Report No. 13034-AM

ArmeniaAgriculture and Food Sector Review(In Two Volumes) Volume l: Main Report

February 6, 1995

Natural Resources Manageement DivisionCountry Department IVEurope and Central Asia Region

Document of the World Bank

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CURRENCY EQUIVALENTSCurrency unit - Ruble (R)US$ 1 = R 684 (March 1993)US$ 1 = R 2,600 (October 1993)

Currency unit - Dram (D) - Introduced November 22, 1993US$ 1 = D 14 (November 1993)US$ 1 = D 408 (January 1994)

WEIGHTS AND MEASURESMetric System

ABBREVIATIONSAl Artificial InseminationAU Animal UnitCFM Collective Farmer's MarketCMEA Council of Mutual Economic AssistanceCPF Collective Peasant FarmsCSO Cooperative Support OrganizationCSQC State Commission for Seed Quality ControlCST Commission for Seed TestsDBH Diameter at Breast HeightDWSI Department of Water Supply and IrrigationEBRD European Bank for Reconstruction and DevelopmentEU European UnionFSU Former Soviet UnionFU Feed UnitGDP Gross Domestic ProductGIS Geographic Information SystemsGNP Gross National ProductHICOOP Armenian Consumers UnionMOA Ministry of AgricultureMOF Ministry of Food and ProcurementNMP Net Material ProductNPO Scientific Production AssociationsNTB Non Tariff BarrierO&M Operation & MaintenanceOME Operation and Maintenance EnterprisesRSC Rural Service CooperativeTA Technical AssistanceTCFP Target-Oriented Comprehesive Food Production ProgramUSDA United States Department of AgricultureVAT Value Added TaxWUA Water Users' Association

CONTENTS - VOLUME I: MAIN REPORT

PREFACE

EXECUTIVE SUMMARY .................. i

I. BACKGROUND AND RECENT DEVELOPMENTS . .A. AGRICULTURAL RESOURCE BASE. 1B. AGRICULTURAL STRUCTURE AND PERFORMANCE. 3C. CONSUMPTION AND SELF SUFFICIENCY. 4D. TRANSITION UNDER BLOCKADE .5

II. OVERALL STRATEGY FOR CONTINUING REFORMS IN FOOD ANDAGRICULTURE... 7A. MAJOR COMPONENTS OF A PROGRAM

FOR FURTHER REFORMS. 7B. SOCIAL POLICIES IN SUPPORT OF RURAL TRANSITION ... 10D. POLICY AGENDA FOR CONTINUING REFORMS .14

III. DEVELOPMENT OF A MARKET FRAMEWORK . .17A. MACROECONOMIC AND INCENTIVE FRAMEWORK .17B. PRODUCER PRICES AND FISCAL POLICIES .20C. INTERNATIONAL TRADE AND TRADE POLICIES .25D. PUBLIC ADMINISTRATION: ROLE OF

AGRICULTURE MINISTRY .28

IV. CONTINUATION OF LAND REFORM .. 31A. PROCESS OF LAND REFORM .31B. EMERGING NEW FARMING STRUCTURE .34C. DEVELOPMENT OF A LAND MARKET .37

V. COMPETITIVE LINKAGES FOR PRIVATIZED AGRICULTURE .. 43A. PRODUCTION SERVICES .43B. AGRICULTURAL PROCESSING .44C. PRODUCT MARKETING .46D. DEVELOPING A COMPETITIVE SUPPORT AND

PROCESSING SYSTEM .48E. FINANCIAL SERVICES .53F. DEVELOPMENT OF RURAL SERVICE COOPERATIVES .58G. NEED FOR EXTENSION SERVICE .60

VI. IMPROVING AGRICULTURAL EFFICIENCY AND SUSTAINABILITY 63A. IMPROVEMENTS IN IRRIGATION .63B. IMPROVEMENTS IN CROP PRODUCTION .64C. ADJUSTMENTS IN THE LIVESTOCK SECTOR .68

D. ENVIRONMENTAL SUSTAINABILITY ................. 70E. MODERNIZING HIGHER EDUCATION ................ 72F. INVESTMENTS IN FOOD AND AGRICULTURE .... ....... 74

VII. EXTERNAL ASSISTANCE ............... ................. 77A. CRITICAL INPUTS FOR AGRICULTURE PRODUCTION ... ... 77B. TECHNICAL ASSISTANCE AND INSTITUTION

BUILDING .................................. 77C. NEW INVESTMENT ............................. 78D. THE BANK ASSISTANCE PROGRAM .................. 78

BOXES: 2.1 Target-Oriented Comprehensive Food Production Program.. 72.2 Agricultural Reform Agenda .. 93.1 Proposed Schedule of Agriculture Price, Trade, Policy Reform . . 186.1 Water Resources Inventory .. 636.2 Recent Changes in Cropping Patterns .. 646.3 Armenian Agricultural Research and Education System . .72

FIGURES: 6.1 Lowland Cropping Patterns .666.2 Armenian Livestock Population .68

TABLES: 1.1 Land Resources .. 21.2 Development of Agricultural Production . . 31.3 Agricultural Output .. 31.4 Self Sufficiency and Per Capita Food Consumption. . 43.1 Marketing of Agricultural Produce .. 193.2 Comparative Price Indices ......................... 213.3 Agricultural Transfers and Taxes in 1993 . .233.4 Agricultural and Food Trade .. 253.5 Major Agricultural Imports and Exports . .264.1 Privatization of Land .. 334.2 Privatization of Machinery as of January 1994 . .345.1 Private Food Processing Operations .. 455.2 Design Capacity and Utilization in Food Processing . .455.3 Farm Output Sold to State Processing Enterprises . .475.4 Armagrobank Balance Sheet .. 546.1 Output of Major Crop Products ...................... 646.2 Comparative Yields ............................ 656.3 Net Return to Irrigated Agriculture ................... 656.4 Contraction of Livestock Sector 1990-1993 .. ...... . 686.5 Production of Livestock Products 1985-1992 ...... ........ 69

MAPS: 1 Agro-Climatic Zones (IBRD #25695)2 Average Annual Precipitation (IBRD# 25694)

PREFACE

The Arnenian land privatization program is unique among former Soviet Republics inregard to the speed and completeness of its implementation. This review provides a status report on thefood and agriculture sector in the Republic of Armenia in the first years of privatized primary agricultureand assesses the progress of sectoral reforms needed to complete the transition to a market basedagricultural sector. It also recommends adoption of policies that will contribute to the future developmentof the sector, and a short to medium term assistance program to support current reforms. Accordingly,the audience for the report includes Armenian public officials, private industry and organization leaders,the Armenian business and academic community, officials of the World Bank, and international assistanceinstitutions.

ii. The review is based on the findings of a World Bank mission that visited Armenia inMay/June of 1993, and it reflects developments in Armenia since then. The mission was led by C. Csakiand included E. Brook (macro-economics), E. Gazit (irrigation), L. Garoyan (agro-industry), 0. Honisch(crop production, support services), S. LeGore (environment and forestry), M. Lundell (macro-economics), H. Ochs (livestock production), L. Pohlmeier (land reform, cooperatives), and 0. Sacay(rural financing). A background paper on land registration and land markets was provided for the studyby G. Wunderlich.

iii. The Green Cover report was drafted in February/March 1994 by a small team led by C.Csaki, the principal author. The team included E. Brook, M. Lundell, A. Zuschlag, R. Arakelov, andS. Moury. L. Schertz provided editorial assistance. Valuable comments were received from ProfessorsB. Gardner, W. Henrichsmeyer, and S.R. Johnson. Additional comments were received from L. Tuck,H. Sutch, K. Brooks, T. Schillhorn, V. Nercissiantz, E. Chobanian, R. Mauerer, and P. Siegelbaum.The Green Cover report was discussed with the Government of Armenia as well as with representativesof academic and business institutions in September 1994. Comments from these discussions have alsobeen taken into account in finalizing this report in December 1994. Deputy Ministers D.A. Abrahamian,Y.L. Javadian, I.M. Martirossian, and M.A. Azerian were the main Armenian counterparts for thestudy. A. Y. Voskanian, Minister of Agriculture, and K. Danielian, Minister of Nature andEnvironmental Protection, also actively supported the review. The Ministry of Economy, the Ministryof Finance, the Ministry of Food and Procurement, the Ministry of Trade, and the State Department ofStatistics assisted in report preparation in Armenia.

EXECUTIVE SUMMARY

I. This study provides a status report on the food and agriculture sector in the Republic ofArmenia and assesses the progress of ongoing sectoral reforms. In addition to giving an account of thereforms in private agriculture, it recommends a set of policies to complete the transition to a sector basedon private ownership and market control. Chapters 1-6 of the report presents the major conclusions ofthe review. Chapters 7-11 provides background analysis of major subsectors in food and agriculture andcontains the statistical annex.

Performance and Constraints

II. Traditionally Armenia has been a net importer of food and agricultural products. In 1990the country produced only about 20 % of its grain and 30-35 % of its dairy and meat product requirements.At the same time, a high proportion of vegetables, grapes and fruits were exported in the form of freshand processed produce, wines, and brandies. Total agricultural production fell only 17.5% from 1988to 1993, while other sectors declined even more significantly. As a result, the relative importanceof agriculture in the national economy has increased. By 1993, agriculture accounted for 46% of thenet material product (NMP) and over 25% of total employment (compared with 18% beforeindependence). Yet, the country has also remained a net food importer, even though levels ofconsumption are substantially lower than before independence. Production efficiency and crop yieldsare below those of developed countries with similar agro-ecological conditions. Even accounting forharsh environmental conditions, most crop yields are believed to be barely 50 to 60% of their potential.Availability and use of fertilizers are less than optimum for efficient production, and these levels are stilldeclining. Livestock performance is only about one third of Western standards for milk and meatproduction. In addition, losses in storage and distribution are substantial.

III. The overall macroeconomic environment is not favorable for Armenia's food andagriculture sector. Most of the difficulties are similar to those in other FSU food and agriculture sectors,and include the heritage of the "Soviet type agriculture," as well as disruption of trade relations, andpayment problems. These problems are exacerbated in Armenia by the conflict with Azerbaijan. Despitethese difficulties, Armenia has implemented one of the most comprehensive land reform programsin the FSU republics. Land reform was initiated in 1991, and by mid-1994, most of the agriculturalland had been privatized. Concurrent with land reform, in 1991 the Government also began to developa new incentive framework for the food and agriculture sector. The state order system was almost fullydismantled; a substantial part of the producer prices and most input prices were liberalized, and almostall producer and consumer subsidies were eliminated. However, this process was compromised andlimited in its effect by the lack of competition in input and output marketing, and by the delay inrestructuring and privatizing agricultural industries.

Overall Strategy for Continuing Reforms

IV. The blockade brought about by the Azeri conflict, and associated economic and tradedifficulties have led the country to concentrate on food security. It is fully understandable that thisobjective dominates the thinking of policy makers at present. However, the justifiable concerns regardinga secure domestic food supply should not result in an overall self sufficiency orientation. The effortsto increase the level of food self sufficiency as a short-term strategy are justified only by the blockade.Short-term emergency adjustments should be allowed to have only minimal negative impact on the

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development of an open, internationally competitive, food and agricultural system. The ultimate objectiveshould be the integration of Armenian agricultural production and agroprocessing into internationalfood markets. This requires the creation of an open food economy by fully utilizing the potentialcomparative advantage in Armenian agriculture.

V. It will not be economically efficient for the country to produce all of the foodrequired for domestic needs. Increasing the level of cereal, sugar, milk, and meat self sufficiency (asis now indicated in Government programs as a longer term objective) is not supported by the naturalendowment of the country and can not be justified economically. Domestic endowments and traditionsfavor labor intensive horticulture, production of vegetables, viticulture, and livestock productionsuited to domestic feed resources grown on higher altitude pastures and meadows. Longer-termadjustment for field and horticulture crops should include: rehabilitation of irrigation systems compatiblewith private farming; privatization and modernization of processing; and introduction of techniques toimprove product quality both in private agriculture and processing. The livestock sector is likely toremain a supplier mainly for domestic markets. Local feed availability provides a basis for recovery incattle, sheep, and goat husbandry. In recent years there has been no alternative for grain-based pig andpoultry production other than contraction. These adjustments will be facilitated by letting pork andpoultry prices reflect international prices of grain. Later, production in these subsectors might recoveras private sector activity improves and the domestic economy and personal incomes begin to grow.

VI. The Armenian land reform program surpasses efforts elsewhere in the FSU, includingthe Baltic republics. The fundamental conclusion of this report however, is that to take advantage of thispromising beginning, further reforms are still needed to complete the transition to a marketeconomy. The recently completed Government program for developing the food and agricultural sectorup to the year 2005 presents mainly production-oriented projections. At this time, a detailed agriculturaltransformation strategy for Armenia does not exist, reforms that have been implemented do not constitutea consistent package, and the different components of the reform process are not fully coordinated. Acomprehensive strategy for further reforms, which treats the development of an efficient structure ofprivate farming with an adequate legal and incentive framework for the development of supportservices as the major strategic objective of agricultural policy, needs to be formulated. Thisprogram, whatever its elements, must be consistent and coordinated with the overall macro-economicprogram of stabilization and privatization.

Priorities

VII. In the emerging market system, the Government cannot, and should not, directly engineerthe recovery and growth needed in Armenian agriculture, even if it were to have at its disposal greaterresources than currently available. The Government needs only to provide an enabling environmentand to permit enterprises/farms to be the decision makers to create growth themselves. The Governmentshould focus on the following actions:

(a) creating an improved incentive system for agriculture through: (i) removal of exportrestrictions, including licensing; (ii) replacement of remaining state orders with state purchasesunder market conditions; (iii) continued commitment to a liberal import regime; (iv) phasing outof remaining price controls and subsidies; and (v) development of a non-discriminatory systemof land taxation and water charges;

Summary iii

(b) completion of land reform to support commercial and family farming through: (i)completion of land titling and registration; (ii) changes in land ownership laws to establish a landmarket; (iii) creation of real land and lease markets; and (iv) creation of a legal framework tosupport private farming through establishment of farmer's productive and service cooperativesand associations.

(c) demonopolization and privatization of agroprocessing through: (i) privatization of stateenterprises through the adoption of competitive and transparent practices (including foreign tradeorganizations and the grain parastatals); (ii) promotion of new private ventures and processingcooperatives; (iii) implemention of anti-trust regulations with a view toward encouraging fairtrade practices; and (iv) reduction of barriers to entry by foreign firms, including joint ventures.

(d) restructuring the agriculture supply distribution and service systems through: (i) expansionof private and commercial market facilities and services of input supply and product marketing;(ii) facilitation of the development of private extension and advisory services; and, (iv)improvement of rural financial intermediation services based on unsubsidized credit, astransitional measures toward fully privatized rural finance.

(e) redefining the role of Government in agriculture and restructuring public administration ofthe sector through: (i) establishment of clear lines of responsibility for the development of policyand administration; (ii) dismantling the current "agro-industrial complex" - oriented Governmentmanagement structure; and (iii) simplification and reduction of the Government organizationalstructure commensurate with Government's reduced role in the agriculture sector (integration ofthe Ministry of Food and Procurement within the Ministry of Agriculture).

Incentive Framework and Trade Policies

VIII. One of the most critical responsibilities of the Government is to foster economicconditions conducive to the development of private agriculture. Efficient private farmers should beable to realize profit, and the overall economic environment should provide adequate incentives andmotivation for farm development and agricultural production in general. This requires: (a) lowerinflation; (b) domestic product and factor markets related to world market or FSU prices; and (c) freemarkets in agriculture. These conditions will lead to efficient use of domestic resources, increasedproduction, and farm profits for re-investment.

IX. The price liberalization process would be completed with: (a) a full liberalization ofbread prices and removal of all remaining bread subsidies; (b) a full phase-out of subsidies to irrigation,and increased water charge recovery rates up to 80-90%; (c) removal of all remaining grain producerprice controls; and (d) introduction of market methods to procure products for inter-Governmental bartercommitments instead of "state tasks". While the state foreign trade monopoly has already beeneliminated, minimum export prices, mandatory prepayments by private exporters, and some non-tariffbarriers on specific food products remain, as does the foreign exchange surrender requirement. Theseshould be phased out. A new foreign marketing structure, including competitive private trading housesand direct sales by producers, has already started to operate. Liberalization of foreign currencyregulations are also crucial to the development of agricultural trade. An effective set of market

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institutions will be established only as a result of a clear strategy with carefully sequenced priorities forthe short and medium term.

Continuation of Land Reform

X. The move to independent private farming has brought substantial changes to the ruralpopulation. It is not possible to predict precisely what agricultural structure will emerge after transitionis completed, nor what the mix of larger and smaller enterprises will be, but this is not the key issue. Inall probability, over the long term there will be a mixture of smaller family farms, largercorporate-type farming, and variations of cooperatives and looser associations emerging out of thecurrent fragmented farming structure. Family farming, as practiced in Western Europe and NorthAmerica, will emerge fairly slowly. European-style "family farming," even in the longer term, is notthe only model to be considered. In the mountainous areas of Europe, for example, various forms ofcooperative, rather than individual, land use also exists. In fact, farming structure is rather heterogeneousin most countries with private agriculture. Fragmented, manual labor-based, subsistence farming willbe the most typical type of farming for the foreseeable future. This structure has distinct advantagesduring the present difficult period in Armenia. Low labor costs enable the substitution of labor forpurchased inputs that are now priced at international levels. The low output of small farms is lesssusceptible to the vagaries of poorly functioning markets and financial systems, and provides food fortheir owners, and urban relatives and friends as well. Over the medium and longer term however, thecreation of a functioning land market is absolutely essential to the development of an efficientagriculture sector. In all cases, the key to creating an efficient structure is clarity in the definition ofownership rights, the lack of restrictions on use (except for environmental regulation), and theefficiency of title and lease transfers to the most efficient farmers.

Xi. The land consolidation process is likely to be slow and will only gain momentum afterthe overall economy begins to grow. Technologies and operational systems such as part-time farming,can be expected to evolve in ways similar to the situation in some European countries. Consolidation ofland ownership units most likely will be negligible in the near future. The moratorium on sales expiredonly recently and neither the market nor credit institutions are sufficiently organized to serve a largevolume of transfers. Furthermore, if the experience of developed market economies is any indicator,only 3-5% of farmland is likely to change hands in any one year. Consolidation of operating units,however, can take place without ownership transfers by active use of leases. The Government shouldfacilitate this process by creating quick and low cost procedures for the transfer of land from sellers tobuyers and promoting lease of land. Consolidation should take place through the land markets byway of sale or leasing arrangements.

XII. The Government role in supporting private farming should be through the implementationof appropriate policies to facilitate the transition to an efficient and productive farming sector. The mostimportant measures for promoting viable independent private farms include: (a) development of aland ownership and use system where individual farms are not limited as to size; (b) development of amarket system for private transactions in land; (c) creation of a competitive land mortgage system tomobilize savings and to finance investments, including purchasing equipment as well as land; (d)development of a competitive bank credit system for financing investment and working capital; (e)development of competitive input and output markets; (f) development of infrastructure, transportation,roads, and public services; and, (g) development of a private farm management and technical advisory

Summary v

service and a Government funded agricultural extension service. These measures are discussed in greaterdetail in the main report.

Competitive Agroprocessing and Services for Privatized Agriculture

XIII. The relative backwardness of the processing subsector is an extremely serious handicapfor the sector as a whole. The level of processing is crucial for export products since it determines theirquality and price, and indeed, whether they can be sold at all. It cannot be overemphasized that worldmarket food processing standards will only be attained in Armenia by the introduction of modernequipment and organization of processing facilities. The development of food processing in a way thatis clearly linked to export strategy is an indispensable condition for competitiveness and theimprovement of export efficiency. The improvements will also serve the demands of Armenians as theyincreasingly desire higher and more uniform quality processed food products.

XIV. While Armenia has made substantial progress in privatizing land ownership and use, theold supply and procurement institutions, as well as the agroprocessing industry, have undergone very littlechange. If the new private nature of primary agricultural production is to be matched by efficient,productivity-increasing upstream and downstream sectors, then the Government must implement acoherent program of privatization, demonopolization, and promotion of competition. These tasksrepresent a more complex challenge than that posed by land reform. The development of a market-oriented processing, distribution, and input supply system will require:

* the implementation of a Government program and timetable for the division (demonopolizationI commercialization) and privatization of the large state enterprises that now dominate processing,input supply, and wholesale trade;

* the privatization of the most competitive elements in food processing through open auctions;

* the early and quick privatization of grain parastatals and the reorganization of the consumercooperative HICOOP;

* the rapid privatization of retail food outlets by auction, tender, or worker buyout;

* steps to authorize and facilitate private sector entry, including state programs for developingentrepreneurship;

* establishment of a supporting legal and regulatory framework to encompass anti-monopolyregulations, competition policies, and personal and property law, and contract enforcement; and,

* provision of essential supporting services, notably price and market information, technicalassistance and training services, financial services to assist in establishing new businesses, andmeeting food inspection and sanitary standards.

XV. Armenia has a rather underdeveloped rural financial system. The strategy forstrengthening the rural financial system may be divided into several steps. Fiscal means, rather thanfinancial institutions should be used to sustain the operation of state enterprises having critical importance

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to food security, and to support the newly established private farms. The short-term approach is toimprove the existing system of rural finance to make it a more effective instrument in channelingresources into market oriented businesses and to support the major thrust in privatization. The medium-term agenda is to introduce financial viability into the existing system as well as develop alternativechannels of rural finance to strengthen rural financial intermediation and encourage competition. Theestablishment of rural savings and credit societies should therefore be promoted. A national cooperativebank could eventually be established to serve as the apex bank of savings and credit societies. The long-term goal would be to develop a viable rural financial system as an integral part of the overall financialsystem.

