEB) to start a joint-venture financed
            by VEB. It has not yet been made public what proportion of Antonov’s activities will be
            transferred to the joint-venture with UAC.
              Moving closer to Russian partners is in principle compatible with integration in global
            supply chains. UAC itself is a good example, consolidating the Russian aircraft industry
            while partnering with many Western firms on the Sukhoi SuperJet 100 programme.
            However, further integration with UAC could also delay the necessary governance,
            management and operational reforms needed and thus impede the integration of Antonov
            into global supply chains.
            Source: United Aircraft Corporation (2010), corporate website, www.uacrussia.ru/en, accessed 15 December 2010.




         contract with ATR for the delivery of 20 new ATR 75-500 regional turboprop aircraft. UTair
         has been operating ATR aircraft for several years now and the number of these aircraft in
         its fleet is continually growing.
               Efficient after-sales services are essential to sell aircraft, and even more so for exports.
         As stated above, airlines are increasingly looking at the total cost of ownership. One of the
         key factors influencing this cost is the utilisation rate of the aircraft. To optimise
         utilisation, efficient maintenance, repair and overhaul (MRO) services have to be provided.
            In the past, Antonov customers have publicly complained about the poor quality of
         MRO services. In May 2010, General Director of Rossiya Sergei Belov stated that to generate
         an “acceptable level of profitability”, the Antonov 148 had to be flown 10 to 12 hours a day
         and that would be “difficult” without more involvement from Antonov and its suppliers.
              Several reasons explain the weakness of Antonov in MRO services. Antonov has
         historically been active in military transport aircraft. In that segment, utilisation rates are
         not as sensitive an issue as for commercial aircraft and logistics are often taken care of by
         the client military.
              Another reason may be the cost behind setting up an MRO network. To be financially
         viable, an investment in MRO capabilities should be spread across a sufficient number of
         aircraft in the area covered by the MRO centre. However, to sell aircraft to airlines operating
         in the area, offering efficient MRO services is essential. In that respect, investment in MRO
         can be described as a chicken-and-egg issue. A possible option to develop MRO without
         bearing the whole cost is to partner with foreign players, as Sukhoi experienced with
         Alenia for the SuperJet 100.


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           Closed governance, burdensome legal status and lack of risk-sharing partnerships
           with suppliers
                The governance of Antonov and of the civilian aircraft sector in general hampers its
           competitiveness (Box 8.6). The Ukrainian civilian aircraft sector is as tightly regulated as
           military activities. In fact, it has been regulated in the same way by the same Agency for the
           Military-Industrial Complex. Such governance pushes for an exclusive focus on security
           instead of a business-centred management, which is a potential obstacle to increasing
           competitiveness. Officially, the government has decided to separate civilian and military
           activities. According to a decision at the end of 2010, Antonov is to be monitored by the Agency
           on State Property and Corporate Rights. However, this change has yet to be implemented.



                            Box 8.6. Issues deriving from the legal status of Antonov
                                     – Public procurement and joint ventures
                Procurement by Ukrainian state bodies and state-controlled entities is tightly regulated.
              Tender processes are mandatory and are often lengthy and costly to implement. Ukrainian
              state owned enterprises (SOEs) are also forbidden to establish joint ventures pursuant to the
              Decree of the Cabinet Ministers on Special Issues of State Property Management (31.12.1992).
              The original purpose of this legislation was the prevention of SOE management corruption
              during the early 1990s. The law is an outdated and unwieldy tool which presents an obstacle
              to participation in joint ventures.
                In July 2011, the state amended its public procurement law with the intention of mitigating
              these administrative inefficiencies. This law will be effective from September 2011. Under
              certain circumstances, the amendment allows state-owned companies to bypass the tender
              process and purchase goods or services through the procurement from a single supplier
              procedure. To prevent corruption associated with the single supplier’ procedure, deals are
              overseen by a controlling body of the Cabinet of Ministers. Although the new law may
              increase procurement efficiency, the single supplier clause has been sharply criticised by
              the EU as a mechanism that fuels corruption and that is out of synch with EU criteria.
                Antonov, due to its special tax status, is not included under the scope of the amendment and
              continues to apply previous tender procedures. These procedures reportedly take 4-8 months
              in total. This can result in a chain effect as Antonov often sources parts, for example engines,
              from other state-owned enterprises, which must also undertake their own tender
              procedures. This requires Antonov’s management to devote time and attention to sourcing
              procedures, in an industry where the creation and management of strategic partnerships
              and complex supply chains are the keys to success.
                Antonov’s SOE status could be reviewed alongside an analysis of more efficient legal
              mechanisms to simultaneously control corruption and facilitate partnerships. Reform and
              streamlining of procurement law is needed strike the balance between preventing
              corruption and increasing process efficiency.
              Source: OECD (2010), Ukraine Sector Competitiveness Review, internal working document, OECD, Paris.