Improvement of Production Efficiency - Investments

XVI. The continuation of land reform, enterprise restructuring, and privatization are importantpreconditions for improving the efficiency of primary agricultural production, processing, and distributionof food and agricultural products. New investment should improve quality and quality controls. Basedon the review of the current situation and the major tasks of transition, the investment priorities include:

* rehabilitation of irrigation facilities and their adjustment to the needs of private farming;

* development of physical facilities, including wholesale vegetable and fruit markets, cold storagefacilities, and local warehouses, to create a working market for agricultural products and inputsfor agriculture;

- capitalization of the emerging new farming structure through agricultural lending institutions;

* reconstruction and modernization of support services (such as seed industry, livestock breeding,machinery maintenance) and agroprocessing;

* introduction of production methods more compatible with environmental conditions; and

* development of education, research, and development potentials.

XVII. The private sector should play a decisive role in future investment in agriculture andfood processing as privatization proceeds. The Government role is to provide an enabling environment,including an incentive framework that creates the right motivation for private investment in primaryagriculture as well as in agricultural processing and distribution. Public investment needs to be directedat improving human and physical infrastructure, and to be linked to the implementation of a program offurther reforms which set clear priorities.

CHAP[ER 1

BACKGROUND AND RECENT DEVELOPMENTS

1.1 Armenia is the smallest of the former Soviet republics and has a population of about3.7 million people. The break-up of the USSR left Armenia with an economic structure highly dependenton outside sources for energy and raw materials for its industries, and grain for its people and livestock.Starting in 1991, agriculture has had to play an increasingly important role in the national economy as theoutput of the economy as a whole declined more than agricultural sector. Where agriculture hadaccounted for around 18% of both net material product (NMP) and employment during the 1980's, thesector accounted for 46% of NMP and over 25% of total employment in 1992. Crops with the highestvalue of production per land area include grapes and other fruits and vegetables which are grown underirrigation at lower altitudes, particularly in the Ararat valley. A high proportion of the production wasexported during the Soviet period in the form of fresh produce, wines, brandies, and processed fruit andvegetables. Agricultural exports accounted for roughly 12% of total export earnings in 1990. Grain, meat,and dairy products have traditionally been largely imported. In 1990 Armenia produced only 20% of itscereal and 30 to 35% of its dairy and meat product requirements. In 1992 agricultural imports (includingUS $30 million worth of food aid) made up more than 30% of total imports while agricultural exports hadrisen to 23% of all exports. In 1993 the country has also remained a net agricultural importer even thoughlevels of consumption are substantially lower than before independence.

1.2 Unfortunately Armenia is faced with a number of problems that make implementation offurther reforms difficult. In addition to being affected by the difficulties inherent in the adjustment froma centrally planned to a market based economy and the break down of established economic relationshipsamong the FSU republics, Armenia must also cope with devastation of the 1988 earthquake and thesuffering and economic consequences of the dispute with Azerbaijan over the status of Nagorno-Karabak.The Azerbaijani blockade and the instability in neighboring Georgia has effectively blocked all establishedtrade and transportation routes into Armenia, and the lack of energy and raw material supplies has broughtArmnenia's industrial sector to an almost complete stand still and created serious shortages in input supplyfor agriculture. As a result, in 1992 GNP per capita declined from US $2160 in 1990 to about US $660'in 1993, demand for food declined accordingly and the annual rate of inflation was 3750% in 1993 andan estimated 46% in the first quarter of 1994 and less than 3% per month in the third quarter. GDP fellby 52% in 1992 and a further 15% in 1993. However, in the first half of 1994, output increased slightlyin comparison to the same period in 1993.

A. AGRICULTURAL RESOURCE BASE

Labor Force

1.3 In mid 1992, 69% of the population of Armenia lived in urban centers and 31 % in ruralareas. However, only about 40% of the rural population are in the economically active age group asopposed to about 60% of the urban population. Total employment in agriculture was an estimated

Source: Estimating Dollar Per Capita Income for the States of the Former Soviet Union. World Bank, June 15,1993.

2 Chapter 1

285,000 in 1990. With privatization in 1991, there was a sharp rise in the number of people employedin agriculture. Nearly 232,000 people were recorded as newly employed on private family farms whilethose remaining on the other types of farms apparently fell by only 173,000. Thus, the official statisticssuggest an increase in total agricultural employment of nearly 60,000.

Land and Climnate

1.4 Out of Armenia's total land areaof about 29,740 Km2 (2.97 million hectares), Table 1.1: Land Resources (1990)

about half is suitable for crop production and Category Area % ofgrazing. The balance of the area is waste lands 000 (ha) Total

and high mountains (see Table 1.1). Cultivated Arable Land 494.7 16.6

land lies within an altitude range of 600 to 2,500 Perennial Plantations 85.6 2.9m with mountain peaks to 4,090 m above sealevel. Only 28% of the land is located below Meadows 137.6 4.61,500 m of elevation and only 29% is flat or has Pastures 666.1 22.4

slopes of 3 degrees or less. Armenia has a great Unused Land, Forest & Heath 1,590.3 53.5variety of soils. About 48% of arable land is Total 2,974.3 100.0comprised of fertile chernozems and another 46.514%, fertile chestnut soils. Of the 580,300 ha of which cultivated land 1,384.0

of arable land, and perennial crop area about Source: Ministry of Agriculture

286,000 ha, only about 50% are equipped withirrigation facilities. The irrigated land is 80% surface irrigated and 20% pipe irrigated. Irrigationintensities range around 100%, but under-irrigation is practiced in most irrigation schemes. Historically,agriculture has had a strong dependence on irrigation, nearly 80% of total crop production is producedwith irrigation. The irrigation system shows signs of deterioration and inadequate management, whichhas led to increased salinity in sizeable areas. Water resources are considerable and would allow furtherexpansion of irrigated agriculture.

1.5 Armenia enjoys a variety of climatic conditions depending upon altitude. The Araratvalley is characterized by dry hot summers and cold dry winters, with annual precipitation not exceeding300 mm. Precipitation increases toward the mountains to 1,000 mm per year. Temperatures decreasewith altitude and have an annual average of 10o C in Yerevan and 4o C at Sevan Lake. Growing periodsvary between 250 days in the lowest valleys, 170 days around Sevan Lake, and 95 days in mountainareas. Monthly precipitation is highest from April to June and lowest during July to September. Cropwater deficit during May to August ranges between 200 to 700 mm, which cannot be supplied from soilmoisture alone and irrigation is thus necessary for crop growth. Agroclimatically, Armenia is dividedinto eight regions, some of which are further split into subregions.

1.6 Armenia has limited forestry resources. At the beginning of the 19th century, 25% ofthe country was covered in forest. This was reduced by exploitation to only 7% by the 1950s. Sincethe 1950s, the forest cover has been increased to 11 % as a result of active reforestation.

1.7 Of the many environmental issues facing Armenia today, the most critical ones affectingagriculture include: (a) soil erosion, which has been progressing at an alarmning pace; (b) soil salinityproblems; (c) runoff and contamination of surface water caused by improper use of agricultural chemicals

Background and Recent Developments 3

and inadequate safeguards; (d) disruption of the ecological balance and pollution of the water supply ofLake Sevan due to agricultural chemicals and lack of pollution controls, and (e) deforestation due toillegal harvest.

B. AGRICULTURAL STRUCTURE AND PERFORMANCE

1.8 The production ofcrops in Arnenia accounted for Table 1.2: Devdopment of Agricultural Production,% Shares

45 % of total agricultural product in (Based on 1983 comtant Rubles)the 1980s. Livestock contributed Livestock as % Crop as % of Ag Ag Output as %

55%. These shares have changed of Ag Output Output of total NMP

substantially during recent years 1988 48.2 S1.8 18.5

due to the significant contraction ofthe livestock sector. In 1993 1989 55.8 44.2 14.4

66.3% of gross agricultural 1990 54.8 45.2 17.2

production originated from the crop 1991 46.3 53.7 32.2

sector. It is likely that thisproportion will decrease somewhat 1992 33.2 66.8 45.6

when the livestock sector begins to 1993 33.7 66.3 NArecover (Table 1.2). Source: IBRD Statistical Handbook 1993, .State of the FSU, and

Ministy of Agriculture1.9 Agricultural outputin Arrnenia began to decline in the second half of the 1980's. From 1988 to 1990, agriculturalproduction fell by 28%, more than anywhere else in the FSU. Production started to recover however,in 1991, and continued to rise through 1993, when production was still 17.5% below that of the 1988level (Table 1.3). Preliminary estimates of the Ministry of Agriculture indicate a further increase ofproduction in 1994. Declines in crop production have been more moderate than in the livestock sector;in fact, in 1993 the crop output almost reached the 1988 levels. The crop sector is expected to growby about 14% in 1994 over 1993 levels and surpassing the 1988 levels. At the same time, livestockproduction continued to decline until 1992. In 1993 there was a modest 1.5% growth in the livestocksector, but no further growth is projected for 1994.

1.10 The country's croppingstructure has undergone a dramatic shift Table 1.3: Agricultural Output (Constant 1983 Rubles)over the last three years (1991-93); the Livestock Crop Output Total Output

proportion of annual food crops outputincreased substantially at the expense offorage crops, perennial, and industrial 1988 100.0 100.0 100.0

crops. The livestock sub-sector is in a 1990 79.1 64.9 72.0

deep and unprecedented crisis. After 1991 74.5 85.9 80.2peaking in 1987/88, livestock productionstarted to decline due to the combined 1992 64.8 99.0 81.9

impact of reduced livestock populations 1993' 65.8 99.2 82.5and lower production intensity. -Pelini DalaCompared to 1987/88, total 1992 output Source: IBRD Statistical Handbook, 1993 States of the FSU, andof meat dropped by 38%, milk by 31 %, Ministry of Agriculture

4 Chapter I

eggs by 60%, and wool by almost 40%. Particularly hard hit has been poultry meat production, downby almost two-thirds from 1991. Total 1993 meat production fell by another 30% from 1992, eggs by40%, and wool by 10%, while milk production remained almost at the 1992 levels according to Ministryof Agriculture estimates. Livestock output declined by 44% from 1998 to 1993.

1.11 Production efficiency and output levels are below those reached in developed countries.Crop yields are generally low and, even accounting for harsh environmental conditions, the actual yieldsof most crops are believed to be barely 50 to 60% of their potentials. Livestock performance in the late1980s was only about 35 to 40% of Western standards for milk and meat production. At that timeaverage fertility rates were 67% of those in the West. These have deteriorated further in the past twoyears. Particularly alarming are decreasing slaughter weights, and unacceptably high mortality rates, longfattening periods, and feed conversion ratios 2 to 3 times lower than in the West for broilers and pigproduction.

C. CONSUMPTION AND SELF SUFFICIENCY IN AGRICULTURAL PRODUCTS

1.12 Armenia is far from self sufficient in food production since it produces less than 30% ofthe flour for bread, and only three quarters of the livestock products consumed in the country. Almosthalf of food output by volume consists of fruits and vegetables, in which Armenia is self sufficient andable to export in freshand processed forms.Since per capita TABLE 1.4: Self-SuMciency and Per Capita Food Consumption

consumption of all (1985-1993)

products except bread Self Sufficiency Consumptionproducts and potatoes (kg per capita) %

fell between 1985 and Products 1985 1993 1985 1993 change

1993 (Table 1.4), foodimport needs have Bread products 27.1 33.0 134.0 138.6 3.4

dropped as well. Potatoes 141.8 132.1 65.0 84.0 29.2Armenia now meets alArgernhar nof its f Sugar 13.9 0.0 28.7 5.4 -81.2larger share Of itS foodconsumption through Vegetable Oil 83.3 0.0 2.4 1.6 -33.3

domestic resources Meat and Meat products 65.1 90.6 49.0 13.8 -71.8

because demand forlivestock products has Milk and Milk Products 38.0 92.6 433.0 106.1 -75.5

dropped by 60 to 70%. Eggs (pieces) 116.9 65.0 148.0 78.0 -47.3Dependence on importedflourdehas onimportbee Fruits (including Grapes) 232.6 111.4 47.0 44.0 -6.4flour has not been Source: Ministry of Agriculturesubstantially reduced.

1.13 Through 1993, cereal production amounted to about 300,000 ton per year, and irnportsamounted to about 450,000 to 500,000 ton/per year. Before the decline in livestock production in thelast two years, Armenia required an additional 400,000 to 500,000 ton/per year of cereals for animal feedpurposes. Because of the blockade over the last two years this requirement has not been met, and is,among other factors, the most important reason for the decline of livestock production. The net shortageof cereals for human consumption in the coming years might decrease slightly. If the price of bread,

Background and Recent Developments 5

which presently is the only commodity that is subsidized, is fully liberalized as planned, then cerealsconsumption would fall2. An increase of 50% in bread prices would cause a reduction of about 10% inthe estimated consumption of cereals. Potatoes are another important staple of the Armenian population.Demand and supply are approximately balanced at 250,000 tons per year or 60 kg per person. Until the1988 earthquake approximately 20,000 tons of sugar per year were being produced domestically and thebalance of about 100,000 tons was imported. After the 1988 earthquake the sole sugar factory wasdismantled and sold to Georgia. With the difficulty of import because of the blockade, sugarconsumption has fallen by two-thirds.

1.14 Until 1991 local production of milk and dairy products usually met less than half of thecountry's needs. For meat, domestic production met almost two-thirds of consumption. The reductionof commercial imports since the start of the blockade in 1991 and the large reduction in consumerincomes have pushed up consumer prices and reduced effective demand for livestock products to muchlower levels compared to the end of the 1980s. Both meat and egg production have dropped by over60% and with low imports (or none in the case of eggs), consumption has fallen by more than 50%.Imports of dry milk powder have continued, but at such a low level that consumption of milk productshas fallen by over 70%. For all of these products, the combination of high income elasticity and halvingof real income over the past three years has accounted for over half of the fall in demand.

1.15 In adjusting to higher prices and reduced incomes, the population has shifted itsconsumption into more potatoes and maintained bread and fruit consumption close to the levels of the mid1980's. This has been facilitated by stable or increasing output of potatoes and fruits as well as increasedgrain production and Government priority given to negotiating and organizing the delivery of food aidgrain shipments. Thus, the population has been able to maintain a minimum level of nutrition and caloricintake.

D. TRANSITION UNDER BLOCKADE

1.16 At present Armenia's food and agriculture sectors are operating in an unfavorablemacroeconomic environment. The sector faces difficulties similar to those in other FSU republics relatedto the heritage of the "Soviet type agriculture"; distorted input and output prices, huge subsidization, lowfood prices, high inflation, and other factors related to the collapse of the Soviet economic area such asdisruption of trade relations and payment problems. In addition, these problems are exacerbated inArmenia by the conflict with Azerbaijan which has resulted in a blockade of energy and raw materialsupplies. As a result, while attempting to restructure the economy, the Government must also deal withfurther disruptions in trade, increasing energy costs, inflation, and higher unemployment than anywhereelse in the FSU.

1.17 Despite these hardships, Armenia has implemented one of the most comprehensive landreform programs in the FSU republics. By mid 1994 most of the agricultural land had been privatized.At present, the 534,000 total ha under farm cultivation is farmed by some 294,000 farm families (anaverage of 1.2 ha per family), 65 State farms and three cooperatives. Concurrent with land reform, in1991 the Government also began to develop a new macroeconomic framework for food and agriculture.The state order system has been almost completely phased out; producer prices and most input prices

2 Subsidies to bread prices will be phased out by April 1995.

6 Chapter I

were almost fully liberalized, and most producer and consumer subsidies (except bread subsidies) wereeliminated. However, this process was compromised and limited in its effect by the lack of competitionin input and output marketing. Agricultural and food processing, input supply, and marketing are stillmonopolized by the state. With the emergence of new private farms, the state enterprises have beenunable to provide timely supplies of inputs and procurement of agricultural products. An incentivesystem providing the right motivation and financial resources for newly established private farms has yetto be created.

CHAPTER 2

OVERALL STRATEGY FOR CONTINUING REFORMSIN FOOD AND AGRICULTURE

2.1 The ongoing reforms and future strategies for agriculture in Armenia suggest that theGovernment is fully committed to continuing reforms in the overall economy of the country, as well asin food and agriculture, and to completing the transition to a market system based on private ownership.Furthermore the land reform, the substantial elimination of subsidies, the almost fully liberalized prices,and the conditions whereby agricultural land can be freely marketed, give Armenia a better starting pointfor agricultural recovery than anywhere else in the FSU. The challenge is to select from the wide rangeof policy options available to Armenia for directing the future course of its agriculture development. Therelated strategic issues and priorities are discussed in this chapter.

A. MAJOR COMPONENTS OF A PROGRAM FOR FURTHER REFORMS

2.2 The fundamental conclusion of this report is that further reforms are still needed to fullycomplete the transition to a market based agricultural sector. Leaving monopolized structures in foodprocessing, marketing, and input supply unchanged would undercut the reforms that have already beenachieved and the potential contributions of privatized agriculture. Without completing the developmentof a market structure and the related legal and institutional framework, as well as adequate incentives andsupport services and infrastructure for private agriculture, the efficiency of agriculture will continue toremain low and the sector will not be able to fully achieve its role in the economic recovery of Armenia.

2.3 Successful implementation offurtlher reforms necessitates a comprehensive Target-Oriented Comprehensive Food Productionand consistent program of action. The Program (TCFP)recently completed Government program fordevelopment of agricultural and food sectors The TCFP is the result of considerable effort on theup to the year 2005 presents mainly Government's part to project food production in the mediumproduction oriented projections (Box 2.1). At term (1996-97) and in the long term (2005). Ihe departurepoint for these to target dates is the production levels fromthis time, a detailed agricultural 198s88. All calculations and projections are based ontransformation strategy for Armenia does not domestic consurnption, possibilities for exports, and the needexist, reforms that have been implemented do for imports. The objective of the TCFP is to provide self.not constitute a consistent package, and the sufficiency in a number of asricultural products by 2005.different components of reformn process are This includes all short shelf-life produce. Cereals, sugar,milk, and meat are intended to be provided mostly fromnot fully coordinated. Therefore the domestic production. Further imports of vegetable oil aredevelopment of a comprehensive reform projected. Greater efficiency from existing labor, landsstrategy is necessary as soon as possible. A water, and financial resources and infrstructure are the maincomprehensive and consistent program of means for achieving these goals. General targets are for a

1.5 times increase in volume of aricutural oroduction, and afurther policy actions must be based on a .5-25 mehigherexportoffoodstuffsandprodusofcombination of international experience and agricultural origin.local conditions to speed up the completion ofagricultural transition. This program needs tobe credible and participatory to be politically Box 2.1acceptable and sustainable. Moreover, the

8 Chapter 2

agricultural strategy has to be consistent and coordinated with the overall program of stabilization andprivatization.

2.4 The land reform in Armenia had the clear advantage of putting the agricultural land underthe control of private farmers during the time of the blockade when shortages of various kinds (fuel, spareparts, chemicals) limited large scale and equipment dependent operations. The disruption in agriculturalproduction due to the blockade would have been much more severe under the kolkhoz/sovkhoz structure.The land reform, together with the food aid, has been the main reason why the country has been able toavoid famine and to maintain a reduced but still sufficient level of food availability. The highlyfragmented ownership of agricultural land as a result of land reform, however is being criticized formoving most private farmers toward the direction of subsistence farming and for not being conducive toachieving economies of scale. The development of an efficient structure of private farming with anadequate incentive framework and support services therefore needs to be the major strategic objective ofagricultural policy.

2.5 The blockade and associated economic and trade difficulties have forced the country toconcentrate on food security. It is fully understandable that this objective dominates the thinking ofpolicy makers at present. Self sufficiency orientation however, as a short term strategy, is justified onlyby the blockade. The ultimate objective should be the integration into international food markets and thecreation of an open food economy by fully utilizing the potential comparative advantages of Armenianagriculture. This rational longer term strategy should be taken into account as much as possible. Thenegative impacts of short term emergency adjustments upon the potential to create an open, internationallycompetitive Armenian food and agricultural system need to be minimized. This can be done byGovernment policies which treat self sufficiency as a short term measure to cope solely with blockadeconditions.

Short Term Adjustments Under Blockade

2.6 In the short term, production increases in crops which are essential for improvingdomestic food supply (i.e., grains and potatoes), or which can substitute for imports, fortunately alsooffer the greatest economic potential for the country. Changes in prices at the farm level should beallowed to reflect this advantage, so that producers will respond. Blockade conditions will continue toturn farmers away from the traditional horticultural products of Armenia and limit the number of productsavailable for export. The FSU republics, mainly Russia, will remain the major markets for Armeniantraditional export products, such as brandy, wine, honey, processed vegetables and fruits. Export ofagricultural products to the West will be limited by transportation difficulties and by the condition of thecurrent capital stock in food procurement and processing. In the short term, Central and EasternEuropean countries might offer opportunities for export of limited quantities of horticultural products,wine, and brandy.

2.7 The livestock sector has already undergone a dramatic contraction, which isunprecedented even among FSU republics. Armenia's livestock sector was developed largely on the basisof imported feed for domestic needs and supported by large subsidies. Recent changes in relative priceshave dramatically affected the profitability of Armenia's traditional agricultural commodity mix.Imported feed and other inputs at world prices would not permit large scale pig and poultry enterprisesto be profitable, even if feed imports were physically available. The size of Armenia's former livestocksector is overscaled for the new economic conditions and grain production potential of the country. The

Overall Strategy for Continuing Reforms 9

grain based segments of the livestock sector have really no alternative to contraction. The incentivesystem should encourage structural change of the livestock sector by utilizing domestic feed resourcesand by allowing livestock product and import prices to reflect hard currency world market prices.

2.8 The future (post-blockade) size of the livestock sub-sector as well as its composition willneed to be determined by market forces. In the imtnediate years ahead, however, ruminant production(particularly cows and sheep milk production) should at least be stabilized at 1994 levels due to: (a)strong demand for milk and dairy products (as the country traditionally produced only 25 to 30% ofdomestic milk consumption); (b) good export possibilities for sheep milk products and live lambs; and,most importantly, (c) the fact that ruminants are more efficient converters of the domestically available,relatively low quality/low protein-content feedstuffs than pigs and poultry.