                International examples show that other countries that also cherish their national
           independence have organised their aeronautics sectors differently. In the United States,
           Boeing is active in both civilian and military activities in roughly equal proportions. It is still
           a standard corporation, listed on the New York Stock Exchange. The necessary processes
           have been put in place to guarantee a “Chinese wall” between civilian and military activities,
           including setting up two different headquarters in Washington State and Missouri.


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             To reduce their own financing needs, global aircraft manufacturers have increasingly
         involved a selection of tier-1 suppliers as risk-sharing partners. These risk-sharing
         partners are involved from the design phase and finance a part of the development cost of
         the programme. For Boeing’s 787 programme, Japanese risk-sharing partners alone will
         invest a total of USD 3 billion (Table 8.7).


                                Table 8.7. Investment in the Boeing 787 programme
                                          by Japanese risk-sharing partners
                          Companies                              Components               Investment (USD m)

                          Mitsubishi Heavy Industries            Wings and engines                 900
                          Fuji Heavy Industries                  Airframe                          400
                          KHI                                    Airframe and engines              650
                          Ishikawajima-Harima Heavy Industries   Engines                           350
                          ShinMaywa Industries                   Airframe                          150
                          Toray                                  Composite material                250
                          Second-tier suppliers                  Equipment and systems             300
                          Total                                                                  3 000

                         Source: Pritchard, D. and A. MacPherson (2005), “Boeing’s Diffusion of Commercial
                         Aircraft Design and Manufacturing Technology to Japan: Surrendering the US Aircraft
                         Industry for Foreign Financial Support”, Canada-United States Trade Center Occasional
                         Paper, No. 30, State University of New York, Buffalo, www.custac.buffalo.edu/content/
                         documents/OccasionalPaper30.pdf, accessed 15 September 2011.



              The Ukrainian civilian aircraft industry is too centralised around Antonov and too
         closed to international collaborations for this type of risk-sharing partnership to take
         place. At present, integration with the Russian aircraft industry is more an industrial
         partnership than a genuine risk-sharing one. Antonov currently bears the financial burden
         of new programme development on its own.

         Sustainability of skills in question
             The sustainability of the skills necessary to maintain and improve the level of
         excellence of the Ukrainian civilian industry may not be assured in the medium to long
         term. As with other sectors of the economy, the civilian aircraft sector is suffering from an
         ageing workforce. Younger generations are less numerous and brain drain’ to western
         countries is an additional issue, especially for the most skilled employees.
               Production jobs may be the biggest problem. In the OECD Country Capability Survey
         conducted in 2011, 55% of the responding companies declared that they faced a major or a
         minor skills gap at the production worker level. 46% reported the same issue for
         supervisors and only 36% for engineers. While the education of top-level specialists seems
         to be satisfactory, standards are not always met for mid- to low-level jobs (Figure 8.10). This
         has been confirmed in interviews with Antonov management, who expressed concerns
         about the availability of competent floor workers and supervisors.
               Access to financing is restricted for both manufacturers and potential customers.

         Limited financing in the development phase
              Aircraft manufacturing, especially in the development phase, requires a large amount
         of investment. These financing needs are usually addressed through banks and financial
         markets, risk-sharing partnerships and various kinds of government support. The
         Ukrainian civilian aircraft industry is currently lagging on all these dimensions.

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           Figure 8.10. Surveyed entrepreneurs assessed the skill gap in the aircraft segment
                           Replies to the question “In which areas do you feel the presence of a skill gap?”

                                          Légende                               Légende
               %
               60


               50


               40

                                                                                                                 45
               30

                                                                                              42
               20                               25
                            13


               10                                                     7
                            13
                                                 9                                                               10
                                                                      7
                0                                                                              3
                         Managers            Engineers           Salespeople              Supervisors      Production floor
                                           and designers        and marketing                                 workers

           Source: Calculations based on OECD (2011), Country Capability Survey, internal working document, OECD, Paris.


               Western aircraft manufacturers and their suppliers rely heavily on debt financing by
           banks and financial markets, as firms from other capital-intensive sectors do. As an
           example, the EADS corporate website indicates that the group’s financial toolbox comprises:
           ●   Cash. EADS set an objective of holding EUR 3 billion of “strategic cash” on hand at all
               times. This cash is the result of both accumulated profits and debt issuance.
           ●   Bank revolving credit facilities of up to EUR 3 billion. This facility, typically not drawn, gives
               some additional financial space to the company.
           ●   French commercial paper of up to EUR 2 billion. This is a short-term debt security maturing
               within 12 months of issuance.
           ●   Bonds (Euro Medium-term Note programme) of up to EUR 3 billion. This long-term financing
               line has been partly drawn, up to a current total of EUR 1.5 billion, maturing in 2016
               and 2018.
           ●   Other financial instruments, including derivatives. Aircraft manufacturers bear currency,
               counterpart and other risks that can be partly hedged through financial instruments.
                Antonov, by contrast, can only access some domestic bank financing. As a state-
           owned company of special status, it is barred from capital and debt markets. Financing by
           international banks is also hampered by this status. Antonov therefore has to rely on its
           own cash generation or on the government budget.

           Lagging customer financing
               The financing needs of the industry include not only financing of aircraft development,
           but also financing of aircraft purchases. There again, there is a gap between western
           companies’ practice and the situation of clients of the Ukrainian industry.
                    The financing of aircraft purchases can take several forms:
           ●   Syndicated loans. A group of banks issues a loan to the airline for the purchase of the
               aircraft, using the aircraft as collateral.




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         ●   Operating leases. Companies such as the International Lease Finance Corporation (ILFC) or
             GE Commercial Aviation Services (GECAS) purchase aircraft and then lease them to carriers.
         ●   Finance leases. Generally involving the creation of an ad hoc financial vehicle, this more
             engineered type of lease is financed through equity and debt issuance on international
             financial markets.
              Regarding these financing schemes, the Ukrainian industry faces several difficulties.
         Ukrainian banks cannot match foreign syndicates in their ability to finance large projects
         such as aircraft purchases. More importantly, the two major operating leasing companies
         are not Antonov customers. The ILFC only leases Boeing and Airbus planes, while GECAS
         relies on Airbus, Boeing, Bombardier and Embraer. This is key, as Antonov’s primary
         customers remain Ukrainian and Russian carriers that are not always deemed credit-
         worthy enough to access other financing solutions. Regarding finance leases, the level of
         development of financial markets and of macroeconomic stability in Ukraine hampers the
         competitiveness of the Ukrainian industry.
             The Ukrainian government is well aware of this issue. Deputy Prime Minister
         Kolesnikov, when interviewed in 2011 about the possible sale of 15 An148/158 to Aerosvit,
         declared: “airlines will buy these aircraft only if the government is able to provide world-
         class financing terms, that is leasing costs below 2%”.

         Lack of overall government support
             The aircraft industry in most countries has been supported by governments in a series
         of ways, both on the manufacturer side and on the customer financing side.
              Direct support from governments to manufacturers has often taken the form of R&D
         and innovation incentive schemes. In the case of Europe, Airbus has secured several loans
         from the European Investment Bank. As late as July 2009, the EIB awarded Airbus a
         EUR 800 million loan to finance research and development projects aimed at reducing
         aircraft fuel consumption and CO2 emissions. Even in countries hosting only risk-sharing
         partners of foreign OEMs, there has been some direct government support. In Japan,
         Pritchard and MacPherson (2005) have estimated that government support for the Boeing 787
         programme will total USD 1.6 billion. After reworking of the plan due to the concerns of the
         WTO, Pritchard and MacPherson (2005) estimate that 70% of this support will be
         reimbursable loans, while the remaining 30% will be made up of non-refundable grants.
              The current situation of Ukraine leaves little financial space for the government to
         provide financial support to its domestic industry. The current fiscal deficit, excluding
         bank recapitalisations, reached 8.7% in 2009, 7.4% in 2010 and is expected to be 3.5%
         in 2011 (World Bank, 2011). IMF intervention was requested by the government of Ukraine
         and an IMF loan equivalent to USD 14.9 billion was granted. As this loan is subject to
         regular performance reviews at the disbursement of each tranche, it is likely that the
         government budget will remain tight and that no large-scale support to the civilian aircraft
         industry will be provided.
             Government support to the industry can also be indirect, through customer financing
         schemes. Export Credit Agencies (ECAs) play an especially important role. Coface in Europe
         and the US Export-Import Bank provide financing for many aircraft purchases. Acting as
         guarantors, they lower the cost of. Historically, such schemes have been used in ways that
         have distorted competition. Today, the importance of such schemes is decreasing as the
         Arrangement on Officially Supported Export Credits, negotiated at the OECD, restricts


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           conditions that can be offered by exporting countries. Still, Ukraine, not having such a
           powerful financing tool, is at a disadvantage compared to its global competitors.