Longer Term Perspectives

2.9 There is a longer terrn potential for creating an efficient agriculture sector in Armeniawhich is integrated into international agricultural markets. It will not be efficient for the country toproduce all food required for domestic needs, nor should it be a national economic objective undernormnal conditions. Efforts to improve the level of food self sufficiency are justified only by prevailingconditions in the short term. Increasing the level of cereal, sugar, milk, and meat self sufficiency as alonger term objective up to the levels as indicated in the TCFP of the Government is not supported bythe natural endowment of the country and economically can not be justified. Domestic resourceendowments and traditions favor labor intensive horticulture, production of vegetables, viticulture, anda livestock sector suited to domestic feed resources provided by higher altitude pastures and meadows.Longer term adjustment of the crop-horticulture sector is a rather important task for agricultural policy.The sector is suffering from deterioration of essential irrigation facilities as well as declining domesticdemand and stagnant export possibilities for its traditional labor intensive products. Rehabilitation andadjustment of irrigation facilities to private farming, structural changes, improvement of product qualities,and creation of a private trading and processing sector should be the major objectives in the cropsubsector.

2.10 The livestock sector should continue to remain a supplier mainly for domestic markets.Local forage availabilities provides profitable opportunities for cattle, sheep, and goat husbandry withoutsubstantial demands on local grain production. Grain based pig and poultry sectors have limited potential,even in the longer term. Pork and poultry prices should continuously reflect the costs of imported,internationally priced grain and feed supplements. Production in these subsectors might recover as privatesector activity improves and the domestic economy, as well as personal incomes, begin to grow.

2.11 In the long term, Armenia definitely will remain a net agricultural importing country.Potentials exist for improvement of efficiency and production increases under private ownership as theoverall economic environment becomes more supportive. The privatization and rehabilitation of agro-processing is an important precondition for any sizable food and agricultural export to developed markets.The traditional products of the country, such as brandy, canned vegetables, and fruits provide a goodstarting point. Specialty products and markets provided by the Armenian diaspora should be taken intoaccount. The improvement of production efficiency and the more active participation in internationaltrade, however, should be guided and managed by the private sector, supported by appropriategovernment policies and infrastructure.

10 Chapter 2

2.12 In the emerging market system the Government cannot, and should not, directly engineerthe recovery and growth needed in Armenian agriculture, even if it were to have at its disposal greaterresources than are currently available. The Government needs only to provide an enabling environmentand to permit enterprises/farms to be the decision makers to create growth themselves in the agricultureand food economy. The key components of further reforms in Armenian agriculture are therefore: a)macro-economic stabilization; b) creation of a proper incentive framework for farmers that providesmotivation for development on the basis of the right to retain sizeable farm profits; c) continuation andcompletion of land reform; d) consolidation of private farms; e) reform in agro-processing, input supply,production services, and input marketing that creates reliable input supply and competitive markets forfarm products; and f) further regulatory reforms establishing the framework for a working market in foodand agriculture.

Food Secuity

2.13 With the decline of agriculture imports and fall of production, the domestic availabilityof food has worsened. The increased production following land reform and food aid have provided somerelief, however, the supply of some major food commodities, such as milk and meat, has become critical.To avoid further decline of food supply and serious food shortages the Govermnent should continueimports of food and essential input needs for agriculture. The continuation of food aid to Armenia shouldalso be facilitated. Due to the fact that Armenian agriculture is based on irrigation, the availability ofwater for farmers has a crucial importance. The irrigation system in the country is in a deterioratingphysical condition. Some of the irrigation facilities are in critical need of repair, and in their presentdeteriorating state cause extreme environmental problems. Furthermore, the system urgently needs tobe adjusted to the needs of private farming. Therefore, rehabilitation of critical water infrastructurefacilities should receive very high priority in order to improve food security.

B. SOCIAL POLICIES IN SUPPORT OF THE RURAL TRANSITION

Urban Needs

2.14 Concerns about unemployment and inadequate income to meet national needs are oftenraised as an argument against change. The population of Armenia is facing extreme hardship asconsequences of the blockade and transition from a command to a market economy. Measures are,therefore, needed to protect the most vulnerable groups from serious hardship, especially to ensureminimum consumption levels for the poorest as prices adjust in the coming years. In realizing thisobjective, the determination of the eligible group and the setting of a poverty line is an important issue.

2.15 Many urban people will need either income supplements or some sort of food supplementto maintain adequate diets. There are several options to ensure adequate food supply and to protect thepoor, all of which have advantages and disadvantages. Price subsidies are the least compatible with amarket economy and therefore are not recommended. Using the cash benefit system seems to be the mostdesirable solution under stable economic conditions. Food stamp systems may also be workable, and withhigh inflation, are preferable to cash benefits since they can be quantity-denominated. Food for work

Overall Strategy for Continuing Reforms 11

programs, already practiced in Armenia, are rather good tools under high unemployment. A new systemof social support based on cash and in-kind benefits was introduced in October 1993. The so called"Social Support Network" is run by local municipalities which are also in charge of identifying theeligible groups in their territories. Based on the initial results of this system, it should be furtherstrengthened and refined, in order to use the limited funds available for social protection in the mostefficient manner. The introduction of social support networks is an important step toward more effectivesocial expenditures. However, much remains to be done to rationalize expenditures on pensions and otherbenefits, particularly in view of the expected further increase in unemployment and the elimination ofgeneralized subsidies and transfers to the population.

2.16 All the above methods have advantages and disadvantages. Price subsidies are the leastcompatible with a market economy and, therefore are not recommended. Adopting the cash benefitsystem seems to be the most desirable solution under stable economic conditions. Food stamp systemsmay also be workable, and under the conditions of high inflation, they are preferable to cash benefitssince they can be quantity-denominated. Food for work programs, already practiced in Armenia, arerather good tools under high unemployment. They should, therefore, be enlarged and applied morewidely in Armenia together with some form of food stamps program.

Rural Needs

2.17 Decollectivization, privatization, changes in the structure of agricultural production, andthe sharp decline in industrial production, have produced profound changes in Armenian villagecommunities. The transformation processes affect households, villages, and regions in varied ways.Significant effects already have been experienced with respect to the level and structure of rural incomes.Some families have experienced sharp increases in their farming incomes as a result of receiving landfrom the former collective farms. However, many rural households have suffered a decline in cashincome as a result of growing off-farm unemployment.

2.18 There will be significant demographic transformations for the next several years. Thedecline of village populations will be halted temporarily and possibly reversed, and the proportions ofyoung people and men in rural communities are likely to increase toward more normal demographicpatterns. As a result of these changes, social tensions within villages and households may increase,particularly as long as employment prospects remain bleak. Many of the potential difficulties associatedwith changing rural demography could be mitigated by the development of appropriate policies to providerenumerative employment to an increasingly diverse rural occupational structure.

2.19 The two most critical needs in the village communities are: (a) developing an enablingenvironment to stimulate increased employment in the villages; and (b) enhancing local ability to respondto social and demographic change by providing communities with greater financial control over taxpayments. Except for appropriate steps to insure minimal health, nutrition, and sanitation and to improvethe general quality of life in rural areas, attempts at direct state intervention do not seem desirablebecause of lingering local suspicion of government motives and the difficulties in developing cost-effectivepolicy instruments. A coherent and integrated strategy should be developed to facilitate rural comnnunitydevelopment through devolving responsibility for these activities to the local communities themselves.

12 Chapter 2

Rural Labor and Employment

2.20 The sharply deteriorating overall employment situation in the country is forcing theagricultural sector to assume the role of employment buffer. The increase in the supply of rural labordisplays large regional variation, with rural communities near urban areas being most affected. As thisphenomenon is likely to persist, it is important that this growing supply of labor be given due weight instrategies for developing agriculture and that these strategies be coordinated with overall developmentstrategies for the country. More specifically, the past emphasis on large-scale mechanization and labor-displacing technologies in order to release agricultural labor to meet the demand for labor in other sectorsof the economy, needs to be reconsidered. The low land/labor ratio, relative abundance of cheap labor,and limited employment prospects in the non-agricultural sectors suggests that a shift in emphasis towardmore labor-intensive product mixes and modes of production may be called for in both urban and ruralareas.

2.21 As a result of past policies, the rural economic base is oriented singularly towardagriculture. There is a virtual absence of non-agricultural economic activities. This implies that theentire burden of rural employment creation falls on agriculture, making agriculture excessively dependenton distant markets and sources of inputs, reducing local linkages and multiplier effects, and has provideda strong incentive for the young and educated to migrate to urban areas. Solutions to the problems ofrural unemployment and under-employment in agriculture as well as the problems of seasonal variationsin the need for labor in agriculture must to a large extent be found in a general expansion anddiversification of the rural economic base through development of non-farming economic activities. Inthe short and medium termns, special emphasis should be placed on promoting the entry and growth ofenterprises serving agriculture and providing rural services, both upstream and downstream.

2.22 Acute employment and income problems in rural areas are severely affected by industrialdecline, and require special measures in terms of employment-creation policies. Short-term public worksprograms, organized by local government or contracted with local non-governmental organizations(NGOs), might usefully be considered to counteract persisting unemployment problems in rural areas.Suitable activities for public works programs would include reforestation and construction of physicalinfrastructure. Public works programs need to be complemented by efforts to create sustainableemployment from promotion of intensification of agriculture through a focus on high-value products (viz.,horticulture and vegetables in peri-urban areas, and high-quality dairy products in mountain areas).

2.23 Future policy measures in support of the agricultural transition should take into accountthe particular needs of women in agriculture. Agricultural research, extension, and education should beformulated with recognition of these needs. Rural credit programs should provide convenient access bywomen farmers to credit for production inputs, micro-enterprise development and longer-term investment.During the transition period, efforts to improve the position of women farmers should focus on their roleas critical economic agents. Better access by farm women to key inputs--education, information, land,credit--could impact positively on productive capacity and incomes in the sector.

The Rural Social Safety Net

2.24 Privatization and the transition to a market economy will remove state control over theexisting rural social safety net and the provision of diverse social services in the rural communities. Withsome important exceptions, rural incomes have improved relatively over the past few years. Thus,

Overall Strategy for Continuing Reforms 13

policies aimed at poverty alleviation and income enhancement should focus on the revitalization of therural economy in general and of the agricultural sector in particular, while safeguarding the interests ofparticularly vulnerable groups. The rural social safety net should seek to improve the quality of villagelife and be complementary to the economic reform program.

2.25 Housing. A housing problem in rural areas is to be anticipated, resulting from the returnmigration of industrial workers and the increasing stability of rural populations in general. Localgovernments should be enabled to offer house plots at market prices to citizens seeking a return to theirvillage communities. Purchase prices might be paid over long terms or by the provision of communityservices. Housing loans should be made available, with the housing to serve as collateral.

2.26 Education. Rural schools have long been disadvantaged compared to their urbancounterparts due to less generous funding and by having a curriculum that differed from urban schools.Such conditions have been exacerbated by fiscal difficulties in Armenia's transition to a market economyand by the loosening of administrative controls over the schools and their teaching staffs. To improvethe overall educational circumstances of the rural communities, rural and urban curricula should bestandardized to remove the cultural bias against agriculture in the national educational system and toencourage urban pupils to view agriculture as a potentially renumerative pursuit. Specifically in the ruralareas, housing and salary incentives might be offered to teachers to remain in rural areas or relocatethere. Successful pupils at the general school level should be identified and allowed to compete forstipends and other kinds of assistance to attend agricultural and silvicultural high schools.

2.27 Countrywide training programs in the fundamentals of business administration, financialanalysis, marketing and modem commercial farmning are needed to remedy the current shortages ofcritical skills in these areas. Such programs would need to be pursued at two levels: a more advancedand comprehensive level for the specialized agricultural work force, and a second tier of trainingprograms at a more rudimentary level targeted at the agricultural labor force at large. Evening schoolsshould be promoted in rural areas to assist in implementing training programs for this target group.

2.28 Rural Nutrition. Health and Sanitation. At present, and with the exception of isolatedindividuals and groups, rural nutrition is generally good. However, there is the risk that households mostnegatively affected by the change to the market economy (i.e., single aged individuals, the landless,and/or those previously heavily dependent on wage labor) will be financially unable to provide a sufficientdiet for their members. There have been long traditions of giving food to relatives and neighbors in needin the villages and towns. These traditions need to be encouraged and perhaps institutionalized to ensureadequate nutrition across the entire rural population through, for example, interventions by local churchesand establishment of community food banks. The transition has also placed the delivery of rural healthcare services under some pressure. Nevertheless, basic medical care seems widely available.

14 Chapter 2

D. POLICY AGENDA FOR CONTINUING REFORMS IN FOOD AND AGRICULTURE2

2.29 The details of a desired strategy for further reforms are discussed in the main body ofthis report. However, the core recommendations are summarized in the following matrix, which providesan overview of proposed short and medium term Government actions and ultimate policy objectives.

ISSUES RECoMMENDATONS ULTiMATE OwECTVrS

A. Macroeconomic andIncentive Framework

Agricultural Prices. Subsidies, 0 Phase out remaining subsidies to * Microeconomic incentiveand Taxation producers and trading agencies, including framework reflecting real factor

credit subsidies and product prices

* Move as rapidly as possible to fully * Water charges are based on actualliberalize prices and unify markets costs in providing water to

farmers* Guarantee that farmers are able to retain

profit for development 0 Distortion-free marketing andincentive system

* Create a fair taxation of farmers'incomes and assets * Fiscal stability

* Include energy costs in water charges and * Efficient agricultural productionimprove bill collection from water users that provides acceptable incomes

for living and farm development

* Replace consumer price subsidies with anadequate "social safety net' of subsidiestargeted to low income and vulnerableconsumers

Agricultural Trade and * Phase out any remaining part of the state * Competitive agricultural marketsMarketing order (state trade) system

* Market transparency* Remove administrative restrictions on

exports and imports, and remove export * Cost-effective export and importtaxes and reduce import tariffs to a low transactionsand uniform rate

* Proceed with demonopolization,corporatization, and phased privatizationof internal and external tradingenterprises

* Pursue active trade policy to improvemarket access for Armenian food andagricultural products, especially inrepublics of the FSU and Central and

2 The macroeconomic issues listed here include only those of immediate importance for agricultural productiondevelopment. In addition, the development of the sector requires the establishment and maintenance of a stablemnacroeconomic framework and the implementation of a structural reform program conducive to efficient allocation ofresources. The details of these measures are beyond the framework of this review, but are discussed in greater detail in theArmenia County Economic Memorandum. March 24, 1993. Report no. 11274-AM, World Bank.

Overall Straegyfor Coninuing Reforms 15

B. Comuledon of Land Reform

Land Tenure and Farmiing * Develop and implement a land * Secure and transferable land useSystem registration, information and cadastre rights conducive to promoting

system to provide security of tenure, full -long tenn invesener access toinformation on land transactions, and a financial markets, and enhancedbasis for land taxation land mobility

* Prepare and implement a program to 0 Open land and labor markets thatpromote the emergence of land markets wiO allow these resources toto support land consolidation and the move into their most productivemove towards a more efficient holding usesstructure

0 An appropriate system of local* Rearrange responsibilities for providing and municipal strctures, with

social services in rural areas and adequate fiscal powers, to takeguarantee the continuation of ural social over responsibility for socialservices after transfer services from agricutural

enterprisesPrivaLe Faming * Establish competitive land mortgage and * Individual private farming as the

credit system major component of farmingsystem

* Adjust irrigation system to the newrealiry of private farms

* Create a conducive framework fororganizing local and regional servicecooperatives

* Provide technical assistance to farmers toachieve optimum production mix andefficiency

* Foster the development of a privatesector farm management and technicaladvisory service

* Establish Western style agriculturalextension services

C. Comuedtive AgcoroEsanEand Services for Prtrate

Agricultural Input Supply, * Implement program of demonopolization, * Facilitation of the emergence ofOutput Marketing and corporadzation, and privatizadon of the new and restructured firms, andAg ossing centralized agricultural input supply, the growth of competitiveness and

output marketing, and agro-processing efficiency in both input andenterprises output markets and in

agroprocessing

* Establish feasible and reasonable quality * Improved product quaity, andand safety standards for agriculturl penetadon of both domestic andimports and exports foreign markers

* Acquire technical assistance and trainingin enterprise management

* Promote joint ventures to tap foreignexpertise, technology, capital, andprovide access to foreign markets

* Promote research and development ofnew products and markets

16 Chapter 2

Working Financial System for * Use fiscal means other than financial * Efficient allocation of credit toAgriculture institutions to sustain the operation of profitable activities undertaken by

state enterprises critical to food security clients willing to repay loans

* Study the feasibility of providing: (a) * Viable financial institutionsequity rather than credit lines; (b) dollar serving the agricultural sectordenominated loans, or hard currency efficientlyloans

* Banking system within a proper* Establish legal framework and implement banking regulatory framework

program to organize local savings andcredit societies

* Promote the emergence of competitiveinsurance services for agriculture

D. New Role for theGovernment

Public Agricultural * Adjust public agricultural administration * Efficient and effective publicAdministration to the needs of a market economy sector administration and support

for commercial and privateagriculture

* De-link the Government from agricultural * Improved quality of policyproduction planning and management formulation and the analysis of

emerging constraints

* Promote the establishment of a system to * Accelerate the agricultural reformnprovide for technical assistance for process and minimize cost ofenterprise restructuring transition

Agriculture Production 0 Review and analyze agricultural research * Improved technology, managerialTechnology and Farm requirements from the point of view of practices, and efficiency inManagement Practices agriculture's current problems and its agriculture

long term prospects

* Determine research priorities and the 0 Imnproved product quality to meetappropriate structure and organization for the demands of domestic andthe research system, including the foreign marketsrespective roles of the public and privatesector in financing and operating thesystem

* Strengthen farm management andagricultural economics disciplines

* Strengthen the reorganized researchsystem

* Strengthen the agricultural educationsystem to prepare both adults and theyounger generation for the challenges ofthe transition to a private market orientedenterprise system

CHAPTER 3

DEVELOPMENT OF A MARKET FRAMEWORK

3.1 Armenia has made significant advances in dismantling the planned economy inagriculture. This progress is largely a result of the far-reaching land reform which Armenia adopted in1991 (see Chapter 4). The progress made to date needs to be expanded to include the replacement ofthe old administrative economic institutions by a market-based agricultural system. Though Armenianpatterns of consumption have adjusted as the country moves in the direction of a market economy, onlyfurther development of the market can provide incentives to producers to profitably restructureagriculture's specific sub-sectors and raise income.

3.2 A market system will be established in agriculture only if the Government of Armeniacommercializes, demonopolizes, and privatizes state agricultural input trading enterprises, as well as agro-processing, marketing, and retailing enterprises. In addition, the Government must allow the structureof production, input prices, wage rates, and interest rates to adjust as the economy develops a marketorientation. All this cannot and should not be done instantaneously. But the Government has to providethe framework for further reform since the development of market institutions requires a comprehensivestrategy. This chapter discusses the obstacles to market development in agriculture and offers proposalsfor further action in encouraging market institutions.

A. MACROECONOMIC AND INCENTIVE FRAMEWORK

3.3 Despite all the difficulties which Armenia is facing, the Government is trying torestructure the economy and develop a new macroeconomic framework. Inflation in Armenia was lowerthan in Russia until late 1992 when it exceeded the Russian rate for the first time (about 3750% in 1993compared with 1100% in Russia). High inflation and steady continual erosion of real income have hada profound impact on the economy and the agriculture sector especially. With the introduction of its owncurrency, the dram, in November 1993, Armenia gained monetary independence and soon began totighten financial policies. Inflation declined from 46 per cent per month in the first quarter of 1994 toless than 3 percent per month in the third quarter of 1994, and interest rates became positive in real termsas well.

3.4 As a critical step establishing a market economy, the Government has to provide amacroeconomic framework conducive to the transition of agriculture to a market-based system. Thisrequires further progress in four policy areas: (a) reduction of inflation; (b) stabilization of the currency;(c) creation of a domestic price system based on border prices; and (d) removal of remaining obstacles(mainly inherited structures) to free markets in agriculture. A transition to a market economy requiresthat signals on product and factor markets are related to world market prices. In addition, an incentivesystem has to be ensured for the private farms and enterprises that guarantees the most efficient use ofdomestic resources. If such conditions prevail, the country can expect to increase production efficientlyon the basis of domestic resources.

3.5 The present incentive system is still distorted. Because of the high uncertainty aboutinflation, expectations of economic agents are not stabilized. Prices of tradeable goods paid to domesticproducers are below border price levels and producers are still being subsidized for some importantinputs, such as the cost of energy for irrigation water. Hence, agricultural producers receive distortedsignals for their production decisions.

18 Chapter 3

3.6 An effective set of market institutions will be established only as a result of a clearstrategy with carefully sequenced priorities for the short and medium term steps. A proposed scheduleof agricultural price and trade policy reforms and subsidy reductions is presented in Box 3.1.

Proposed Schedule of Agicultual Price, Trade Poicy Reform, and Subsidy Reduction

Inmmediate Meaures Second Step Third Step

Consumer Prices Eliminate existing food Remve profit and Orient domestic prices toprice subsidies. mnarketing margin world prices via open

restrictions, foreign trade.

Producer Prices Make state procurement Foster the establishment Demonopolize andcontracts protect farmers of commodity exchanges. privatize agricultural Inputagainst inflation. Fully give up price suppliers and mnarketers.

controls.

Food Security Move state purchases for Strengthen the existing Replace in kind supportformation of food security protection syster for with cash transfers to thestocks to the market. targeted consumer poor.

groups. __

Water Subsidies Reduce water subsidies. Make farmers pay the full Phase out irrigation priceTransfer subsidy costs of operation and subsidies.incidence to farmers. mnanagement, except full

__________________________ energy costs,

Foreign Trade Create a tender system Reduce scale of Limit state role infor bilaterally negotiated negotiated trade. agricultural trade toexports. Privatize state trading develop overall trade

companies. Move toward policy framework.reduction in tariffs, tariffbarriers, and export

taxes.