Policy recommendations
           The governance of Antonov needs to be reformed and corporatisation promoted
                The governance of the civilian aircraft sector is currently unsatisfactory. Ukraine, as
           various OECD and non-OECD countries do, may wish to retain control of activities related
           to the military, including military aircraft manufacturing. However, the civilian aircraft
           sector needs private and foreign investment. The government could therefore separate
           governance of civilian and military activities. In this regard, the initiative of putting
           Antonov under the sole supervision of the Agency on State Property and Corporate Rights
           is a positive step, but it now has to be translated into action.
               Changing the governance of the sector would also mean changing the governance of
           Antonov. The OECD Guidelines on Corporate Governance of State-owned Enterprises states that
           “governments should strive to simplify and streamline the operational practices and the
           legal form under which SOEs operate. Their legal form should allow creditors to press their
           claims and to initiate insolvency”.
               More concretely, the government may want to consider the “corporatisation” of
           Antonov, i.e. its transformation into a corporation of standard status. This would have
           positive consequences on several dimensions:
           ●   Better access to financing on domestic and international financial markets.
           ●   More possibilities for international collaboration. The company’s status would be more
               transparent to potential partners and potential disputes could be resolved before
               ordinary courts.
           ●   More operational freedom. In particular, this would be an incentive to adopt the most
               efficient governance and business processes. It would also enable better strategic
               decisions.

           Need to improve the investment policy and promotion of the sector
                The Ukrainian government needs to implement changes in its investment policy,
           opening up the sector to foreign and private investors. This would help solve financing
           issues, as foreign investment could provide significant capital inflows. In particular,
           investment policy reform is necessary to shift to a risk-sharing partnership model. It could
           also help build relations with the international financial system, allowing better financing
           of companies and customers. A more open sector is also key to the development of MRO
           networks, which would be virtually impossible without a partnership with an already well-
           established partner. Finally, it would help to hardwire governance changes (Box 8.7) and
           switch to a business-centred policy.
                Investment in the civilian aircraft sector could be encouraged by specific investment
           promotion measures. Putting in place support mechanisms would only prove efficient after
           the suggested investment policy reform and governance reforms have been. InvestUkraine
           could be one of the lead bodies in this effort.
                There are a number of steps that could be taken to actively promote the sector to
           foreign investors. For example, the civilian aircraft industry could be included as a top
           priority in the overall investment promotion strategy of Ukraine. Secondly, a sector-specific


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                       Box 8.7. Investment policy actions recommended for Ukraine
            1. Several Ukrainian laws refer to national security and strategic sectors, which – according to the
               Commercial Code (Article 117) – could justify sectoral and territorial restrictions on FDI. The law
               “On the Fundamentals of National Security of Ukraine” provides the following definition of
               economic threats to national security: “critical dependence on the business cycles of
               international markets” and “increases in the share of foreign capital in the strategic sectors of
               the Ukrainian economy such that they jeopardise its economic independence” (Article 7).
            2. Neither domestic nor foreign investors may participate in a number of activities defined as
               “strategic” which have to remain in the hands of more than 1 000 state-owned enterprises and
               are therefore excluded from privatisation. The 1992 privatisation law established that
               participation of foreign investors in privatisation of “strategic” enterprises (the so-called G-
               group) requires a special permit from the Parliament and the Cabinet of Ministers but does not
               specify the authorisation procedures. This incomplete legislative framework has opened the
               possibility of non-transparent privatisation deals, enabling certain investors from countries
               with better local connections to get stakes in key industries deemed to be strategic, such as
               the oil industry or the gas transport network (Dubrovskiy et al., 2007).
            3. As already mentioned, the economic reform programme for 2010-14 underlines the role of
               privatisation and encourages participation of foreign investment in modernisation of the
               national economy. On one hand, it sets the objective of defining clearly the sectors and
               enterprises in which the state will maintain exclusive or majority ownership and, on the other
               hand, of fostering privatisation in other sectors, including with the participation of foreign
               investors. The new law on privatisation currently under preparation intends to introduce a
               methodology for determining the “critical” level of foreign ownership in “strategic” sectors,
               which would then be used by state agencies managing state property to define the level of
               foreign ownership in these sectors.
            4. Ukraine’s current legislation therefore refers to “national security” and “strategic sectors” in
               relation to foreign investment in different contexts without clearly defining the sectors
               concerned or specifying relevant authorisation procedures for participation by foreign
               investors. New legislation in preparation is supposed to define with more precision the notion
               of “strategic sectors” in the context of privatisation. But the planned procedures for selecting
               sectors and determining the level of authorised foreign participation in the privatisation
               process still appear to leave considerable room for administrative discretion.
            5. The Ukrainian authorities should consider adhering to the recommendations of the OECD
               Guidelines for Recipient Country Investment Policies relating to National Security (OECD, 2009c), which
               were adopted by the OECD Council in May 2009. These Guidelines help countries to design and
               implement national security goals with the smallest possible impact on investment flows by
               complying with the principles of non-discrimination, proportionality, transparency and
               accountability. In particular, the Guidelines recommend that governments treat similar
               investors in the same way, make transparent their regulatory objectives and practices, clearly
               publish relevant laws and consult interested parties when considering legal or regulatory
               changes. To ensure procedural fairness and predictability, the review or authorisation
               procedures for foreign investment should be based on clear criteria and specify the
               modalities, including the documents to be submitted by applicants, the timeframe for replies
               by relevant authorities, and the possible appeal or redress procedures against administrative
               decisions. Such measures would help to reduce the current legal and regulatory uncertainty
               not only in the area of strategic sectors and national security but also, more generally,
               enhance the transparency and predictability of the investment regime in Ukraine.
            Source: OECD, (2011) Investment Policy Reviews: Ukraine, Paris.




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           investment promotion strategy would need to be defined and an action plan detailed. The
           dialogue with international investors could be fostered through international events.
           Finally, a dedicated team in charge of investors in the aeronautical industry could be
           created, acting as a one-stop-shop before and after investment.

           Review trade policy
                In a second phase, it could be useful to review trade policy and how it impacts the
           operations of companies in the sector. Trade barriers do not seem to impact the industry
           today, as integration in international supply chains is low. In the future, the implementation
           of other policy reforms could make a review of trade policy extremely useful to tap the full
           potential of opening the sector to international investors, ideas and practices.

           Skills sustainability
               The government of Ukraine might want to take action to preserve and enhance
           aeronautical skills. Box 8.8 describes the Brazilian experience in this area and it shows that
           enhancing training and R&D has been an important step in sustaining competitiveness. To
           do so, several types of reform could be considered:
           ●   Reforming initial education. Reforming curricula through public-private dialogue could be an
               appropriate first step. It would greatly impact the quality of the education of aeronautical
               specialists, while also involving local and foreign manufacturers. Additionally, it could pave
               the way for more ambitious reforms of universities’ organisation, management and funding.
           ●   Reforming vocational education and training. Specific action on secondary technical
               education and its relevance to business needs could be considered. Similarly, strong
               involvement of businesses in curriculum design would be helpful.
           ●   Reinforcing continued education. The development of efficient, aeronautics-specific
               programs could also be useful in preserving and enhancing the skills of workers and
               engineers. Acting on continued education would yield two specific benefits. It could first
               be targeted at specific groups of people, namely floor workers and supervisors. Second,
               it would yield quicker benefits than reforming initial and vocational education.

           State support to the industry and its clients needs to be reviewed
                The government might want to be cautious in extending support to the aircraft
           industry, as no industry, including strategic ones, should be granted automatic, unqualified
           state support. However a thorough review would be a useful instrument to refine the state’s
           industrial strategy and direct funds to where they can be utilised most efficiently.
               A review would enable efficient implementation of governance reform. It would also
           be useful to make sure that the government defines an appropriate strategy for maximal
           development of its civilian aircraft sector, under two main constraints: tightly controlled
           government expenditures and fair competition under WTO and other international rules.
                As part of this process, the government might want to consider becoming a participant
           in the OECD Sector Understanding on Export Credits for Civil Aircraft.* This Working Group
           currently includes Australia, Brazil, Canada, the European Union, Japan, Korea, New
           Zealand, Norway, Switzerland and the United States. Joining this process would act as a
           catalyst for reform in the sector while reinforcing links with international aircraft-
           producing countries.


           * www.OECD.org/officialdocuments/displaydocumentpdf?cote=tad/pg(2011)3&doclanguage=en.