Box 3.1

3.7 Markets can only provide clear signals if there is competition and transparency in themarket. The present system however, in which state enterprises retain monopolistic positions in tradeand food processing, creates substantial inefficiencies and is highly distorted and the market's ability togenerate efficiency and growth is substantially impeded. Even though the Government wishes to moveto a market economy, it assumes that the blockade and the socioeconomic system reduces the population'sability to cope with market forces, and thus has delayed decisions regarding privatization of stateenterprises engaged in input distribution, marketing, and food processing. Nevertheless, the share of theGovernment procurement of agricultural commodities has been falling steadily. While the state ownedprocurement structure designed to implement the state order system is still in place, private farmers aredirectly marketing their agricultural products in increasing quantities despite limited transport and storagefacilities (Table 3.1).

Development of a Market Framework 19

Consumer Prices

3.8 Retail prices Table 3.1: Marketing of Agricultural Produce (Shares In %)

throughout the Armenian

economy were largely Product Purchases From Purchases by Output Sales toderegulated in 1992, and the Private Farms as Private Marketers State Processors as

widespread use of subsidies for a Share of All as a Share of AU a Share of Total

f o o d products was Purchases, 1992 Purchases, 1992 Output, 1993

discontinued. This represents Meat 33 10 NA

significant movement towards a Milk 80 0 NA

market economy, as prices areallowed to play their role of Eggs 4 3 NA

directing consumer demand. Grain 80 0 10

The main exception to this Potatoes 98 93 1

trend has been subsidization ofbread consumption by the Grapes 100 25 36

fixing of bread prices sold in Other Fruits 100 99 4

state stores. In addition, a Vegetables 99 35 1

number of periodically Source: Minusty of Agriculture

imported food products (butter,sugar, vegetable oil and rice)have been subsidized and rationed through state stores. As this subsidization generates lower revenuesfor the state enterprises producing bread and trading the imported products, it prevents thecommercialization of these enterprises.

3.9 With the deregulation of consumer prices in January 1992 and the withdrawal of mostfood subsidies, retail food prices tripled, thereby outpacing the rise of the overall retail price index andthe growth of wholesale prices of the food industry. Food prices in the markets that had sold atunregulated and unsubsidized prices in the past (known as the collective farmers' markets or CFM) roseonly 15 % in January 1992. Thus, the price jump in the state retail food sector reflected the high levelof subsidy which was removed in January 1992.

3.10 In reviewing the 28-month period after initiation of price deregulation in December 1991(Table 3.2), it is clear that despite high levels of consumer food subsidy in the past, price deregulationhas not caused food prices as a whole to increase relative to non-food prices. Meat and milk productprice increases have largely kept pace with inflation because they are no longer subsidized (and sinceArmenia is a net importer of both).' Still, retail food prices rose less than the consumer price index asa whole for two main reasons; bread subsidies have not been eliminated, and greatly reduced demand byprocessors has kept fruit prices depressed. Thus, if bread subsidies are reduced and export demand forprocessed fruits and vegetables rebounds, food prices would likely increase relative to non-food goods.This is reinforced by the high income elasticities for non-food goods which have been at work reducingdemand for them as real consumer income has continued to contract since 1991.

There are no excess supplies of these products on the domestic market, in contrast to the situation in net exportingFSU countries where reduced export demand has induced rapid herd liquidations and excessive downward pressure onprices.

20 Chapter 3

3.11 An important sign of success in deregulating consumer food prices in Armenia is thatcomparison of CFM prices with those in state stores shows the two sets to be quite close. Two factorshave fueled this convergence:

a) many state food stores have been rented out to former employees and new private sellers who now offer a much wider variety of foods (many imported) and face minimalmarketing restrictions; and,

b) restrictions on official state retailing enterprises and the Armenian Consumer CooperativeUnion have been lifted except for maximum processing and retail margins on breadproducts.

3.12 At this stage, the Government should recognize that the rationing of food and food pricesubsidies are not efficient methods of providing food security. Market prices should be charged for food,but needy segments of the population should be targeted for receiving income supplements through socialprograms. The reduction and eventual phasing out of bread subsidies will remove the burden of foodsecurity from enterprises and place it more manageably in the Government's hands as a fiscal issue, notone of price control.

B. PRODUCER PRICES AND FISCAL POLICIES IN AGRICULTURE

Producer Prices

3.13 Agricultural producer price subsidies have also been discontinued and producers are freeto market their output outside of state channels. State orders (state tasks) are set only for grains and someagricultural exports included in bilaterally negotiated trade lists. A substantial amount of potatoes, fruits,and vegetables, as well as imported agricultural and food products are marketed through private channels(Table 3.1). Though this is a positive development, farmers are currently taxed by the low prices theyreceive for agricultural output sold to state procurement enterprises. In food markets, state processorsand retailers are still instructed by the Ministry of Food and Procurement (MOF) on how to price theirproducts in the still relatively high inflation environment. Thus a "cost plus" system with suggestedprofit and marketing margins is perpetuated by the MOF for enterprises under its jurisdiction. This isnot the only factor which places downward pressure on producer prices (Table 3.2); demand is alsosuppressed, owing to low capacity utilization and high unemployment in the country as a result of theblockade.

3.14 Comparisons of Armenian agricultural producer prices with those on the world marketshow the degree to which the former are depressed (Statistical Annex, Table 33). Grain prices are theleast depressed, attaining roughly 50% of world market levels. These policies allow grain deliveries toprocessors at $50-60 per ton. Given the increased reliance on bread products in the Armenian diet asnational income has contracted, strong demand would make for higher prices were it not for subsidizedgrain. Careful consideration should therefore be given as to how food aid and imported grain prices areset. Livestock prices are only one quarter of world market prices levels, but this is largely the result oflower quality and drastically reduced per capita consumption in Armenia.

Development of a Market Framework 21

3.15Though the state no Table 3.2: Comparative Price Indices (%)

longer subsidizesagricultural output December 1991 = 100 December April April

prices and controls 19 I93 I94

a decreasing share Consumer Price Index 2,118 5,062 964,444

of domestic output, Retail Food Price Index 2,273 4,548 668,931

it still influencesagricultural prices Bread Products 3,665 4,479 79,616

of products which Fruit 602 1,239 825,733

are major inputs to Potatoes 625 1,000 133,387

the state foodp r oc e s sing Vegetables 585 1,738 1,043,040

enterprises or which Milk and Milk Products 1,601 5,156 1,006,127

are imported in Meat Products 1,636 4,175 736,818

significantquantities. The Farm-gate Price Indices 975 5,351 NA

most important of Grain 778 6,538 NA

these are tomatoes Fruit 1,275 3,141 NA

and grapes andwat grands mil Potatoes 1,113 3,158 NAwheat and milkpowder. The prices Vegetables 309 3,377 NA

of tomatoes and Milk 756 5,637 NA

grapes have beenLivestock & Poultiy 606 2,452 NA

under pressure overthe last two years Grapes 506 6,539 NA

since processing Wholesale Price Index 925 3,087 NA

factories have hadtrouble raising Food Industry 1,825 6,351 NA

sufficient working Chemicals 169 349 NA

capital to maintain Electricity 1,802 4,830 NA

their operations.their s rate s. Oil Products 220 862 NAThe state has Source: Armenian State Committee for Statistics, CIS State Committee for Statistics.contributed to thispredicament byinducing these enterprises to use incorrect methodology when evaluating costs, thereby exaggeratingprofits, assessing excessive profits taxes, and draining the enterprises' working capital. In the case ofwheat and milk powder, the state has priced imported food aid shipments at well below internationalprices, and in some cases not charged processors at all for these inputs. This practice puts downwardpressure on prices and makes profitable activity by private processors less sustainable. Though it maylower prices to consumers, there are ways to achieve food security targets without hurting enterpriseprofits.

3.16 The establishment of a market-oriented agriculture will require the full completion of pricereform. Prices received by producers should be allowed to adjust by: (a) eliminating remaining pricecontrols; (b) removing remaining delivery obligations and restrictions on domestic trade; (c) eliminatingcost based pricing mechanisms, including the system of fixed profit margins for processing and trade;together with, (d) creating competition both in input supply and in output marketing.

22 Chapter 3

3.17 The system of prices based on the cost of production is inappropriate in a stableenvironment and is harmful under inflationary circumstances. Cost based pricing formulas do not takeinto account changes in demand or world prices. Moreover, under rapid inflation, cost based pricingdepresses agricultural product prices, since costs incurred several months prior to harvest are generallynot adjusted to reflect real costs of inputs at the time of harvest. If cost based price interventions arediscontinued and trade is liberalized, the resulting pricing structure would reflect both Russian and worldmarket prices. Products that can be sold on the hard currency markets would tend toward the domesticequivalent of world market prices. Products sold primarily within the FSU would move toward Russianprices.

3.18 Procurement of agricultural output has been affected by inflation of prices contractedbetween farmers and the state and consumer cooperative purchasing ministries (the MOF and HICOOP).This price erosion must be addressed by a contract formation which stipulates the selling price at timeof planting and includes an advance for working capital for the farmer. Contracts for farm output shouldstipulate protection of price against inflation, otherwise farners will lose the incentive to produce underthe present conditions of inflation.

Water Charges

3.19 Water charges were instituted in 1991 and raised in 1992 and 1993 by taking totalexpenditures on operation and maintenance, making allowance for predicted inflation and dividing by thetotal amount of water used. The resulting charge was R 1.5/m3 for 1993. For pre-mountainous andmountainous areas the state budget subsidized half of this cost, leaving the farmers with a charge of R0.75//m3. Only about 8% of water charges due were collected in 1992 and about 11 % by October 1993.Reasons for the low collection rate of water charges include the delay in completing irrigation relatedlegislation in 1992, and the late or incomplete payment for crops delivered by farmers to the state-ownedprocessing enterprises. The water charges implicitly subsidize farmers as the cost of energy in theoperation and maintenance is imputed at a very low rate. These subsidies were significantly reduced inDecember 1994, by an increase in electricity tariffs. By the end of 1995, the GOA intends to set averageelectricity tariffs to cover the full operation and maintenance of electricity supply. This should furtherreduce implicit subsidies in irrigation water charges.

Subsidies and Transfers

3.20 Armenia is one of the few FSU republics to have seemingly embraced subsidy reductionfor agricultural input prices, farmer output prices, and consumer food prices, however a few implicitsubsidies remain. By eliminating most explicit subsidies to producer and consumers, Armenia took alarge step towards liberalizing its price system and allowing it to better reflect relative prices in worldmarkets. What remains is to facilitate international trade and reduce transactions costs so that domesticprices for basic agricultural commodities better reflect their international worth. This would reduce theimplicit taxes and subsidies currently present in the Armenian agricultural price structure. Furtherreduction of subsidies would entail charging positive rates of interest on credits advanced to theagricultural sector for working capital, and phasing out the remaining subsidies on irrigation water forproducers and bread for consumers.

Development of a Market Framework 23

Taxes

3.21 Farmers were exempt from Table 3.3: Agricultural Transfers and Taxes, 1993

income tax in 1991 and 1992, though they have (Billions of Rubles)

been making payments for the land they Producer Transfers 27,553

received through de-collectivization. Since1993, they were levied a profits tax of 30%, but T fthe difficulty in verifying income of the 300,000 Water Subsidies 8,000

new private farmers has meant that this tax was Capital Investments 2,290

assessed on government-estimated net returns toland in each rayon and for specific types of Operating Expenses 1,454

crops produced. It is not clear what percentage Irrigation Repair 681

of this tax is collected, as farmers are exempt 964from the tax if they can demonstrate that their Eucation and Scienceactivities were unprofitable. All processing and Implicit Credit Subsidies for Purchased 2,014

input supply enterprises are subject to a Seeds, Fuel, and Irrigation Repair

graduated profits tax as are other Armenian Implicit Credit Subsidies to Individual 6,750enterprises (Table 3.3). and Cooperative Farmers

Implicit Credit Subsidies to Food 5,4003.22 Agricultural commodities have Marketing and Processing Sector

been subjected to VAT since its introduction in1992, but since the Tax Inspectorate could notcalculate the tax on individual farmers' sales, Land Tax Payments as Indemnification 10,000they were, de facto, exempt. As of April 1993, under Land Reform

primary agricultural commodities, meat and Rent for State Pasture and Croplands 10,000

milk products, and flour milling and bread' . ~~~~~~~~~VAT and Profits Tax on Processing and 3,500

baking, are exempt of VAT. Other processing Input Supply Enterprises

enterprises and input supply enterprises aresubject to a VAT tax of 20%. (Farmers' sales Taxes less Subsidies -4,053

are exempt but not zero-rated because they Consumer Bread Subsidies 20,000receive no refunds of VAT embodied in

Tax Receipts from Wage Income and 11,800purchased inputs. Processing and trading Private Enterpriseenterprises can deduct the VAT embodied inpurchased inputs as costs before the VAT is Taxes leas Subsidies -8,200

assessed on their sales.) 'Estimates of the Ministry of FinanceSource: Ministry of Finance, Department of Taxation,and World Bank estimates.

3.23 The main taxation issuesconcerning the agricultural and food sector are the way in which profit taxes on private farmners will beadequately assessed and collected, and the current lack of a method to revalue enterprise assets andinputs. Until a nation-wide taxpayer identification system is in place for households, a tax on the assessedvalue of agricultural land should be utilized. The system currently being implemented by thegovernment, which assesses normative net income for private farmers by land and crop type, should bemodified in the future to tax a registered assessed value of farmland. Once the personal income tax iswell established, land taxes could be reduced. With the current high rates of inflation, the failure torevalue enterprise assets and inputs purchased early in the year (most notably those in the input supplyand processing industries) reduces deductions for depreciation, overstates profits, and thereby artificially

24 Chapter 3

inflates profits taxes. Revaluation of assets and inputs in line with inflation would reduce profits taxesand increase the funds available to enterprises for working capital and investment.

3.24 To address the valuation problems that firms face under severe inflation, internationalaccounting standards and practices should be introduced, with specific focus on the revaluation of assetsand inputs used in the production cycle. Redrafting of reserve fund formation regulations for thedistribution of profits would allow enterprises greater command over the use of their profits.

3.25 Ministry of Agriculture staff need more extensive training in public finance issues so asto be better able to participate in the definition of taxes on the agricultural sector. By working closer withthe Tax Inspectorate and other Ministries on these issues, the Ministry of Agriculture personnel couldmore forcefully reflect the agricultural sector's views in the debate.

Budgetary Implications of Subsidies and Transfers

3.26 The total amount of transfers to the agricultural sector in the 1993 state budget forfarmers and agricultural input and processing enterprises was 8 billion rubles for water subsidies and 5.4billion for capital investments and construction, irrigation repair and operational expenses, andagricultural education and research. In addition, credit advances of 15.5 billion rubles were made toprivate and cooperative farmers and state agricultural processing and input enterprises. Because theseloans carried a 30-40% interest rate, their grant component was close to 90%. Thus the R 15.5 billioncredit amounted to a subsidy of roughly 14 billion rubles. Government revenue from primary agriculturalproducers (including private farmers) was roughly 10 billion rubles in land tax payments for land receivedunder the land reform and another 10 billion rubles paid by those renting state and cooperative lands thathave not been privatized (pasture lands and some crop lands also). In addition, agricultural processingand input supply enterprises paid roughly 3.5 billion rubles in VAT and profits tax.

3.27 In sum, producers are slightly subsidized in terms of direct taxes and subsidies.However, if we consider the depressing effect that the Government grain import policy has on wheatprices, a net implicit tax on farmers of roughly $30-$40 per ton on 300,000 tons of domestic production(totaling $10 million) needs to be considered. This was the equivalent of 11 billion rubles in 1993.Other agricultural and livestock products are being implicitly taxed, but the degree to which Govermmentpolicy is responsible is difficult to evaluate. Reduced export demand from the FSU has depressedprocessed vegetable and fruit exports and lowered raw product prices, and the lack of demonopolizationpolicies has exacerbated the situation even further. In any case, farmers are clearly undergoing heavyimplicit taxation as a result of Government policies, leaving them with a sizeable net tax burden. Incomparison, 1993 bread subsidies of about 20 billion rubles were significantly greater than the 11.8billion rubles from taxes on private enterprises and wage incomes. This indicates the Armenianconsumers are recipients of net subsidies because of food policies.

Development of a Market Framework 2S

C. INTERNATIONAL TRADE AND TRADE POLICIES

Trade Patterns and Partners

3.28 Trade is important to the Table 3.4 - Agricultural and Food Trade (millions)

economy of Armenia, and agricultural andfood trade has been sizeable (Table 3.4). 1990 1992 1993

Typically imports of food and agricultural In 1990 In 1990 Current

goods far exceed exports because about Rubles Rubles Rubles

70% of Armenian food has to be Ag. & Food Exports 424 342 11,549

imported. Until 1993, Armenianagricultural trade had been confined As%of Total Exports 12% 23% 7%

mainly to the FSU. In 1990 agriculture Share to FSU 98% 95% 97%

and food comprised about 22% of the total Ag & Food Imports 1045 680 148,871

imports and 12% of the total exports. By As % of Toa Impors 22% 33% 51%

1993, agricultural imports (including foodaid) exceeded 50% of total imports and Share from FSU 49% 70% 29%

agricultural exports had fallen to 7% of Source: The World Bank, Statistical Handbook, States of the FormerUSSR, No.3, September 1992, Armenian State Connittee for

total exports. In absolute terms, both Statistics 'Economics of the Armenian Republic January-April 1993'.

agricultural and food imports and exportsfell 30-40% from 1990 to 1992, but non-agricultural trade collapsed even morequickly in this period.2 Prior to the current blockade, Armenian agricultural trade usually consisted ofsizeable imports of cereals, livestock products, and agricultural inputs, while the exports were mainlybrandy, canned fruits and vegetables, and mineral water (Table 3.5).

3.29 In 1993 the share of imports from outside of the FSU increased mainly because of foodaid which started to come to Armenia from the United States and the European Community. Thedominant share of exports to non-FSU countries, however, remained. Ukraine used to be Armenia'smain trading partner in agricultural and food products. In 1990 about 50% of agricultural importsoriginated in Ukraine; about 34% in Russia; and about 16% in other FSU republics. Russia, on theother hand, was the recipient of 80% of Armenian exports, with all other exports spread among otherFSU republics. Since 1990, Armenian agricultural trade has been declining, mainly due to the blockade.The terns of trade have been worsening as well, mainly because FSU exporters of agricultural inputs(including energy) have raised their prices toward world market levels while real prices of vegetables,the main ingredient of the canned products, have declined significantly.

3.30 Agricultural production in Armenia is completely dependent on imports of all the majorinputs. There is no domestic production of agro-chemicals, agricultural machinery or seeds. One of themost important imported inputs in Armenian agriculture is energy, which is needed more for crops thanfor livestock production. Imports of protein feed, feed additives, antibiotics, drugs for treatment ofinternal and external parasites, and vaccine are also essential to the livestock sector. Limited availabilities

2 Information on actual trade flows for 1992 are rough estimates as the customs service began to register trade withthe FSU only as of January 1993. The large number of small private Armenian import-export businesses which handleprocessed foods (and to a lesser extent, raw agricultural commodities) makes measurement of agricultural trade difficult aswell.

26 Chapter 3

of agricultural inputs hascontributed to the declines in Table 3.5 Major Agricultural Imports and Exports

agricultural production and 1986-88

exportable surpluses. Average 1991 1992'

Application of pesticides, forexample, was far below optimum Imports

even pre-independence (less than Total Cereals, 1000 tons 1279 838 505

50% of agricultural needs) and Bread Grain, 1000 tons 745 441 339

dropped substantially further in1991, 1992, and 1993. In Fodder Grain, 1000 tons 534 397 166

addition to losses in production, Meat and Meat Products, 1000 tons 66 9 3

storage, and processing aresubstorage,antial(oer2 foe are Milk and Milk Products, 1000 tons 1047 246 64substantial (over 25 % for rnanycrops). Even so, the reduction Sugar, 1000 tons 96 72 73

in agricultural exports is due Exprtsmore to the high transactioncosts imposed by the blockade Wine & Champagne, 1000 3076 NA 725

and the lower demand for decaliters

Armenia's products in other FSU Brandy, 1000 decaliters 885 NA 135

republics, than it is due to the Fresh Early Vegetables, 1000 tons 99 NA 9unavailability of supplies.

Fruit preserves, million cans 218 NA 17

Processed Vegetables, million cans 84 NA 69Trade Policies 'Work Bank estimates using information from Ministry of Economics.

3.31 As Armenia ishighly dependent on foreign trade for almost 70% of food consumed, and faces a partially blockadedinternational transportation network, the country has adopted low import tariff rates for agriculturalproducts.' Exports do not require licenses, but exports outside the framework of interstate agreementsare subject to minimum reference prices with goods invoiced below the reference price subject to a 100%tax on the difference. Exports by private enterprises are subject to a mandatory 25 % prepayment. Fiftypercent of net export proceeds have to be surrendered to the exporters' bank, albeit at the market rateof exchange. The imposition of reference prices and foreign exchange surrender are to be removed inthe course of 1995. The Government's formulation of import policies has been a positive developmentin agricultural trade, and the further export liberalization planned for 1995 needs to be implemented assoon as possible to give an adequate incentive to agricultural exports.

3.32 Moreover, the practice of setting state order (state task) levels to meet export targetsbilaterally negotiated with other FSU countries continues, thereby braking the development of large-scaleprivate marketing channels. As products such as brandy and processed fruits and vegetables could findoutlets on the world market, potential hard currency sales are not realized. Given the difficulties otherFSU republics have in meeting state arranged deliveries, these agricultural exports could be moreprofitable for Armenia if they were not controlled by the state. Though the Government may need toarrange strategic imports such as fuel, it would be better to settle Government-arranged imports in

3 Tariifs on 95% of current non-CIS imports are 0-10%; CIS imports are not subject to tariffs.

Development of a Market Framework 27

currency rather than through barter, so as to be able to eliminate procurement of tradeable goods throughstate order.