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              Box 8.8. Brazil – An array of educational, training and research institutions
                                   for competitiveness in aeronautics
              To support the development of Embraer, an array of educational, training and research
            institutions are active in the region of Sao Paulo:
                Initial education relies mainly on two types of institutions:
            ●   The Aeronautic Technology Institute (ITA) trains aeronautical engineers, including
                several Embraer CEOs.
            ●   Sao Paulo State technical colleges (FATECs) train technology specialists.
              Research and development, consulting and continuing education is managed by the
            Aeronautics Technological Center (CTA), which is part of the Aeronautics Ministry. Several
            institutions play a key role:
            ●   The Institute of Advanced Studies (IEAv) is mainly responsible for fundamental
                research.
            ●   The National Institute for Space Research (INPE) provides post-graduate training.
            ●   The National Industrial Learning Service (SENAI) trains apprentices.
            ●   The Industrial Foment Institute (IFI) provides consultancy services.
            Source: Embraer (2010), Annual Reports, http://ri.embraer.com.br/show.aspx?idCanal=iM2P2p1lloUsWi5mzDbdbA,
            accessed 15 December 2010.




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Competitiveness and Private Sector Development: Ukraine 2011
Sector Competitiveness Strategy
© OECD 2012




                      Conclusion and roadmap
                     for implementation phase


         This chapter summarises the strategic recommendations. It presents a framework
         to prioritise among sector specific policy recommendations, based on the country’s
         strategic advantage and the areas of intervention that the government can leverage.
         A final section discusses the next steps needed to start the implementation phase
         and to build-up long term capabilities.




                                                                                               187
III.9. CONCLUSION AND ROADMAP FOR IMPLEMENTATION PHASE




A roadmap for creating a favourable business environment and attracting
investment
            This study provides a prioritised list of policy issues for consideration by the Ukrainian
        government that aims to foster private sector development and create a favourable business
        environment attractive to foreign investors. It analyses firstly the investment environment at
        a general level and then proposes some specific recommendations based on a sectoral
        assessment of the structural issues affecting growth in four selected pilot sectors.

        Economy-wide measures are the keystone of the reform agenda
             Although necessary macroeconomic reforms are not analysed here, they remain the
        keystone for establishing credibility and securing the long-term stability demanded by
        domestic and foreign investors. The new lending programme worth USD 15.2 billion signed
        with the IMF in July 2010 eased concerns over the country’s sovereign risk; however,
        cooperation with the Fund and disbursement of the third tranche of credit (originally due
        in February 2011 and then frozen due to lack of reforms) depends on the government’s
        ability to respect the requirements of the IMF’s package. The reform agenda urgently needs
        to address deeper fiscal measures. In this direction, in July 2011 the parliament approved
        pension reform legislation, which gradually increases the retirement age for women
        from 55 to 60 and introduces a new cap on pensions. A second intervention considered as
        a priority in the IMF’s deal is the gradual increase of gas tariffs for households and heat
        suppliers, nevertheless there has been no progress on this point. It is crucial to maintain
        the reform momentum and strengthen the fiscal position of the country. The delay in
        receiving the third tranche, which is now expected to be disbursed by the end of 2011,
        could put further pressure on the country risk premium and on the government’s
        credibility regarding respect for international commitments.
             Within the context of this broad reform agenda the OECD Investment Policy Review of
        Ukraine proposes investment policy advice based on the Policy Framework for Investment (PFI)
        in order to ameliorate the still-challenging business climate (OECD, 2011). A first set of
        general investment policy recommendations includes, among other things:
        ●   the abolition of the moratorium on land ownership and the implementation of a unified
            registry of land and real estate;
        ●   the lifting of outstanding foreign investment and trade restrictions in line with the WTO
            commitments;
        ●   the observation of the principles of non-discrimination, proportionality, transparency
            and accountability in implementing investment measures related to national security, in
            line with the 2009 OECD Guidelines for Recipient Country Investment Policies relating to
            National Security.




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             A second set of recommended measures aimed at improving the investment climate
         focuses on:
         ●   finalisation of the VAT arrears refunding and the improvement of the VAT
             administration;
         ●   the development of public-private consultation on business-related legislation and
             regulations with the business community, including foreign investors, notably within
             the Council of Local and Foreign investors.
               Thirdly, some specific measures were identified in the field of energy efficiency
         investment, including:
         ●   the phasing out of the energy tariff subsidies before the end of 2012, the launch of
             privatisation in the energy sector, the unbundling of Naftogaz and the establishment of
             an independent energy regulatory agency;
         ●   the setting up of a transparent legal and regulatory framework to mobilise investment in
             energy efficiency and energy production from alternative sources.

Targeted interventions are recommended to build long-term capabilities 
in promising sectors
              Four pilot sectors have been identified as a focus of the analysis, according to the
         Sector Prioritisation Framework and extensive consultations with the relevant stakeholders.
         The previous chapters contain an assessment of the drivers of these sectors in the short-
         and medium-term and of the policy barriers hampering their growth. Several specific areas
         of improvement have therefore been identified. In order to develop a prioritised reform
         programme and a roadmap for the implementation phase of the Sector Competitiveness
         Strategy for Ukraine project (Phase II), the proposed recommendations have been assessed
         according to two dimensions:
         ●   Strategic Advantage: distinguishing between static comparative advantage and dynamic
             comparative advantage (Krugman 1987; Lall, 1990). As explained in the methodology
             (Chapter 1) a static comparative advantage is based on natural endowments and short
             term drivers, such as low labour costs which might be difficult to sustain over time.
             A dynamic comparative advantage leverages long-term strategic positioning, being
             rooted in learning-by doing and higher-value activities.
         ●   Areas of Intervention: the government can have an impact through either rules or
             capabilities. Rules and regulations build the framework for a sector; however they can
             easily be reversed. Capabilities can be broadly defined to refer to the entire complex of
             skills, capital resources and technology which an economy can build over time. Both
             rules and capabilities are important, however capabilities create positive externalities
             for the economy.
              The proposed framework provides the government with an instrument to implement
         strategic policy-making. However, alternative strategies are not mutually exclusive.
               In the agribusiness sector the areas of intervention selected for the next implementation
         phase are: Access to Finance (for the grain value-chain) and Human Capital Development
         (for the dairy value-chain) (Figure 9.1).
               Regarding energy production from alternative sources, the selected areas of intervention
         are Investment Policy and Promotion (Figure 9.2). As explained earlier (Chapter 1)
         interventions belonging to the quadrant Rules-Static Comparative Advantage, such as the


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III.9. CONCLUSION AND ROADMAP FOR IMPLEMENTATION PHASE



                         Figure 9.1. Selected areas of interventions in the Agribusiness sector
                           Access to finance and Human Capital Development have been selected for next phase

   Strategic advantage

                                                                  Investment                 Access to finance
   Dynamic                                                          policy                                                        Human capital
   comparative                                                                          – Co-operative banks
   advantage                    Quality standards             – Attract FDI in the      – Supply chain financing,            – Initial education
                                                                dairy processing          warehouse receipts                 – Vocational education
   Based on                  – Food safety regulation           industry                – Leasing                            – Continued education
   high-value added          – Streamline of controls         – Geographical                                                 – Match the needs
                                                                                        – Credit guarantee schemes
   long term                 – Certifications                   export
                                                                diversification         – Microfinance                         of the private sector

                                                                                                       Infrastructures
   Static                                     Land reform
   comparative                                                                                  – Road system
   advantage                                                                                    – Grain carriers
                                       – Land reform completion
                                                                                                – Port infrastructure
   Based on
                                       – Lift the moratorium on land sale                       – Storage facilities
   natural ressources
                                                                                                – Cold chain
   labour cost
   short term
                                                 Rules                                                      Capabilities             Area of intervention


Source: OECD (2010), Ukraine Sector Competitiveness Review, internal working document, OECD, Paris; Framework based on Krugman (1987)
and S. Lall (1990); P. Krugman, (1987), “The Narrow Moving Band, the Dutch Disease, and the Competitive Consequences of Mrs. Tatcher.
Notes on Trade in the Presence of Dynamic Scale Economies”, Journal of Development Economics, Vol. 27, No. 41-55; Lall, S. (1990), Building
Industrial Competitiveness in Developing Countries, OECD, Paris.


Figure 9.2. Selected areas of interventions in the Energy production from alternative sources sector
                                     Investment Policy and Promotion have been selected for next phase

   Strategic advantage                                                                       Investment Policy
                                                                                        – Attract FDI along the biomass       Investment promotion
   Dynamic                                                 Privatisation                  value-chain
   comparative                                    – Privatisation of State-Owned        – Incentives to alternative energy   – National Action Plan
                                                                                          production                           of biomass sector
   advantage                                        utilities, power and distribution
                                                    assets                              – Streamline administrative          – Communication and
   Based on                                                                                                                    Promotion
                                                  – Entry and exit of players             hurdles to investment
   high-value added                                                                                                          – Increase public awareness
                                                                                        – Incentives to technological
   long term                                                                              upgrade


                                   Payment                        Institutions                         Infrastructures
   Static                         mechanisms
   comparative                                                – Autonomous market               – Modernisation of distribution
                             – Enforcement of                   regulator authority
   advantage                   payment collection
                                                                                                  infrastructure
                                                              – Transparency of
   Based on                  – Design of new                    regulation
   natural ressources          mechanisms
   labour cost               – Solve payment arrears
   short term
                                                 Rules                                                      Capabilities             Area of intervention