3.33 Though agricultural trade policy is set on the basis of tariffs, there are some non-tariffbarriers (NTBs, e.g. licensing of brandy exports) which need to be transformed into tariffs. Inagricultural production where Armenia relies on imports for raw materials and feedstuffs for over halfof total consumption, there is little rationale for protection of the domestic market (sugar, vegetable oil,foodgrains). In these sectors where Armenia has no long-run comparative advantage (and no infantindustry argument can be reasonably made), tariffs could be reduced even further. Here the Governmentshould develop an explicit plan for tariffication of NTBs, reduction of import and export tariffs, andphasing out of other controls on agricultural trade, especially the practice of Government-negotiated tradewith other FSU republics.

3.34 Although an open agricultural trade policy will expose Armenia to price fluctuationstransmitted from abroad, domestic price band policies should be avoided as they are quickly turned intopermanent agricultural support programs (as the experience of Central and Eastern countries clearlyattests). The Government should rather focus on developing functioning spot markets with welldistributed price information and well defined product grades and standards. The availability of clearinformation as to product attributes and prices on the domestic market will pave the way for developmentof a futures market. With efficient customs operations, an effective anti-dumping system, and developedfutures markets, price fluctuations can be reduced to a manageable level.

VAT on Externally Traded Goods

3.35 If imports from the FSU include VAT, an equivalent amount can be deducted from finalsales made in Armenia or on exports to other FSU countries. In 1992-93 VAT was assessed only on thevalue added in production in Armenia. Exports to non-FSU countries are exempt from VAT. However,up until May 1993, exporting enterprises were not reimbursed for the VAT embodied in the inputs usedin the production of the exported good. This led to higher prices for goods exported to non-FSUcountries and further reduced export levels. The zero-rating of exports to non-FSU countries (noimposition of VAT on the exported good plus reimbursement of VAT paid in input prices) was adoptedby Armenia in June 1993. The Tax IrLspectorate has deemed that the potential negative impact of zero-rating on revenue is more than offset by increased revenue from higher export levels.

Short and Medium Term Outlook

3.36 Recent changes and problems in agricultural trade are partly caused by domestic factorsand partly by economic difficulties in trading partner countries. Even though the exportable agriculturalsurplus contributed relatively little to the total exports of Armenia, the reverse linkage is quite strong;macroeconomic instability with high inflation is a significant impediment to agricultural trade, as is thereduced availability of production for export. Inflation and economic instability contribute to drops indomestic investment. Stabilization of the economy, however, and further liberalization of trade policywill help to build up exportable surpluses.

3.37 Armenia has potential for increasing agricultural and food production and therebyreducing its dependency on imported food. The geographical location of the country makes it harder than

28 Chapter 3

most other FSU republics to access and integrate into the world economy. However, privatization oftrading institutions would make it easier for the country to find the right agricultural products niche whichreflects a comparative advantage, export potential, or can contribute to import substitution.

3.38 The current imposition of state orders to meet bilateral trade agreement levels with FSUcountries should be replaced by a tender system open to all producers and trading companies. Importsagreed upon bilaterally should also be sold to domestic enterprises on an auction basis. In the short-term,the Government of Armnenia should limit the use of bilaterally negotiated trade lists with FSU countriesand allow more opportunities for the development of private sector trading. The Government's maininvolvement in agricultural trade should become the negotiation of food assistance and trade agreementswhich increase the possibilities for Armenian agricultural exports. Once received by the Government,food aid shipments should be distributed through an auction process open to bids from all food processorsand retailers.

D. PUBLIC ADMINISTRATION: THE ROLE OF THE MINISTRY OF AGRICULTURE

3.39 Government management of agriculture still reflects the characteristic features of thecommand economy. A relatively large bureaucratic administrative structure is still functioning above thefarm level to provide central control to farms and other agricultural activities. The Ministry ofAgriculture (MOA) is responsible for the implementation of agricultural policy and the realization ofagricultural production objectives. The Ministry of Food and Provisions (MOF) oversees agroprocessingprocurement and food policy, the marketing of agricultural products belongs to the Ministry of Trade.The Ministries of Finance and Economy also have powerful roles in agriculture as well, as they aredirectly in charge of price and subsidy policy as well as trade and marketing regulations. There are alsoa number of other ministries and central comrmittees with "ministry" level status that have a stronginfluence on the agricultural sector such as the Ministry of Energy and Fuel and the Ministry ofTransportation and Communications.

3.40 Ministry of Agriculture. At the regional levels, the administrative structure of thesocialist era has been preserved almost without change. The Ministry is organized into five functionaldirectories each headed by a Deputy Minister: Crop and Livestock Production; Input Supply andServices; Land Reform and Privatization; Irrigation; and Foreign Relations and Scientific Research. Inaddition, there are four departments which are directly under the Minister. These are: Economics;Marketing and Agro-Processing; Administration; Legal; and Special Services Departments. The totalstaff of the MOA is about 180 in headquarters and 500 in the districts. Agricultural specialists in thedistricts are attached to the district administrations. The MOA still has some farms, mainly in seedproduction, and about 30 enterprises involved in food processing. A number of institutions involved inresearch, education, animal health, and soil sciences are also managed under the MOA.

3.41 The present organization of MOA raises two concerns: (a) the structure of the Ministryis much too complex, making it unnecessarily difficult for Government to react quicldy and efficientlyto the rapid evolution of the agricultural sector; and (b) the organization does not yet reflect the changingrole of Government in the economy, i.e., the change from a central planning role to the role offacilitating and supporting the development of private players in the agricultural sector.

3.42 Ministrv of Food and Procurement. The Ministry of Food and Procurement (MOF) hasbroad responsibility to supply food to the urban population. Formerly the Ministry of Food andProcurement in the FSU, it was also responsible for supplying food to other Republics according to

Development of a Market Framework 29

directives from Moscow. Because of these tasks, it became responsible for all the major agro-processingenterprises in the country. The Ministry controls about 600 enterprises, of which about one fourth arescheduled for privatization in 1995. Recently, the MOF has also become responsible for issuing licensesto private entrepreneurs to establish and operate enterprises. So far, over 500 licenses have been granted,most of which are for small-scale enterprises such as flour mills and bakeries. This means that there willno longer be a role for the State associations once privatization of the enterprises is completed. The MOFitself is scheduled to be incorporated within the MOA in the later half of 1995.

3.43 Proposed Changes. The transition to a market economy requires a fundamental changein the role of the Government in agriculture and in the economy in general. Direct governmentintervention in the agricultural economy, such as central distribution of investments and inputs, must bephased out. The Government's role should be to establish the general rules, and facilitate the conditionsfor smooth operation of markets and independent business organizations. This role is no less importantthan the previous one; however, it requires a different philosophy, as well as different institutionalarrangements.

3.44 The Government of Armenia needs to make a high level commitment to changing thestructure and scope of government organizations involved in the management of agriculture. The overallprinciples driving this change should be: (a) establishing a single locus of responsibility, e.g. mergingthe structures of MOA and MOF; (b) dismantling of the current direct governmental managementstructure for agri-business and agroprocessing; and (c) simplifying the structure of governmentalorganizations corresponding to changes in public sector responsibilities in agriculture, as well, as theprinciples of modern administration.

3.45 Within a market driven economic system the Government should play three roles:regulation, provision of supporting services, and analysis. Regulation should include such things as foodinspection, seed inspection, establishment and enforcement of grades and standards, establishment andcontrol of phytosanitary standards, epidemiology and livestock disease control. Essential support servicesof a public nature should be provided. These should include domestic and foreign market information,agricultural research, farm advisory services, and higher education in agriculture. Finally, theGovernment should monitor, review, and diagnose the implication of changing circumstances and developoptions for public policy. MOA's policy unit should also include an office to coordinate and facilitatethe support provided by bilateral and intemational donor and finance organizations.

3.46 As the transition proceeds, the whole structure of MOA and related institutions can befurther simplified, with fewer institutional units and fewer employees. A relatively small administrationwould be adequate to enforce agricultural regulations, promote development, and provide extension andmarket information services.

3.47 New Legal Framework. The establishment of market agriculture requires the developmentof a new legal framework, with new laws, and amendments to existing legislation. Most important isthe establishment of the legal framework for an efficient land market. Laws that establish the basicprinciples for private voluntary cooperatives, and an agricultural marketing law that establishes theframework for fair competition, anti-cartel policy, and quality control are also needed. At a later stage,general regulations for agriculture and forestry must be established according to the new ownershipstructure and economic management philosophy.

30 Chapter 3

CHAPTER 4

CONTINUATION OF LAND REFORM

4.1 Armenia has implemented one of the most comprehensive land reform programs in theFSU. Most land has already been privatized, the traditional Soviet kolkhoz/sovkhoz system has beendisbanded, and private farming and services have already started to operate. Further actions are needed,however, if the institutional and legal framework is to be created for a land market and support andadvisory services. This chapter reviews the results of land reform in Armenia and providesrecommendations for the completion of the land reform process.

A. THE PROCESS OF LAND REFORM

4.2 The establishment of private ownership of land and production assets is a key elementin the transformation of agriculture in the former Soviet republics. The first enabling Union-levellegislation was passed by the USSR Supreme Soviet between November 1989 and March 1990 (the Lawon Leasing, the Law on Property, and the Law on Land). These laws permitted individuals and familiesto hold long-term leases on land within and outside the collective and state farms, as well as allowing thegranting of individual proprietorship (vladenie) over land. Proprietorship gave lifetime inheritable rightsto work the land, but not the right to buy, sell or mortgage it. This Union-level legislation delegatedimportant powers to the republics to pass additional laws on these subjects to provide essential details andmechanisms for the legal process of establishing private land ownership and private peasant farms.

4.3 In January 1991 Armenia decided to implement the first comprehensive land reformprogram in the FSU republics. The decision to move promptly was based on the recognition that theexperience with the traditional Soviet type kolkhoz/sovkhoz system had been a failure, and that focussingon land reform had the potential to yield a rapid supply response, thus increasing the Government'soverall efforts to move to a market economy. The most notable features of the Armenia land reformprogram have been its speed and comprehensiveness. While the reform process has not been free ofimperfections, there is no question that it has far surpassed the efforts in other FSU republics, includingthe Baltic countries.

4.4 The legal basis for land reform and the privatization of collective and state farms isestablished by four laws: (a) The Law on Peasant and Peasant Collective Enterprises (Feb. 20, 1991);(b) The Land Law of the Republic of Armenia (February 20, 1991); (c) The Law on Privatization (June1992); and (d) The Law on Enterprises and Enterprise Ownership (March 24, 1992). Land reform andprivatization were mainly implemented at the village level by local committees formed by the local villagecouncils. The distribution of land ownership rights is guided by four principles:

Priority to village residents. This principle was established with the objective of distributing landfirst to those who have been living continuously in the village and who have the possibility ofdirectly using the land by working on it. Although all village families had a home garden plotpreviously, and many would have undertaken seasonal work on collective farms, only a relativelysmall proportion of the rural population has been permanently engaged in agriculture. Membersof other occupations, for example teachers, construction workers, drivers, etc., were also eligibleto receive land. Former inhabitants of the village and other citizens resident in Armenia havethe right to apply for remaining land after allocations to the village residents if they present

32 Chapter 4

evidence of their willingness to settle in a particular village or farm.

* Quantity of land allocated according to family size. Families with three or fewer membersreceived one unit of land; those with four to six members, two units; and those with seven ormore members, three units. The land tract available for distribution in each village was dividedby the number of entitlements to arrive at the size of a unit for that village. This exercise wasperformed for four categories of land: arable irrigated, arable non-irrigated, perennial crops andmown grassland. Pastures for extensive grazing have not been privatized. Depending on thenumber of units to which they were entitled, each family received units of different categoriesof land. On average, each family received two to four units of land. Each of these units is ina different category and at considerable distance from the other land unit(s) obtained. Theaverage total size of all the land units obtained per family is about 2 ha.

* Location of individual units decided by lottery. After it was determined who would get whatquantity of land in each of the four land categories, the actual location of the land units receivedby each family was decided by lottery.

Land received has to be paidfor. The amount the new owner paid for the plot varied by qualityclass. The price was set at 70% of two years annual "net profit." This net profit is more or lessa net rent to land, as calculated under old measures. The result was a very low price, referredto as a "symbolic" price by officials involved in the process. The new owners took possessionof planted crops, and often the crop revenues from the sale covered the purchase price. The landwas paid for in two installments, each due at the end of subsequent calendar years. For example,the law stated that failure to meet the first payment by the end of 1991 would result in a 0. 1 %penalty per day. Owners failing to make the first payment by July 1, 1993, would forfeit theirland. Few owners lost their land because the nominal price was low, and apparently, theseminimal requirements were not strictly enforced.

4.5 In principle the members of a kolkhoz/sovkhoz had the option of maintaining the previousfarmn structure. Two thirds majority was required to preserve, either fully or in part, the old structure.Only a few cases resulted in the retention of the kolkhoz/sovkhoz structure, the rest were dismantled in1992 and 1993. By mid-1993 most of the sovkhozes had been dismantled and only a few kolkhozcollective farms remained.

4.6 The process of land privatization in Armenia had largely been completed by the end of1993. Of the 800 or so previously existing state and collective farms, less than 70 remain. It is expectedthat these remaining state farms be maintained only for specific purposes such as seed production, animalbreeding centers, etc. Apart from this type of state owned agricultural land, a reserve of about 20% ofthe land in each village tract has been set aside, under the management of the village council, to allowfor future expansion of the village settlement. The remainder has been allocated to local rural familiesfor their own use.

4.7 Official figures on the progress of privatization indicate that 94% of arable land had beenprivatized and 77% of perennial crop land, together with 61% of grassland, had been distributed by theend of 1993 (see Table 4.1). The privatization process was originally scheduled to last 2 years, but theGovernment now proposes that the program be extended for a further 2 years to make amendments toland allocations where necessary (apparently to establish equity) and to privatize further portions of the

Continuation of Land Reform 33

remaining state farms andreserve land. Table 4.1: Privatzaton of Land (July 1994 - 000 ha)

Arable Perennial Mown Pasture Total'4.8 In addition to Crops Grassland

land, the buildings,machinery, and livestock Total Area 445 74 145 688 1352previously owned by Available for 397 68 133 0 598

collectives and privatized privatization

state farms are also being Reserve land 86 7 15 0 107

sold at "symbolic" prices. Arelatively high percentage To be privatized 311 61 118 0 491

(about 50%) of these Already 308 48 74 0 430

privatized assets had been privatized

sold to newly formed % Privatized 99% 79% 63% 0% 88%

collective farms, since many 'Excludes 43,600 ha of kitchen gardensindividuals were not Source: Ministry of Agriculture

interested in or were not inthe position to use big farmbuildings or machinery, or did not have the stables to accommodate livestock. Individual landownersoften established cooperative farms with the aim of demonstrating their capacity to make use of theseassets.

4.9 The privatization of assets, however, is much less advanced than the privatization of land.By early 1993, less than 50% of buildings, machinery and livestock had been sold to the rural populationand new collectives, and only about 25% of buildings and other fixed assets, compared to 87% of theland earmarked for privatization (Table 4.2). The main reason for this discrepancy is that the legalprovisions for the privatization of land are much clearer than for the privatization of assets whichproceeds on an almost trial and error basis.

Table 4.2: Privatzation of Machinery as of January 1994

Tractors Combines Vehicles Planters/Drillers

No. Value No. Value No. Value No. Value (R.I (R.OO) (R. 000) (R.OOO) I °)

Stock as of 12,508 (64,615) 2,245 (18,679) 11,464 (47,949) 2.335 (2,754)Jan. 91

Privatized as 8,077 (39,197) 976 (8,341) 7,823 (28,655) 1,176 (1,368)of Jan. 93

Privatized to 4,679 456 2,357 534Individuals

Privatized to 3,388 456 2,357 534CPFs

Percent 65% 44% 68% 50%Privatized

Source: Ministry of Agriculture

34 Chapter 4

B. EMERGING NEW FARMING STRUCTURE

4.10 The agricultural privatization process has created a population of new settlers on landformerly owned by the state and managed either by the state or the collectives. Experience withirrigation and agriculture practices is therefore often limited. However, with the uncertainties of prices,food availability, and the economic future in general, most families regard their new shareholding as anindispensable asset. As economic stability returns, it is to be expected that significant numbers oflandowners will wish to sell their holdings, or at least rent them out and engage in more familiaroccupations.

Private Farns

4.11 As a result of land reform, individual private farms became the dominant form offarming. Originally about 225,000 private farms were created. Their number has been increasingcontinuously as remaining collective farms disintegrate. In early 1994, there were 294,000 private farmswith holdings averaging less than two ha. Most holdings are fragmented because irrigated and rainfedland, orchards, grassland, and pastures were distributed separately within each village.

4.12 The move to independent private farming has brought substantial changes to ruralpopulations. Formerly most rural inhabitants were employed by institutions that provided stable, regularsalaries. Prices were fixed, the supply of staple goods was generally reliable, and future developmentsappeared predictable. In the transition to free markets, new private farmers have been forced to becomeself-employed, managing their own enterprises to support themselves and their families.

4.13 In response to uncertain economic conditions, farmers have tried to concentrate onproviding a basic supply of staples, particularly wheat and milk. There appears to be a sharp decreasein the use of fertilizers and chemicals. This reflects an attempt by farmers to reduce their costs and risks.Renting machinery for plowing, planting, and harvesting, as well as input procurement and outputmarketing are new challenges for which most farmers are ill prepared. At present, farmers are pullingtogether to share the expense of inputs as well as to combine their expertise. As experience andconfidence rise, these loose associations are likely to give way to independent operations, or once legalframeworks are in place, more structured farmer groups or cooperatives.

4.14 Despite limited experience in private farming, financial returns for private farmerscompare favorably with those of salaried employment. For example, a 3.5 ton yield of wheat would givea net return per hectare considerably in excess of the annual salary for most professional employees.Returns from vegetable and fruit crops are much higher, if they can be sold for cash. However,production costs are two to three times higher for grapes, fruits, and vegetables which incur hightransportation charges for delivery to factory or market. A reduction in the real price by delay inpayment during high inflation however, can easily turn a nominally high return into a real loss. Hencethere are strong incentives to maximize home processing of fruits and vegetables, or in extremecircumstances, leaving the crops in the field.

Continuation of Land Reform 35

Collective Peasant Farms (CPF)

4.15 During the process of agricultural privatization, some 60,000 of the new land ownersdecided to establish organizations which would assist them in the management of land and assets. Someof the so- called collected peasant farms (CPF) were established solely for the purpose of obtaining assetsfrom the privatization of collective and state farms and they usually have a very limited and short-termobjective, i.e. to purchase buildings, machinery or livestock. Many of these assets (e.g. big buildings,combine harvester) could not be subdivided and therefore individual small-scale farmers were notinterested in purchasing them. In other cases, the privatization authorities gave some priority to sellingassets to groups of farmers over individual farmers. These CPFs were established in order to qualify asa priority purchaser. The livestock and asset(s) obtained are either managed on a group basis, or themanagement is left to one or a few group members. Frequently, the leading group member buys outother group members and the CPF is dissolved.

4.16 CPFs have also been established by land owners with the objective of consolidating theland units of several families together, and jointly cultivating this land, raising cattle, or operating assets.The prime motives in establishing the CPFs seems to be the lack of farming experience of many new landowners as well as the small size of the plots and assets obtained. In many instances, land ownerspreferred joining CPFs to leasing out their land because the option of leasing, in its various forms, andthe corresponding contractual arrangements are not yet well known in Armenia. Generally CPFs arequite different from the previous collectives or kolkhozes since the former are voluntary organizations,have a democratically elected leadership, and separate employment from membership.

4.17 Experiences in other countries suggest that cooperative agricultural production is rarelya sustainable form of organization, since, on average, cooperatives are far less efficient than family farmsor commercial farms. Family farming will probably increase in Armenia once a land market evolves andindividuals interested in full time farming can buy or lease additional land. Until that time, however,CPFs might remain an important organizational form for landowners because it allows them to combinetheir resources. In the long run, CPFs are not expected to remain significant players in agriculturalproduction.

4.18 Although there appears to be a general willingness of the new smallholders to assist oneanother and cooperate in farming, marketing, and the shepherding of livestock, the number of CPFs hasalready been declining (from 8,200 as at 1 April 1992 to about 6,000 at the end of 1992) while thenumber of independent peasant farmers rose to nearly 300,000 by the end of 1994.

Outlook for Farming Structure

4.19 The move to independent private farming has brought substantial changes to the ruralpopulation. It is not possible to predict precisely what agricultural structure will emerge after transitionis completed, nor what the mix of larger and smaller enterprises will be, but this is not the key issue.In all probability, over the long termn there will be a mixture of smaller family farms, largercorporate-type farming, and variations of cooperatives and looser associations emerging out of the currentfragmented farming structure. Family farming, as practiced in Western Europe and North America, willemerge fairly slowly. European-style "family farming", even in the longer term, is not the only modelto be considered. In the mountainous ares of Europe, for example, various forms of cooperative, rather

36 Chapter 4

than individual, land use also exists. In fact, fanming structure is rather heterogeneous in most countrieswith private agriculture. The fragmented, manual labor based, subsistence farming will be the mosttypical type of farmring for the foreseeable future. This structure has distinct advantages during thepresent difficult period in Armenia. Low labor costs enable the substitution of labor for purchased inputsthat are now priced higher. The low output of small farms is less susceptible to the vagaries of poorlyfunctioning markets and financial systems, and provides food for their owners and urban relatives andfriends as well. Over the medium and longer term however, land consolidation is absolutely essentialto the development of an efficient agriculture sector. In all cases, the key to creating an efficientstructure is clarity in the definition of ownership rights, the lack of restrictions on use (except forenvironmental regulation), and the efficiency of title and lease transfers to the most efficient farmers.

4.20 The land consolidation process is likely to be slow and will only gain momentum afterthe overall economy begins to grow. Technologies and operational systems such as part-time farming,can be expected to evolve in ways similar to the situation in some European countries. Consolidation ofland ownership units most likely will be negligible in the near future. The moratorium on sales expiredonly recently and neither the market nor credit institutions are sufficiently organized to serve a largevolume of transfers. Furthermore, if the experience of developed market economies is any indicator,only 3-5% of farmland is likely to change hands in any one year. Consolidation of operating units,however, can take place without ownership transfers by active use of leases. The Government shouldfacilitate this process by creating quick and low cost procedures for the transfer of land from sellers tobuyers and promoting lease arrangements. Consolidation should take place through the land markets andby leasing arrangements. Remaining unprivatized reserve land also needs to be used in support ofcreating an efficient farming structure.

4.21 The growth of private farms is expected to evolve gradually from subsistence farming tocommercial oriented farming as farmers gain experience and accumulate capital, and as the input andoutput marketing systems improves. However, even with modest growth in the number of commercialfarms, it can be expected that these farms may run into financial difficulties within the first few years oftheir formation. This will constitute a natural weeding out process and should not be regarded as awaste of resources. More importantly, it should not be considered a reason to expand governmentsubsidization of agriculture in general or to newly emerging farmers in particular. This would only leadto the creation of a new class of inefficient, dependent farmers.

New Role of Village Councils

4.22 Until two years ago, the kolhkozes/sovkhozes held real power in the countryside.Although there were 320 village councils, covering one to three villages each, and these were the localarm of the district administration, they could do very little because they lacked resources. Thus, thekolkhozes and sovkhozes organized public services and amenities, and solved municipal, educational, andcultural problems.

4.23 Under the land privatization provisions, land, cattle and equipment of thekolkhozes/sovkhozes were allocated to the village councils and, together with the local communities, thecouncils have carried out the privatization program. Largely through their role in the distribution of land,but also because they have filled a void left by the dismantling of kolkhoz/sovkhoz farm management,village councils wield considerable authority and economic power. Apart from administering 20% of thetotal land area allocated to the village and controlling the "self-supporting enterprises" operating

Continuation of Land Reforn 37

machinery etc, they may play a key role in organizing input supply, liaising with the local branch of theIrrigation Department and in the collection of water charges.

4.24 By 1992 there were 859 village councils (a council for every settlement of 200 inhabitantsor more). Each village council has an executive committee which is responsible for dealing witheconomic, social and cultural problems under the auspices of higher authorities, including the districtexecutive committee, to which it reports. The executive committee develops and presents current andprospective plans to the council which is then responsible for allotting resources to carry out its decisions.Forty per cent of local taxes (principally the land tax) are allocated to the village councils which alsoreceive revenues from rental of reserve land and other sources. Some village councils have engagedagricultural specialists from the former kolkhozes and sovkhozes from their own funds.

Support to Private Farms

4.25 Supporting private farning should have high priority in designing Government agriculturalpolicies. This is necessary to facilitate the transition to an efficient and productive farming sector. Themost important measures, for promoting viable independent private farms include: (a) development ofa market for land ownership and use rights where individual farms are not be limited as to size, andsystem for private transaction in land; (b) a competitive land mortgage system for financing investments,including purchasing equipment as well as land; (c) a competitive bank credit system for financinginvestment and working capital; (d) development of competitive input and output markets; (e)development of infrastructure, transportation, roads, and public services; and, (f) development of aprivate farm management and technical advisory service and a Government funded western-styleagricultural extension service. These measures are discussed in greater detail later in the report.

C. DEVELOPMENT OF A LAND MARKET

4.26 Emergence of an efficient farming structure can not be expected without any transfer ofownership and use rights. Lease and rent arrangements are equally important to sales. Marketagriculture can not function without a land market, but overall environmental and social objectives (e.g.,zoning regulations) require land market regulation as well. Land registration offices and cadastral surveysare required immediately to facilitate the establishment of the market in which buyers and sellers couldmeet and trade title for land. Development of the land market will permit commercial banks to acceptland as collateral for investment and working capital loans and, hence, provide and essential element inthe development of market based agriculture.

4.27 Land ownership and land market relations need to be based on the following principles:

* property rights in land are secure, open, and protected by law;* property rights in land are available to the majority of people;* system designed for people (users), not the government;* can buy, sell, mortgage, and lease;* ease of use and access to data;* buildings are part of land;* involves banks and finance;

38 Chapter 4

* investment and development based on mortgages; and* involves private professional lawyers, surveyors, land agents, valuers, bankers, and developers.

4.28 The buying and selling of land was liberalized in February 1994 when the three yearmoratorium on land sales expired. A Land Market Action Plan should be progranuned with the followingobjectives:

* to create as soon as possible a modem property registration system to record, display and protectrights to real property;

* record as soon as possible the newly created property rights as well as public rights to realproperty in this system;

* Establish programs and institutions of land markets which will support: (a) the accurate valuationof real property; (b) improvement of information about the supply and demand for land in themarket; (c) land use zoning to guide urban and rural development; (d) preservation of agriculturalland; (e) access to the land market by capital poor families; and, (f) full liberalization of the landmarket.

Land Titling, Cadastre, and Registration

4.29 Delays in Land Titling and Registration. Although the Government's resolve in theprivatization of agricultural land and the pace of its implementation has been commendable, the processis not complete. The privatization of agricultural land will be considered complete when all land parcelsare surveyed and marked, titles prepared, examined, validated, and registered by an authority entrustedto be responsible for land registration. Major constraints in this area are indicated below.

* Slow progress in surveying and preparation of titles. Progress on the surveying of allotmnents hasbeen hindered by resource constraints and a lack of experience in cadastral issues. Although thereappears to be an adequate supply of 'land development specialists" within government agenciesto undertake fieldwork, major constraints are lack of funds for vehicles, petrol, surveyingequipment, computers, marking materials and adequate training. By May 1, 1994, 20,838farmers' holdings (around 84,000 land parcels) had been measured. However, based on actualhectares surveyed, of which 15,863 had been completed by May 1, 1994, the completion figureof surveying work is less than 4%. At the same point in time only 10,859 Certificates of Titlehad been prepared, of which only 460 have been actually issued to farmers. It was forecast thatby the end of September 1994, the total number would be 2,800. If this target was achieved,then this represents less than 1 % of the Certificates of Titles drafted in their present formn, to beissued for the entire program. Clearly, at this rate of progress, the initial five year program isextremely ambitious and unlikely to be achieved without a major injection of additional resourcesand capacity building. The decision of the Armenian Government in September 1994 to speedthis procedure and complete land titling by October 1995 seems to be even more unrealistic givencurrent conditions.

Continuation of Land Reform 39

* Inadequate Procedures. The present procedures being adopted in Arrnenia are deficient and willcause major problems in the future, in two areas in particular. The first involves the completelack of proper land parcel marking. The "land development specialists" have 'surveyed" anddefined the allotments, but no survey marks have been placed. This will eventually lead todisputes as to the exact location of boundaries and will impede the efficient operation of a landmarket, due to the uncertainty of parcel delineation in relation to dimensions indicated on theCertificates of Title. The second deficiency is that each Certificate of Title contains the totalholdings of each farmer. Under a modern land registration system, each land parcel has aseparate Certificate of Title and the transfer of ownership details are recorded on the back of theCertificate of Title and registered. In other words, the modem land registration system is landparcel-based, not owner-based, as is the case in the present approach being used.

* Lack of an Appropriate Institutional Framework. Another major constraint is the absence of anappropriate institutional framework within which a land market could operate. Although theCertificates of Title are being prepared by the Soil and Agrochemistry Institute (SACI), theexamination and validation of proposed sales of land is being undertaken by the notary offices,and the Inventory Board of the Communal Services Department has responsibility for registrationof these transactions. Clearly, under the present arrangements there is significant scope forerrors, omissions, variable standards, and lack of coordination. In terms of other non-agriculturalland parcels in Armenia, the Yerevan Municipal Department of Inventory is responsible forYerevan and the Inventory Board of the Communal Services Department is responsible for landparcels outside of Yerevan. This means that there are three separate agencies all issuingTemporary Certificates of Ownership, which will all eventually prepare separate Certificates ofTitle, and two of these agencies have responsibility for registration of the Certificates of Title andchanges of ownership. With such plethora of uncoordinated agencies, and no central agencyproviding policy direction in land and property issues, it is not possible to establish a modem andefficient land registration system. Such an agency needs to be introduced in Armenia.

* Lack of Land Valuers. In addition to the institutional problems, there are no qualified landvaluers or real estate agents, elements that are necessary for the efficient and effective operationof land markets. There are no courses available to train these professionals. There are legalprofessionals available in Armenia who could perform the necessary contractual agreements andtransfers between parties if it is decided that this work should be performed outside the notaryoffice structure. Although SACI have 35 "valuers", their valuations are based solely on soilproductivity and agricultural yields rather than intrinsic land values that are set by the market andtake into account location, accessibility, infrastructure, adjacent property values, and other"intangibles".

* Lack of Cadastral Experience. Regarding the presence of land surveyors in Armenia, this workhas been performed by "land development specialists" within SACI. The training that thesepeople have received in cadastral matters is limited to the former Soviet Union Cadastre, whichwas primarily based on soil types and agricultural productivity. This aspect would also be aconstraint in the efficient functioning of the land market.

4.30 After February 20, 1994, land obtained during the land reform can be bought and sold,that is, a land market is expected to develop. At present, however, there are serious technical andinstitutional constraints inhibiting land market development. The advantages of a market oriented

40 Chapter 4

economy will be difficult to realize unless dramatic steps are taken to create a modem propertyregistration system by reorganizing, equipping, and training property registration offices to carry outurban and rural property registrations. As time passes, the existing information on who has ownershipand leasehold rights to the land will become out of date. This will limit the marketability of the land,make mortgages difficult to acquire, and in all likelihood increase conflicts over ownership andboundaries. The security of tenure required for the level of investment that the country needs will bedifficult to achieve. Moreover, without a systematic and comprehensive system for incorporating rightsof land changes, the extreme fragmentation of holdings will remain a constraint on the consolidation ofland ownership and thereby reduce the farmers' ability to take advantage of economies of scale.

4.31 Any national land registration system should cater to all land parcels in Armenia. Thisincludes other privatized property such as residential dwellings, dachas, apartments, as well as reservesand State property. The new registration system in Armenia should be:

* uniform throughout the nation, for use with all types of land (e.g., agricultural, urban,residential, and industrial);

* able to deal with all types of tenure (full property rights, use rights, leases), and different typesof parties or owners, whether private citizens or public or private enterprises;

* able to handle single plot or dwelling arrangements, as well as apartment and courtyarddevelopments owned in condominium arrangements or in standard single owner arrangements;

* operate in an agency independent from the fiscal cadastre, as both have different objectives,purpose, priorities, and financial frameworks;

* decentralized and operated in convenient city locations throughout Armenia to provide servicesto property owners; and

* paid for by those who will benefit most from the operation of the system - the property ownersthemselves and those who most use the services on a professional basis - the notaries, and in thefuture, surveyors'.

Transfer of Ownership and Use Rights

4.32 In market exchanges of land, the basic functions of finding land, negotiating contracts,and conveying rights must be performed either by the buyer and seller, or by a third party. For technicalor legal reasons some of the specific actions must be performed by third parties. The present situationin Armenia does not require the establishment of a real estate brokerage organization for agricultural land.The brokerage function will still be done, at least initially, by the buyers and sellers themselves.

4.33 In mature markets, brokerage, appraisal, surveying, legal examination and documentation,insurance and public recording services are performed by specialist organizations. A system of registered

I Based on Aspects of the Lezal Cadastre in Armenia, December 1993. Lynn C. Holstein, US Agency forInternational Development.

Continuation of Land Reform 41

titles performned in the public sector may reduce some (,, ti leqal aiid insurance functions in the privatesector. Indeed, most of the titling and conveyanCcillne fullr.:i ions Could be provided either as a private ora public service. Armenia has an opportunity to ui Lld it .wVII 'tINctture, drawing on the experiences(pluses and minuses) of market economies. Findin il,, ! ,i i,. . conveying functions must be done,but many options are available.

4.34 As the options are considered SOc e VI ue' inust be resolved. The division ofresponsibilities between government and the private sect. li al! is.sue in virtually all functions. Forexample, the government could assume responsibility for reaJr one large, multiple listing service foruse by potential buyers and sellers, or the private sect)Or c(u! 1 J ! .ave a single, cooperative listing service,or each brokerage house could create its own listiL 1 Tr l ith ch e, how are the participants and thepublic best served? One answer is to look at in tiT e' Jii T'n!nbii t h. Those who perform a serviceshould have an incentive to perform well at tlie ii I\ vi "'.A c' t and should also be accountable forits success or failure.

4.35 The following are suggested as initial :;r tions:

* Brokerage. Government involvemnent shouli !. ! iiii,,urm, allowing independent brokers todevelop. At first buyers and sellers imity pr , li brokerage functions. As an interimmeasure, if warranted, government could ix' p.: i ; f available properties. As brokeragedevelops, private brokers should be registered an)d bilei hy the government, thus standardizingthe scope of their activity (national and iHiaCrutf h I J . IC uhiiter, regional in the region served).Private brokers could benefit from a profCs'i, o ' ; i)r ~) idinig education, ethical standards,and market information.

* Appraisal. Both government and the pri' al have important roles in appraisal.Government appraises and assesses land for taxail o I rivate appraisers counsel owners andothers on land values for purchase, sale lease. se t, and financial planning purposes. Aprogram of education and traininig should !V :,'C . or bolh government and private sectorappraisers.

* Surveying. A large body of surveving ful!tioi.. t w 1 with the government because publicworks geodesy and geological surveys, rionn(' iia ain maipping fall into the domain of thepublic sector. Private sector surveyors co .uiX. ;1 , -ivernment through contracts such assurveys for roads and utilities. A new ar a t'ar pr- :: aect wr surveyors would be providingservices to individual landowners, lenders. anid others involx ed in land market transactions. Thetechnical training for government and private secior ,\ o:ill he similar but private surveyors mayneed additional training in managing a Ct::lwrr.! mrlrrise. The Government should havequalification testing and licensing for all sur\ ev K,i Il ln offices, surveyors should file fieldnotes as well as final descriptionis. Suit -c.v ienee monuments and geographiccoordinates, and should be incorporated int1. b!. v; ip pose cadastre.

* Legal counsel and documentation. Sevcrai alt;as of law relevant to holding, transferring andalienating land are obscure and fluid. A revisw T0- l tv.z if property, succession, and contracts,as they pertain to agricultural and per!ial, j-, %a . :i rcwo:i1mended.

42 Chapter 4

* Insurance. While there may be a role for title insurance, a system of registered titles shouldprovide most of the assurance needed for holding, conveying and securing land titles. Amongmeasures to support the land market, title insurance can be given low priority, at least for thetime being.

* Public records and registration. Public offices can support the private land market by providinginformnation on individual parcels and aggregate statistics on prices, rents, taxes, frequency oftransfer, and other measures of the land market. For individual parcels, title registration(recommended above) provides information on the status of rights held with a warrant of quality.Cooperation with real estate professionals would be useful in compiling and reporting land marketinformation.

4.36 The privatization law transferred ownership of agricultural plots of land to famnilies,identified by the head of the household. The head of the household may or may not have been or becomea peasant. Currently, a large proportion of the new owners are farming their own land. However, someinformed estimates place the number of owners who truly qualify as peasant farmers at half of thosehaving received an allotment of land. These other owners may have entered the market just to sell theirland. If buyers have neither the means nor the inclination to buy, leasing may be a way for farmoperators to expand farm size. The lease is a bridge between asset ownership, in this case agriculturalland, and the operation of the farm enterprise.

4.37 Leasing is recognized under current law, and land leased from the state is entered intothe cadastre. A sample lease is included in the privatization law. For leasing to play a significant rolein the private land market, some additional work, public and private, is needed. Educational materialsbased on general principles of shared, fixed, and case leasing should be developed and distributed.Included in the materials should be a treatment of risk. Due to the complexity of setting rents for shareleases, only landlords familiar with farming practices should use them. Rents vary according to acombination of production results and input and commodity prices. Share leases therefore involve higherrisks, and thus, higher long run returns. Cash leases present landlords with the least risk, andconsequently, the lowest long run return. Levels and forms of rent will be determined by the market andby the value of contributions of landlord and tenant.

CHAPTER 5

COMPETITIVE LINKAGES FOR PRIVATIZED AGRICULTURE

5.1 While Armenia has made substantial progress in privatizing land ownership and use, theold supply and procurement institutions, as well as agro-processing, have undergone very little change.Since the size distribution of farms has become much wider and product specialization often narrower,the scope of farm types and their specialized needs has also expanded. The old upstream and downstreaminstitutions have not responded in a flexible way to this diversification of farm needs for two mainreasons. First, as state enterprises they have never been motivated to seek customers. Second, they oftenhold monopolistic positions in their respective lines of activity and therefore do not feel the pressure ofcompetition to improve their product mix, customer coverage, service conditions, or pricing behavior.If the new private nature of primary agricultural production is to be matched by efficient, productivity-increasing upstream and downstream sectors, then the Government must develop and implement acoherent program of privatization, demonopolization, and promotion of competition. These tasks,discussed in this chapter, represent a more complex challenge than the issue posed by land reform.

A. PRODUCTION SERVICES

5.2 The institutional set-up for the supply of agricultural services and inputs is still asorganized under the FSU but the levels of activity are extremely low. The country has very limited localsupplies of inputs, and the state institutions can no longer avail of the FSU allocations, nor can theyimport due to lack of funds. At present there is no entity which is importing agro-chemicals, veterinarydrugs and farm machinery to supply the agricultural sector. The local urea plant was damaged in the1988 earthquake, and has not yet resumed production. There are production facilities for veterinaryproducts and crop chemicals, but these depend to a large extent on imported raw materials. Inconsequence of the blockade, both raw materials and complete inputs are very difficult and expensive toobtain. Even when it is possible to supply inputs, there is limited demand from farmers, who have noaccess to credit and who are practicing largely a subsistence type of production, involving very little orno use of purchased inputs. The agricultural machinery services operated by the State enterprises havealso collapsed, leaving little option to farmers.

5.3 The supply and procurement of agricultural inputs has been almost fully managed by stateowned organizations. Armplodorodie is the parastatal organization under the MOA responsible for supplyof agro-chemicals, including fertilizers and pesticides, down to the farm level. Armplodorodie hasheadquarters in Yerevan, one main supply depot, five regional supply bases, and a distribution facilityin each of the country's 38 rayons. Armplodorodie gives the impression of competence, appears to havewell qualified staff, and has a long experience with distribution of agro-chemicals and chemicals. Itreportedly has adequate storage and transportation capacity. However, the company was not set up toprovide retail distribution services to many small farmers, as now exist. Usage of agricultural chemicalsand fertilizer has fallen since 1991 partly because of reduced purchasing power by new private farmers,but also because Armplodorie has not had sufficient funds and structure to provide adequate retailmarketing to the much larger number of farmers.

5.4 The private sector has not yet started to operate in the area of input supply, even thoughthere are no legal or technical barriers. However, as some agro-chemicals are toxic, the Government hastaken responsibility for developing guidelines for their importation and distribution. Pending the

44 Chapter 5

completion of these rules, private traders are effectively barred from agro-chemical trade even at the retaillevel. Middlemen may not purchase from Armplodorodie and sell to farmers because of the lack ofauthorizing regulations. Clearly, Government must write appropriate implementing regulations to erodeArmplodorodie's monopoly input supply position. Credit should be extended to those private enterprisesattempting to become engaged in input supply. In a competitive environment, these private supplierswould in turn extend credit to private farmers to buy the agricultural inputs.

5.5 The principal institutions dealing with agricultural machinery in Armenia areArmagroservis and Armplodorodie, parastatals which call themselves "structural subdivisions of theMinistry of Agriculture". While the former is more engaged in the supply and maintenance of machines,and the latter more focussed on provision of mechanized soil fertility and crop protection services, bothcompete nowadays for general mechanized field contract work with farms. Similar to Armplodorodiein organization, Armagroservis has a staff of 5,100 (reduced from 6,000), a central workshop and storagecomplex, five inter-rayon material supply units (bases), and branches in all 38 rayons of the country.For repair and maintenance services Armagroservis has repair stations (workshops) in each district whichtake care of the more common repairs of tractors and agricultural machines.

5.6 The dismantling of state and collective farms has created alternative sources of machineryservices for private farmers. Machinery of former state and collective farms has been auctioned to thoseinterested in purchasing them. By February 1994, 50-70% of the collective and state farms' machineryhad been privatized. The remaining machinery and other assets, for which buyers could not be found,were passed on to the village councils. In these cases, machinery is operated by so-called "self-supporting enterprises" formed by members of the machinery brigades of the former state and collectivefarms. Thus, there are three sources of machinery services: the state system described above, the "self-supporting enterprises" under the village councils, and small private firms.

B. AGRO-PROCESSING INDUSTRIES

5.7 The main agro-processing industries in Armenia consist of flour milling and bakeries;wine and brandy production; preserving fruits, jams, vegetables and dairy products; fish farming andprocessing; and mineral water, fruit juices and drinks production. Processing of confectionery, salt, beerand pasta are also carried out on a smaller scale. The entire agro-processing sector is in the hands of thepublic sector. Only recently, in 1993/94, has the Government authorized private entrepreneurs toestablish and operate small-scale processing enterprises by issuing licenses. In mid-1994 over 500 privateprocessing plants were established. Most of them are in the area of alcoholic beverages, canning andbakeries. (See Table 5.1)

5.8 The MOF has control of the milk meat, canning, baking, feed and flour milling, wineries,distillation, other food processing and retailing operations. The Ministry of Agriculture controls far fewerenterprises, and some duplication exists with the types of enterprises controlled by the two Ministries.For example, both have wineries within their jurisdiction. In addition, there are a few enterprises thatare within the influence of the Armenian Consumers Union (HICOOP). Thus, the State dominates theagro-processing sector, appointing the managers of the enterprises, intervening in their managementdecisions, and engendering little concern for profit. Payment for processed goods by state agencies isoften delayed, which hampers enterprises' abilities to settle their debts with suppliers of raw materials.

Competitive Linkages for Privatized Agriculture 45

Attempts to operate parallel to the state supply system are not encouraged, and as a result supplyproblems remain. Sales stagnate and procurement of raw material declines further.