Source: OECD (2010), Ukraine Sector Competitiveness Review, internal working document, OECD, Paris; Framework based on S. Lall (1990);
P. Krugman, (1987), “The Narrow Moving Band, the Dutch Disease, and the Competitive Consequences of Mrs. Tatcher. Notes on Trade in
the Presence of Dynamic Scale Economies”, Journal of Development Economics, Vol. 27, No. 1, pp. 41-55; Lall, S. (1990), Building Industrial
Competitiveness in Developing Countries, OECD, Paris.


           review of payment mechanisms, are urgently needed and are a prerequisite to developing
           a green growth strategy. However, the areas of Investment Policy and Promotion have been
           prioritised as these will enable a transfer of necessary capabilities from the OECD
           experience. These capabilities will allow the alternative energy sector to maintain a
           sustainable advantage over the long-term. Other renewable sources of energy, such as
           small hydro, wind or solar energy, might also have an economic potential in Ukraine.
               Finally, in the aircraft sector the implementation phase will focus on the sector’s
           governance and investment policy.



190                                                                      COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012
                                                                  III.9. CONCLUSION AND ROADMAP FOR IMPLEMENTATION PHASE



              The recommended next steps include the establishment of three public-private
         working groups, focusing on agribusiness, production of energy based on biomass, and
         civilian aircraft, respectively. These working groups will become permanent bodies in
         charge of designing and implementing the needed reforms for each sector, beyond the
         timeframe of the OECD project.
              Finally, it is recommended that the government of Ukraine include a sub-national
         dimension in its efforts to improve its sectoral competitiveness. At present, an uneven
         distribution of FDI persists between regions: two-thirds of Ukraine’s FDI stock is currently
         concentrated in six regions. A first step in this direction is the OECD Territorial Review of
         Ukraine, started in 2011. The Territorial Review is a national-level diagnosis providing
         evidence-based and detailed analyses of regional policies. A subsequent specific effort on
         the development of a strategy at the sub-national level should also be pursued.



         Bibliography
         Krugman, P. (1987), “The Narrow Moving Band, the Dutch Disease, and the Competitive Consequences
            of Mrs. Tatcher. Notes on Trade in the Presence of Dynamic Scale Economies”, Journal of
            Development Economics, Vol. 27, No. 1, pp. 41-55.
         Lall, S. (1990), Building Industrial Competitiveness in Developing Countries, OECD, Paris.
         OECD (2010), Ukraine Sector Competitiveness Review, internal working document, OECD, Paris.
         OECD (2011), “Investment Policy Reviews: Ukraine 2011”, OECD Investment Policy Reviews, OECD, Paris.




COMPETITIVENESS AND PRIVATE SECTOR DEVELOPMENT: UKRAINE 2011 © OECD 2012                                           191
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                                OECD PUBLISHING, 2, rue André-Pascal, 75775 PARIS CEDEX 16
                                 (25 2011 05 1 P) ISBN 978-92-64-12878-1 – No. 59699 2012
Competitiveness and Private Sector Development
UKRAINE
SECTOR COMPETITIVENESS STRATEGY
Contents

Part I. Methodology
Chapter 1. Approach and methodology

Part II. Economic overview and findings of the Investment Policy Review of Ukraine
Chapter 2. Economic overview
Chapter 3. 2011 OECD Investment Policy Review of Ukraine: Key findings

Part III. Sector-specific analysis
Chapter 4. Agribusiness
Chapter 5. Focus on the grain value chain
Chapter 6. Focus on the dairy value chain
Chapter 7. Energy-efficiency and renewable technologies: Focus on production of energy based on biomass
Chapter 8. Machinery and transport equipment: Focus on civilian aircraft manufacturing
Conclusion and roadmap for implementation phase

Related reading
OECD Investment Policy Reviews: Ukraine 2011 (2011)
Competitiveness and Private Sector Development: Central Asia 2011: Competitiveness Outlook (2011)
Development in Eastern Europe and the South Caucasus: Armenia, Azerbaijan, Georgia, Republic of Moldova
and Ukraine (2011)
Competitiveness and Private Sector Development: Kazakhstan 2010: Sector Competitiveness Strategy (2011)




  Please cite this publication as:
  OECD (2012), Competitiveness and Private Sector Development: Ukraine 2011: Sector Competitiveness Strategy,
  OECD Publishing.
  http://dx.doi.org/10.1787/9789264128798-en
  This work is published on the OECD iLibrary, which gathers all OECD books, periodicals and statistical databases.
  Visit www.oecd-ilibrary.org, and do not hesitate to contact us for more information.




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