Table 5.1: Private Food Processing Operations (Mid-1994)

District Bread/cakes Milk Meat Macaroni Cannery Non Alcoholic TotalAlcoholic Drinks

Drinks

Yerevan 38/23 5 31 8 116 25 152 398

Echimiadzin 2 --- 3 1 3 --- 45 54

Artashat I 1 --- --- 3 22 27

Hoktemberian I -- --- --- 1 I 1 13

Masis I --- --- --- --- 2 20 23

Noyemberian --- --- --- --- 5 --- 3 8

Hrazdan 4 --- --- --- --- --- 6 10

Ararat 2 --- --- I --- --- 3 6

Nairi 1/1 --- --- I --- 3 1 7

Kamo I --- I --- 2 -- 4

Abovian --- 4 - 4 2 3 13

Total 563

Source: Ministry of Food and Procurement

5.9 All agro-processors are operating below engineered capacity, resulting in high unit costs.There are several reasons for the low capacity utilization of facilities. Although centralized administrationunder the USSR was not efficient, apattern and configuration for thedistribution and flow of products did Table 5.2: Design Capacity and Utilization in Food Processingexist. The break-up of the (1993)

USSrequestedR disrupted normaltSrad uesflow w ichuweed formerly Industry Design Capacity Current Utilizationtrade flows which were formerly (os directed by Moscow. Compoundingthe effects of disrupted inter-republic Meat 88,800 2

trade is the rail and road blockade Mixed Feeds 718,000 less than 10'

imposed by Azerbaijan which affectssupplies, energy fuels, and foodstuffs. Dairy Products 354,900 3

Without sufficient wheat and feed Canning 156,110 9

grains, manufacturing ingredients, Flour Milling 556.500 601and other inputs required byArmenia's agro-industrial enterprises, Bakery 430,000 55 2

the food factories have been unable to FAO Mission estimates as precise figures are not available.

operate at efficient levels of output 2 The utilization is less because small-scale and home bakeries are

(Table 5.2). The canning and emerging rapidly.Source: Ministry of Food and Procurement

46 Chapter 5

wine/distilling sectors are the most important for exports.

C. PRODUCT MARKETING

5.10 The private sector is now the largest source of agricultural output, and private marketersare beginning to account for a substantial share of domestic agricultural trade. Even so, the MOF andFSU type cooperative organizations still dominate the marketing and distribution of agricultural outputsand food products. The MOF is still the largest buyer of grain, milk, meat, and eggs, although farmsand processing enterprises are now entitled to sell their products to any buyer. Flour mnills are directedto sell flour only to state-owned bakeries, since subsidized bread is the Government's main tool of foodsecurity. Processed alcoholic beverages (wine and brandy) are largely for export, and practically alltheir production is sold to the state marketing enterprises. These marketing enterprises then barter withtheir Russian buyers, for canning and other packaging supplies needed by the processors. Because of thefood shortage in the country, food processors sell part of their output to the state at lower prices fordistribution through school lunch programs and other targeted outlets.

5.11 Arnenian Consumer's Union (HICOOP) is a consumers' co-operative. Every Republicwithin the Soviet Union had such an association, which was centrally controlled from Moscow. Sinceindependence HICOOP has continued to operate, in principle as a private organization. It is a verypowerful and well organized institution, with particular influence in the rural areas of Armenia. HICOOPhas 750,000 members, including a workforce of 50,000. Control is theoretically exercised by themembership, through a general assembly held every 5 years. The assembly elects a council, which electsa board and a president. In practice, the president has virtually total control of the activities of theorganization. HICOOP is a member of the world association of co-operatives.

5.12 HICOOP controls at least 3,750 shops and restaurants, 43 procurement offices, 42 foodprocessing enterprises, 7 refrigerated stores and 44 fresh produce markets, of which 11 are in Yerevan.In rural areas HICOOP exercises virtually total control of the local agricultural and food markets.Deciding an appropriate future role for HICOOP presents a major challenge for the Government. Atpresent, it is anti-competitive, and in many respects is identical to a State organization as it has beenbenefiting from privileges provided to similar organizations, e.g. administration of a subsidy on breadand obtaining subsidized credit. GOA has not yet reached a decision regarding the future role ofHICOOP, but it is clear that development of market-based agriculture will be slowed down unless it istreated equally with other private enterprise and left to compete with them. In fact, since the eliminationof Government support in subsidized credit, the procurement of agricultural products by HICOOP hasbeen declining because farmers are requesting better prices and immediate payment.

5.13 Constraints on Alternative Marketing Channels. Procurement of agricultural output bystate and cooperative organizations dropped steadily from 1990 to 1993 for all commodities except grainand melons (Table 5.3). More output is being marketed privately and consumed on-farm. Still, privatemarketing has yet to develop a modern marketing infrastructure. Often, the only alternative to receivingdepressed state procurement prices is for farmers to market their products themselves, since privatemarketing enterprises are few and conmmodity exchanges for agricultural products do not yet exist. Asmany farmers do not have the transportation or managerial expertise to market their products, transactionscosts are high and some reliance on the state marketing enterprises is perpetuated.

Competitive Linkages for Privatized Agriculture 47

5.14 Food Retail and WholesaleDistribution. A key factor that needs to be Table 5.3: Farm Output Sold to State Processing Enterprisesaddressed is the role of the old fashioned in 1993cooperatives in food retail and wholesale Connodity Total Output Quantity Percentagedistribution. Clearly in Western Europe, in 1993 Sold to State Sold to State

organizing small retailers and stimulating (tons) (tons)

wholesalers has resulted in the logisticaladvantages of buying in bulk and cost Grain 315,700 31,900 10.1

effective transport to cooperative/private Potatoes 414,000 5,100 1.2

warehouses, thus resulting in lower cost Grapes 135,000 48,7W 36.1and fresher foods. This mechanism, called"logistical alliances", pulls more fresh and Fruits 491,000 18,300 3.7

processed foods from contract farmers who Vegetables 409,600 5,600 1.4

have to achieve a certain quality standard, Source: Ministry of Agriculture

and very often produce crop or livestockvarieties chosen by the buyer, in order fortheir goods to be purchased. In some cases, the entire package of inputs, including seeds, pesticides,herbicide, and fertilizer are determined by the contract.

5.15 It appears the Government is planning the privatization of retail distribution andwarehouses. In other developing countries, private and small retail stores alone are not improvementenough to facilitate marketing efficiency. Often the fragmented and inefficient structures in both state-owned and independent food shops represent an almost insurmountable and high cost marketing problemfor most primary and secondary food producers and processors. Whether it is a monopolizedGovernment or state distribution system, or a fragmented system, the results vis-a-vis food prices are thesame. To privatize the existing physical distribution facilities and retail units without assistance to thedistribution subsector is to do the country a disservice.

5.16 A practical solution, used with fragmented food distributors in Western Europe, is toestablish volume-based private sector chains of food distribution. This can also take the form of aconsumer co-op chain where both consumers and producers band together. Another example is the typeof large chain stores found in the US, which because of their volume purchasing and distribution, cansell food at prices 10% to 20% below that of independent food shops.

5.17 Most of the state- or cooperative-owned food outlets are small. A large percentage ofthem could be remodeled, modernized, and operated with a credit system that was tailored to thesesmaller operations. Ideally, they should be privatized in groups large enough to maintain their owndistribution centers, enabling them to purchase fresh and processed foods in volume, operate under onechain name, reduce food prices, and maximize the profit return on capital investment. These groupswould compete with each other, and through economies of scale, reduce food prices to consumers,provide volume-based marketing outlets for primary agricultural producers and processors, and maximizetheir return on capital.

5.18 Efficient wholesale marketing also will require construction of a network of easilyaccessible points of delivery; improving the grading of agricultural products; defining efficientstandardized marketing rules (with settlement procedures in case of dispute, agreement of inspections,etc.) between professionals (traders, cooperatives, processing industries); facilitating access to forwardand future trading; improving access to international market information (long term agreement with

48 Chapter 5

international companies would provide access to international market information and to electronic tradingof agricultural commodities); and training executives in agricultural and food marketing.

5.19 Emergence of wholesale marketing could be accelerated by subdividing state-ownedmarketing enterprises, the Armenian Consumer Union, and processing monopolies. Private farmers'markets currently provide limited opportunities for marketing. Government assistance and promotion arecritical for creating a wholesaling network aimed at strengthening links to private and personal plotfarming. In the medium-term, the market infrastructure must be expanded to include auction halls,regional cooperative packing and grading facilities, and transportation equipment rental outlets.

5.20 One of the important vehicles to foster trade and stimulate production in a marketeconomy is the commodity exchange, since it promotes the extension of private marketing activity ininput supply and output procurement and the development of competitive markets. As the amounts ofagricultural inputs and grains and livestock products traded outside the state system are currently quitelimited, the formnation of commodity exchanges has not yet been possible. Consequently, commodityexchanges should be fostered and accorded the same juridical and fiscal treatment as other privateenterprises. Such exchanges need rules and regulations and supervision. This includes clearingprocedures to ensure contract enforcement (delivery and payment), and the regulations which deal withthe potential manipulation of the market. Government should provide assistance to marketingprofessionals to develop these rules and make infrastructure and physical equipment available forexpansion of commodity exchanges.

D. DEVELOPING A COMPETITIVE SUPPORT AND PROCESSING SYSTEM

5.21 The development of more efficient, competitive services, better attuned to the needs ofprivate farming, and a market-oriented processing and retailing system in food and agriculture will requirea strategy involving organizational, institutional, legal, and regulatory changes. Contrary to privatizationin primary agriculture the restructuring and privatization of support services to agriculture and of agro-processing industries has been delayed. The rapid privatization in these areas is critical to the successof the transition in food and agriculture. State-owned enterprises must first be made to feel independentof the Ministries, which up to the present have appointed the enterprises' managers and intervened intheir important business decisions. The first step is for the Ministries to stop centralizing an excessiveshare of enterprise profits, a practice which has made enterprises dependent on the Ministries forinvestment funds. In tandem with this, the practice of cost-based pricing with Government-sanctionedfixed profit margins must be fully eliminated. These and other measures described below will accomplishthe commercialization of state-owned firms.

5.22 The other changes which will catalyze the development of a market system in theagricultural and food sector involve the demonopolization and privatization of state enterprises. First,the privatization of the remaining small scale retail food outlets must be effected by auction, tender, orbuyout. Second, a timetable for demonopolization and privatization of the large state enterprises andtrade monopolies that now dominate processing, input supply, and wholesale trade must be established.To develop the institutional rules to which enterprises will be subject, a supporting legal and regulatoryframework encompassing anti-monopoly regulations, competition policies, property law, and contractenforcement must also be established by the Government. In addition to setting up the new legalframework, the Government's main responsibility will be the provision of essential supporting services,notably price and market information, technical assistance and training services, and financial services

Competitive Linkages for Privatized Agriculture 49

to assist in establishing new businesses. The Government will also be charged with setting foodinspection and sanitary standards.

Commercialization-Demonopolization

5.23 Commercialization of state processing and trade organizations is an essential first steptoward a competitive market and privatization. This requires immnediately increasing the autonomy ofthe state-owned enterprises by separating the company management functions from state interferencethrough creation of corporate entities (e.g. joint stock companies) and by changing procedures for theselection of boards of directors and enterprise managers under corporate legislation. The Governmentcan also improve enterprise performance by revising labor legislation to improve flexibility in theemployment of staff and compensation and by providing management training for enterprise directors andmanagers.

5.24 Providing more autonomy for operation of state enterprises means ending Government'spractice of siphoning off profits from successful firmns and underwriting unprofitable units within the sameconglomerate (or set of firms under a given Ministry's purview). This would make it easier to identifyand liquidate non-viable enterprises. It would also promote profitable firms' interest in separatingthemselves off from the other vertically or horizontally integrated units in their conglomerate. In turn,these profitable firms will pursue expansion of profitable lines of activity and establish new connectionsto suppliers and customers via the market. Fostering greater attention to profit among state enterprisescan also be pursued by creating hard budget constraints and access to finance on commercial terms only.It has to be noted, however, that allowing distribution between profitable and unprofitable firms can serveas a basis for liquidation when prices are liberalized and there are not any substantial distortions.

5.25 In order to accurately measure profitability, modern systems of accounting and auditingneed to be adopted. Public enterprises not yet privatized nor subject to immediate privatization shouldbe made to apply one of these new systems as soon as possible. Private enterprises should also beobliged to conform to the new system because their tax liability should be determined on the basis ofstandard accounting practices governing all enterprises. The application of key accounting concepts andasset revaluation procedures will increase firms' awareness of the magnitude of their assets' depreciationin current prices, reduce taxes on profits, and guarantee that all taxpayers are treated identically. It willalso facilitate a market oriented production system and product development which will increase netprofits at the firms' disposal and bolster their reliance on the market, further imposing the hard budgetconstraint.

5.26 Enterprises should be relieved of most of their present social functions. Social security,such as medical coverage, insurance, pensions, and housing should not be a consequence of anemployment contract. Dwellings, therefore, should be separated from the enterprise' assets portfolio andbe distributed in full ownership to their occupants.

5.27 Housing first should be transferred to the municipalities which then would implement andmanage the privatization process. This arrangement has the advantage of preserving the coherence of theownership distribution in the same local area. The legislation for privatizing housing stock (includingthat which was owned by state-owned enterprises) was passed by the Armenian parliament on June 6,1993. This legislation allows for sitting tenants to take ownership of their units effectively free of charge(i.e., with only a nominal fee linked to the size of the unit). A two year period is allowed for filing such

50 Chapter 5

applications, after which ownership reverts to the municipalities. In its Letter of Intent, prepared in May1993, the Government committed itself to implementing the Privatization Act fully during 1994.

5.28 Giving ownership to the occupants does not solve the problem of manpower mobilitywhich might be of paramount importance in a transition economy. the establishment of a housing marketwhere all the restrictions on sales, rental, and leasing arrangements should be lifted (or on newconstruction) is necessary for the smooth transition to privatization in the agricultural sector.

5.29 In tandem with enterprise commercialization, actions to demonopolize the input supply,marketing, processing, and retailing sectors must be taken to address the bulk of the system (the grain,meat, and dairy product sectors) which continues to be heavily monopolized. Large "agrokombinats" andall other monopolies and monopsonies should be broken down into smaller concerns to promotecompetition. These break-ups should be done along both product and regional lines, with the end resultbeing local enterprises functioning as individual profit centers capable of, and allowed to, operateindependently.

5.30 Promotion of small scale enterprises should be encouraged to generate competition withlarge state enterprises. Very efficient small scale processing facilities are available to enable theestablishment of such small companies, such as small milk and cheese plants with 10 tons of milkrequired per batch (from Latvia), jam and preserve manufacturing, flour milling, or specialty meatprocessing. Organizations representing small-scale farmners should be encouraged to become proficientin providing the leadership for such investments by small farmers' cooperatives.

Privatization

5.31 The entire agribusiness subsector, and particularly those parts most important to farmers,such as product marketing and processing, transport, services, and input supply, should be privatized.Though there are many ways in which privatization in processing, distribution and input supply could beeffected, certain objectives should govern privatization. First and foremost is the improvement ofenterprise efficiency by creating an active market and avoiding situations where any one firm orinstitution has a majority of the market. In doing so, the process must be implemented as rapidly aspossible since present inefficiencies result in higher prices to consumers and low prices at the farm level,and/or state subsidies from the budget via direct or indirect channels. In addition, there is the goal ofequity, which as a public good, will increase support for the overall reform process.

5.32 Current Modes of Privatization. The first wave of enterprise privatization in Armeniatook place with an inadequate legal framework. For this reason, and because of rising opposition toreform from vested interests and the population at large as the economic crisis deepened, the privatizationprocess slowed significantly and just began to regain momentum in 1994. In June 1992, the law on"Privatization and Denationalization of State Enterprises and Unfinished Construction" was approved.In January 1994, Parliament adopted a privatization program for 1994 providing for the privatization ofabout 5000 entities through a combination of voucher and cash sales, and more detailed implementingregulation have since been approved. This programn is estimated to represent approximately 35% ofproductive assets owned by the state, and is envisaged as the first stage of a process to privatize all but

Competitive Linkages for Privatized Agriculture 51

a few "strategic' enterprises, which is expected to last through the end of 1997'.

5.33 Two main institutions are responsible for implementing privatization in Armenia, underthe supervision of the Ministry of Economy. The Privatization Commission, which is govemed by a 20member-board (10 appointed by Parliament and 10 by the President) drafts the relevant legal framework,selects enterprises for privatization, and determines the timing and methods of privatization. ThePrivatization Board, which is under the direct control of the Govemrnment, implements the program.

5.34 The implementation of the privatization program has accelerated since the summer of1994. By November 1994, more that 100 small-scale enterprises had been privatized, and over 800additional small enterprises were in the pipeline. The employees of small enterprises have the first optionto purchase the enterprise or if they fail to pay the first instalment, the enterprise is offered for sale byauction. Privatization of the 5,000 small-scale enterprises owned by the state is scheduled to becompleted by mid-1996 (approximately 2,000 of these enterprises are leased to their employees). In1994, some 160 food processing enterprises controlled by MOF are scheduled to be privatized. TheMOA has also selected some 190 enterprises to privatize by early 1995.

5.35 Voucher distribution commenced in October 1994 and is expected to last four months.The vouchers, available to all Armenian citizens at a nominal fee, have an announced value of 10,000drams (equivalent to about US $25), and will be revalued every three months in line with the consumerprice index. vouchers are freely tradeable. The total nominal value of the vouchers currently beingdistributed is equal to 30% of the assessed value of the assets in the privatization program.

5.36 Development of the regulatory framework and infrastructure for mass privatization isaccelerating. Approximately 900 medium- and large-scale enterprises are to be privatized in 1995.About 160 agro-processing enterprises under the MOF and MOA are included in this program. Themajority of these enterprises also form part of a program to convert 1,100 industrial enterprises into joint-stock companies in which the employees receive 20% of the shares free of charge. For all the enterprisesin the mass privatization program, the state will sell 100% of its shares. Fifty percent of those shareswill be sold by auction for vouchers. Subsequently 20% of the shares will be offered to the employeesat the price established in the voucher auction, and the remainder will be offered by auction for cash.2However, if the Privatization Commission considers the enterprise to be of interest to strategic investors,it can be sold by competitive tender rather than by auction. The first auction of medium- and large-scaleenterprises is scheduled for March 1, 1995. The first tender (of the majority shareholding in 10enterprises) is to take place by June 1, 1995. A massive public relations campaign to promoteprivatization is now underway.

5.37 Investment funds are beginning to form and licensing regulations will be adopted by mid-December 1995. According to the Investment Fund Law, funds can own up to 40% of the shares of anygiven enterprise. The funds are therefore expected to play a valuable role in corporate governance aswell as in capital market development and in allowing the population to diversify risk.

The 'strategic category is understood to include certain transport, anrnaments, and energy enterprises.

2 Auctions are subject to a reserve price equal to 50% of the assessed value of the enterprise. If an auction fails toreach this price, it is cancelled and a new auction is held with a lower reserve price. If this price is also not attained, theenterprise is liquidated.

52 Chapter 5

5.38 More generally, privatization, as well as continued advances in the private sector and thegrowth of the financial sector. will cmtnLhuto to the development of capital markets in Armenia.Trading of shares of privatized cormpfanies vA ti he faJcitiated through the creation of secondary markets.To facilitate trading, the Government will dehalL .ini implement a share registry system by April 1, 1995.In addition, the Government will esrahli .h incA wnith regulatory power, investigative authority andenforcement powers which will be resp n r Le>gulating and supervising the capital markets.

5.39 Privatization of Agriculti,all SCrvice antd Marketing Organizations. The reduction ofconcentrated marketing power in inpw IIj i lk <](lUld he accentuated by the commercialization andprivatization of Armagroservis and( Am 1 1> l , ic., their removal from Ministry of Agriculturecontrol and the establishment as indeo1nom ntirpri\es operated by managers accountable to aboard ofdirectors. Their day-to-day activitiCS, HJ .('in- imporuttion and pricing should be removed fromministerial interference. These niatih'noll ! iiould also be broken up into rayon-level businessesoperating independently anrd reliant IJI; utin:i.Wiil resuilts for working capital. In the overallscope of thecountry's privatmltioat i r 1, > . . icvel enterprises couldbe eventuallytransferredfrom state ownership into private hlti -N.u tir t ,tep, existing supply organizations could bedemonopolized by having each regioiaa'I Ilwia> .;i an independent business without any territorialconstraints on sales. New cooperative> , -. n the reorganization of the kolkhoz/sovkhoz sectorcan also become specialized input tlupplj! '- u ' i r tern, private firms, including some foreignones, will become more involvWd if ILt :C 1 J c:, Lire r taken to liberalize domestic and foreigntrade.

5.40 The situation witl, r>p.4i 'l't )(PI is conifused. The organization is officiallyregarded as private. Hlowever, itS I.' lx tc 1,t totally coiimmiiercial, and it is essential that in all

areas of activity there should be free n1 It lI t1IYt Ih r other enlterprises to compete. In the future it islikely that the influence of HIICOOP Lk !I 1c lirie if competitive forces are allowed to operate. GOAshould encourage the development 1 of',-i .ia enterprises in areas such as bakeries and other agro-industries, particularly in the regions, v,ni ih v aduld co(mpete with the commercial activities of HICOOP.The need for competition in the pri 1 fT,.ia tr >li p-roducc mlarkets is also of relevance in this respect,to eliminate any preferential treatmernt 1,1ich 7unlit inhibit competition.

5.41 Related Measures to-Fril i a,l Privatization. The privatization process should besufficiently simple so as to be readily ln'l. l si ,'i.i)(! he; -eneral public. Such an approach will facilitatepublic support. Shares in purchased IT, -r,; ehwuld he tradeable on the open market, which willprovide new owners with transparent owu' 11i.n rgilits. } (reign buyers should be allowed to participatein the privatization as early as possibl. tu r y r:lpresent the largest source of investable funds.

5.42 Though the Ministries zit >ulipc to prepare enterprises under their jurisdiction forprivatization, the enterprises should hu 2cq ajrn- nwd encouraged to prepare their privatization programsthemselves. This will accelerate entcp- i ,1; nolliv and wean the Ministries from the perception thatthe enterprises belong to them. MinJiJ.J.i- ulri anot he allowed to buy shares in enterprises. Largeinvestments to upgrade enterprises prior to p i% aitl7ation sholuld be avoided: experience indicates that themarket rarely values these upgrade. i I'. i. za n t1,1t imanagers envisioned them.

5.43 Ministries must be disr;.:r 'IT:rim the actual privatization process by transferringownership rights of state enterprises t ILL N iw;iir-ics to the Privatization Board. The Privatization

Competitive Linkages for Privatized Agriculture 53

Board must have fixed, realistic timetables for privatization to proceed. Specific plans need to beformulated, and placed into stages of activities and accomplishments to be realized. Delays inprivatization may result if realistic plans are not made and carried out. The Government should re-examine any plans it may have for retaining enterprises under state ownership merely because suchenterprises may be profitable. While the Government may have a strong national desire to retainenterprises which produce superior products under state ownership, this practice should be avoided,especially for those enterprises producing exportable goods.

5.44 Experience in Central and East European countries indicates that foreign participation inprivatization of food processing and distribution could substantially speed up the creation of a competitivesector. However, foreign investors in general require majority ownership or at least a decisive role inthe management of operations and much more freedom in marketing and currency transactions than thosewhich Armenia can offer at present. Efforts should be made to remove those obstacles, because the quickrehabilitation of agroprocessing and marketing cannot be envisaged without considerable foreignparticipation.

5.45 In retailing, wholesaling and processing, some actions can be initiated by the Governmentwithout waiting for formal announcement of the privatization guidelines. Privatization and entry into foodretailing could be promoted by acceleration of auctions and tender instruments, the quick sale of state andmunicipally owned food shops to the present managers and workers, without restriction on resale or sub-letting to interested third parties, and provision of finance to small private food retailers for workingcapital and improvement of facilities (within the limits of national credit policy). Existing regulationsshould be strengthened to allow "fast track" privatization of small enterprises, such as state-owned retailshops or workshops, and to permit transfer of small properties to district or local governments forprivatization by auction.

E. FINANCIAL SERVICES

Financial Institutions

5.46 The Armenian State Commercial Joint-Stock Agrobank (Armagrobank), or Agrobank forshort, is the predominant bank lending to agriculture. Agrobank was incorporated in November 30, 1991out of its predecessor which was the Armenian branch of Soviet AgroPromBank. It was established asa joint stock company, and on January 1, 1994 became a full service, comercially oriented financialinstitution with a new management and board. Set at Dram 157 million, its capital is currently in theprocess of being raised. As of July 1, 1994, approximately 2,100 shares were sold, yielding Dram 77million, or about US $200,000. This amount is held by the the Government (35%), state enterprises(35%), employees (10%), and private individuals (20%). The bank expects the capital to be fullysubscribed by April 1995. Whereas the Government's share cannot exceed 35%, private individuals andemployees shares can - and is expected to increase as State Enterprise shares change hands by April 1995.

5.47 Until 1993, Armagrobank's accounts were kept under the Soviet accounting system.Accordingly, no profit and loss statements were produced. Financed under EU/TACIS, however,consultants from "Credit Agricole de France" are in the process of helping the bank establish Westernaccounting procedures and internationally accepted formats for balance sheets and profit and lossaccounts. Also, the bank is currently in the process of converting its unit of account from the Ruble to

54 Chapter 5

the Dram. As of January 1, 1994, Armagrobank's sunmmarized Balance Sheet, as established by theconsultants is indicated in Table 5.4.

Table 5.4: Armagrobank Balance Sheet(February 1, 1994)

ASSETS (R '000) LLBILITIES (R '000)

Cash in Local Currency 18,660 Equity 2,690

Cash in Foreign Currency 480 Loans from Banks 150

Short and Long Term 6,740 Client Accounts 15,378Loans

Securities - Investments/Deposits 16

Fixed Assets 1,195 Accumulated Income 1,953

Deferred Income 1,575 Other Liabilities 117,383

Other Assets 108,920

Total Assets 137,570 Total Liabilities 137,570Source: Armagrobank/ Credit Agricole

5.48 If "other assets and liabilities", which account for as much as 80% of the balance sheet,are excluded, total assets and liabilities amount to R 20 billion, which at mid-October 1994 exchangerates, was equivalent to about US $6.7 million. Other assets and liabilities consist largely in cross debtswith the Government and State Enterprises, and these are being looked at by Credit Agricole and aGovernment commission with a view to writing them off. The bulk of the remaining assets still consistof short-term loans to State Enterprises, just as the liability "clients" represent the deposits of StateEnterprises. Obviously private sector activities are a small percentage of Armagrobank's portfolio atpresent.

5.49 Deposits are almost entirely current accounts of enterprises. The bank pays annualinterest of 20 % on deposits for three months, 25 % for six months and 35 % for one year. Lending ratesare highly negative considering an inflation rate of over 1000% during the past year. Lending rates arelower than other banks. For agricultural loans, the annual interest rate is 60%, for non-agricultural stateenterprises 84%, and for non-agricultural private borrowers and shareholders 108%. The Agrobankobtains advances from the central bank at 30% and is limited to an interest rate spread of 4%. Arrearsare surprisingly low, amounting to about 6% of the loan portfolio. It was, however, reported that rollingover of loans is common practice.

5.50 The bank's charter states that 70% of its lending should be for agricultural development.The Banking Law allows the bank to lend 20 times its capital. The lending of the bank is primarily forshort-term credit consisting of 90% of loan portfolios. Long-term loans account for the remaining 10 %.About 68 % of the total loans are heavily concentrated in state enterprises such as agricultural enterprisesunder the Ministry of Agriculture, agro-processing enterprises under the Ministry of Food andProcurement, consumers cooperatives under the control of the Government, and enterprises under theMinistries of Construction and Light Industry. The remaining 32% are lent to private farmers,

Competitive Linkages for Privatized Agriculture 55

collectives, cooperatives and other non-state enterprises.

5.51 The staff of branches practice some form of loan assessment. The purpose of loans,profitability and repayment capacity are considered. Land titles and other assets are required to guaranteeloans. For those who have no collateral to offer, the guarantee of the state enterprise is required.Agrobank has provided training to the technical staff of branches over the past year. Loan recovery isnot yet a problem but it is expected to become more critical in the future.

5.52 Armeconombank. The Armenian State Commercial Bank for Economic Development(Armeconombank) is a joint-stock company. This bank does not serve farmers, its clients are commercialenterprises and light industries such as the food processing industries under HICOOP. It keeps accountsfor the enterprises under control of the Ministry of Food and Procurement and holds outstanding loansto brandy factories and wineries (for Dram 100 million or US $260,000), as well as to dairy and meatprocessing kombinats. As of September 1, 1994, it had a paid-up capital of only Dram 9 million (US$23,000), but its management envisaged that this will be increased up to US $400,000 in the near futurewhile the Bank's reserves will rise to 10 times the amount of pre-paid capital. The capital is held by theGovernment (35%), state enterprises (35%), employees (10%), and private individuals (20%).Armeconombank has a network of 23 branches, eight of which are located in Yerevan. Total staffamount to 900 employees. The bank has begun commercial relations with several foreign banks, i.e.,the Banque Nationale de Paris, Westminster Bank, Rics Bank, the Bank of China, and several Bulgarianand Russian banks.

5.53 Commercial Banks. Since the banking sector is highly segmented, very little financingfor agriculture is provided by state banks and the new private commercial banks. The State Industrialand Construction Bank, which is the largest bank, lends no more than 1% of its loan portfolio toagriculture. Armimpexbank was established in 1992 and is now one of the leading commnercial banks inthe country. While the new private commercial banks may be more inclined to lend to agriculture, theamount of loans these banks may provide would not make any significant impact on the availability ofcredit to agriculture. Cooperative banks are also undercapitalized and their operation is oriented tocommercial lending in the urban areas.

Directed Credit

5.54 Because of the need to sustain operations of critical state enterprises and to support thenewly privatized farms, the government has launched special subsidized credit programs for agriculture.Agricultural credit has been targeted towards state enterprises as well as collective farms. Credit tofarmers in the western sense does not exist. Farmers simply are debited by the administering banks forthe amount of inputs Armplodoride and Armagroservice were providing. To illustrate, as late as 1993the Government was allocated R 209 billion in credit from Russia supposedly destined for the privatesector. Of that, MOA obtained R 19.2 billion to be utilized as follows: (a) 11.8 billion to smallholdersand collective farms to finance input supplies; (b) 6.2 billion to state farms mostly to finance inputs andworking capital; and (c) 1.2 billion to agroprocessing.

5.55 Although exact figures are not available, MOA indicates that out of R 11.8 billion, R 7.5billion was distributed to the 37 district councils to be passed on to a total of 10,511 farmers (selectioncriteria unknown) at annual interest rates of 20%. The lines of credit were managed by Armnagrobankand recovery rates are said to be good. This type of "credit" is not really appreciated by farmers as

56 Chapter S

they had to open an Armagrobank account at a hefty fee as a prerequisite to being eligible under theprogram.

5.56 In 1994 the Government instructed the CBA to provide out of its resources Dram 175.5million to Armagrobank for credit to farmers for spring planting, and Dram 50 million for workingcapital for the State enterprises. Again initiated by Agricultural Departments at district level, about2,536 farmers nationwide applied and obtained credit at 15% monthly interest rates. Those credits arerepayable between October and December. The nature of these transactions varies greatly with somefarmers obtaining the credit in cash, others in kind - again in the form for services provided by the state.Repayment reportedly may also occur either in kind (mostly wheat) or in cash.

Agricultural Cooperative Bank

5.57 There is a complete absence of local level savings and credit societies which couldgenerate rural deposits and provide for the household credit needs of members. The only financialinstitution providing deposit services to the rural areas is the State Savings Bank with its extensive branchnetwork. But because of the inability of the State Savings Bank to entertain withdrawals of householddeposits, the confidence of the depositing public has been severely eroded. A form of local level savingsorganization owned and controlled by its members would contribute greatly to the mobilization of ruraldeposits. There are no provisions of law which would allow the registration of credit unions or savingscooperatives. There is also no government entity which could be responsible for the supervision of theseinstitutions.

5.58 The Agricultural Cooperative Bank is a new "farmer's bank" that is currently beingdeveloped with the help of EU financed technical assistance (Credit Agricole de France). The concepthas been developed along the lines of the local credit unions (LCU), based on the principle of mutualism:"one man, one voice", very close to the rural economy, with members playing an active role asshareholders of provincial banks. Seven provincial Cooperative Banks, licensed to perform a full rangeof domestic banking services, managed by professional bankers and reporting to a board of directorselected by the LCUs, are ultimately planned. An apex organization will then be set up to be in chargeof funding and clearing operations in accordance with the CBA, for supervising and auditing of theprovincial Cooperative Banks, for the commercial relations with correspondent banks, and finally, forpolicy guidance.

5.59 At the end of September 1994, an interim director began to recruit a nucleus of localstaff and established a detailed business plan for the first year of operation (1995). Staff have begunstudy tours throughout western europe. This first phase of bank establishment will last until the end of1995. It will further include the creation of small farmer's groups of LCUs with appropriate statutes andgoverning bodies, extensive staff training, creation of the first three provincial Cooperative Banks in theArtashat, Gumri, and Idjevan regions. It is expected that by the end of 1995, the three provincialCooperative Banks will have a total of 20,000 lending operations.

Bank Regulation

5.60 A new banking law was passed in April 27, 1993 to correct the weakness of the presentsystem. This law provides the legal framework of the banking system. It provides the central bank greater

Competitive Linkages for Privatized Agriculture 57

authority to regulate and supervise the operation of commercial banks. The same provision of law wouldapply to all banks including Agrobank and cooperative banks. The minimum paid-up capital requirementwas raised from the present level of R 40 million. Banks are given one year to increase their capital toR 100 million. Mergers and a reduction of the number of commercial banks may be expected.

5.61 In addition to the minimum capital requirement, other regulatory provisions refer to limitson the investment of a single investor (35 % of paid-up), maximum exposure to a single client (not morethat 50% of capital), limits to borrowing by owners of bank (30% of investment), etc. Because the lawwas passed only recently, the National Bank still has to further develop banking regulations. For instance,there is an absence of prudential regulations for provisions for loan losses as this remains at the discretionof the individual banks.

Strengthening the Rural Financial System

5.62 The strategy for the strengthening of the rural financial system may be divided intoseveral time frames. Fiscal means rather than financial instruments should be used to sustain theoperation of state enterprises crucial to the food supply even prior to privatization and to support thenewly established private farms. The short-term approach is to improve on the existing system of ruralfinance to make it a more effective instrument in channeling resources into market oriented businessesand support the major thrust in privatization. The medium term agenda is to introduce financial viabilityinto the existing system as well as develop alternative channels of rural finance to strengthen ruralfinancial intermediation and encourage competition. The long-term goal would be to develop a viablerural financial system as an integral part of the overall financial system.

5.63 Immediate Measures. Because of the high inflation rate, it is not possible for the ruralfinancial system to function properly. Deposits are difficult to mobilize at highly negative rates whileloans would not be acceptable at positive rates. The loan portfolio of banks have been severely erodedso that banks are unable to even maintain the same level of lending in real terms. As previouslydescribed, the government launched a special lending program to meet the immediate needs of theagriculture sector. Until the rate of inflation is contained, and in order to protect the assets of banks frombeing eroded, this mode of financing may be the only alternative for as long as the government is ableto finance this subsidy and it does not fuel inflation.

5.64 Other means of increasing the availability of rural finance should be explored. Inasmuchas agribusiness and agro-processing enterprises are state owned, studies should be made on the feasibilityof banks providing additional equity rather than credit lines to enterprises. This would prevent the realvalue of bank loans from being eroded and would relieve enterprises from incurring large interestpayments. As soon as some measure of macroeconomic stability is attained, banks can liquidate theirshareholdings. The prospective incremental value of equity could compensate for the real costs of funds.It is unclear in the Banking Law if banks are allowed to engage in investment banking.

5.65 Short Term Measures. In the meantime, some initial work can be done in reforming therural financial system. Technical assistance should be provided to Agrobank in auditing, businessplanning, reorganization, credit criteria, lending procedures, accounting systems, etc. Initial work inbusiness strategy planning to cover these aspects would be provided under a short-term EU Commissiontechnical assistance project. Additional assistance on a continuing basis would be needed by Agrobankto improve their system of risk management, enhance automation and strengthen their payments system.

58 Chapter S

5.66 A program to organize local savings and credit societies utilizing private sector volunteersshould be initiated. The legal framework for regulating these societies should be established and thegovernment institution which would supervise these societies should be determined. The feasibility studyfor organizing a national cooperative bank should be completed and a decision reached as to the structureof this institution.

5.67 The creation of a new rural financing institution, totally designed and devoted to servingsmallholders and rural enterprises is proceeding as indicated above, and the Agricultural CooperativeBank (ACBA), will be a universal bank and collection of savings banks organized at village level throughlocal credit unions. The bank will be mainly owned by farmers and other members of the ruralcommunity, governed by them, and managed by professional banking people. The reason for creatinga rural financing institution stems from the realization that farmer's needs are not being met by theexisting institutions.

5.68 Medium-Tern Measures. In the medium term (two to five years), Agrobank shouldaspire to achieve greater independence from government by reducing the equity participation of statecontrolled enterprises and increasing the participation of the private sector. The bank should implementa business plan, increase deposits from rural households, and expand lending to all types of private ruralenterprises. The capital of Agrobank should be increased to at least 10% of risk assets and a policy ofprovisioning based on quality of the loan portfolio should be adopted. Ultimately, the interest rate policyof should be rationalized to ensure that deposit and lending rates are competitive and that interest ratespreads adequately cover the full cost of banks.

5.69 Establishment of savings and credit societies should be continued. A national cooperativebank should eventually be established to serve as the apex bank of savings and credit societies, althoughthese societies should be free to invest in Agrobank or any other bank. Technical assistance to thiscooperative bank could be provided by a management team particularly if financial assistance would beforthcoming during the early stages of development.

F. DEVELOPMENT OF RURAL SERVICE COOPERATIVES (RSC)

5.70 Private control of the commercial system is the most suitable way of supplying inputs andmachinery service. A network of farm supply shops and service firms could be created by privatizingthe existing network and by promoting the establishment of new firms. In Arnenia's current conditions,rural service cooperatives (RSCs) are also expected to gain increasing importance. RSCs should representan alternative to non-cooperative private businesses, and they should be organized on voluntaryparticipation basis. In RSCs landowners cultivate their land individually but combine their resourcesusually for jointly purchasing inputs or marketing their products. Other typical functions of RSCs includeprimary agro-processing, and providing savings and credit facilities to their members. RSCs perform oneor several of these functions. The expected importance of RSCs is based on the following assumptions:

(a) Presently, agro-industry and agribusiness are still almost fully controlled by state-ownedenterprises. Many of these enterprises are expected to be liquidated during the process ofprivatization since they are not viable without continued government subsidies. State-ownedenterprises which continue operations after privatization might significantly reduce theiroperations in the agriculture sector. The net effect of their failure or reducing operations is toleave a significant service gap for agricultural producers.

Competitive Linkages for Privatized Agriculture 59

(b) Part of this gap will be filled by commercial traders and entrepreneurs. However, experiencein other economies in transition indicates that initially private sector players are very selectiveand choose mainly low risk and highly profitable operations. The remaining service gap can onlybe filled by farmers establishing their own organizations. The biggest need for RSCs will be forless profitable activities (e.g. services to small-scale farmers) and for the provision of servicesin remote regions. In addition, farmers might want to establish RSCs to compete with otherprivate sector players.

5.71 Inasmuch as the development of the private sector is supported by tax breaks, technicalassistance and other measures, the same level of support should be extended to cooperatives with the aimof establishing a level playing field for all market participants. In view of the importance of agriculturalproduction, the Government might want to provide general support to the initial development of RSCsin parallel with other private sector support measures and the privatization of state-owned enterprises.

5.72 The development of RSCs in Armenia requires the development of a legal and policyenvironment conducive to the establishment and operation of these organizations. In most countries thelegal environment for RSCs mainly consists of a cooperative law. Armenia does not have such a law,and therefore, the Government should initiate the process of drafting a cooperative law and presentingit to Parliament. Such a law should define cooperatives as part of the private sector, owned by and doingbusiness with members, and managed entirely by their democratically elected representatives andappointed professionals. In addition to these generally accepted principles of genuine cooperatives, acooperative law needs to design a few additional structural elements by choosing, from the variouscooperative models operating successfully in Western countries, the options that best suit the Armenianconditions and requirements. Such structural elements include registration of cooperatives, supervisoryand management bodies, as well as audit requirements.

5.73 With the aim of facilitating, as early as possible, the development of RSCs, the presentlegal vacuum should be filled by a policy declaration on cooperative development possibly issued as astatement of the Council of Ministers. This declaration should commence with a definition of a genuinecooperative and provide guidance on: (a) how existing cooperatives can restructure themselves intogenuine member-based organizations or be transformed into capital-based organizations; and (b) providethe basis for establishing a cooperative support organization (CSO).

5.74 Such a CSO is proposed to "jump start" the development of RSCs in Armenia. Inwestern countries RSCs slowly developed over several decades by their members and leaders testingvarious models through a trial and error process. Armenia can avoid repeating such a lengthy processby drawing on the relevant lessons learned in other countries. The experiences gained in other countriesshould be provided through technical assistance to farmers interested in organizing RSCs or similarorganizations.

5.75 The proposed CSO could assist farmers in organizing groups for: the joint supply ofinputs and credit and for the joint marketing of agricultural products; support to farmer groups who areinterested in the evolution of their group activities into formal cooperative organizations, providing morecomprehensive services on a more permanent and professional basis; and, advise and support to formalcooperatives in their institutional development. Donor grant funding could likely be obtained forfinancing technical assistance. The CSO should have an interim mandate only until the time apexorganizations established by evolving farmers organizations and cooperatives can provide similar services,and thus replace the CSO.

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G. NEED FOR EXTENSION SERVICE

5.76 Agricultural extension services are just being introduced and are very limited. Technicaladvice was formerly provided by specialists based on the State and collective farms. Many of thesespecialists are now unemployed or underemployed. Following the land reform and the creation ofprivate farmers, the need for extension was felt and an Extension Division (ED) was established in 1992within the MOA. The ED in 1994 employed about 170 staff and covers 20 districts. Services providedby the ED include soil testing, seeding norms, pest management, fertilization and fruit tree management.Apart from meeting with farmers, the Division uses mass media to reach and teach farmers. The ED iscurrently working under severe constraints posed by lack of vehicles, operating funds, office and audiovisual equipment and material. Unless these difficulties are addressed, the impact of extension willcontinue to be limited. The USDA is now assisting the MOA to introduce and operate the extensionservice in some districts as part of a 3 year program of development. This is designed to form the basisof a notional service. The assistance now consists of 6 expatriate agents working in close liaison withlocal advisors for six months in 12 districts throughout Armenia during the main growing season. Theprogram started in 1993, and is expected to continue until 1996. Although some training is provided bythe USDA, this is limited compared to the vast need.

5.77 There is an ample pool of qualified staff in the country from which extension agents canbe recruited. Government is now in the process of finalizing extension concepts and design. Cost-effectiveness and lowest possible recurrent cost requirements are, correctly, Government's key concern.One extension center for several rayons, closeness to research and training facilities, and mass mediautilization are thus major factors for determining most desirable size and location of the service. Efficientresearch linkages need to be elaborated; and, most important, a high degree of independence of theservice will need to be guaranteed to obtain farmers' interest and confidence in the service. It is highlydesirable that USDA continue its support to the service. Because of extension's importance to privatefarming development, other development agencies should also be approached by the Government toprovide technical assistance, transport facilities, and other relevant equipment for agricultural extension.

5.78 While an extension service may not be in place that would operate effectively under openmarket conditions, there are assets in place that can be usefully built upon, i.e. especially the relativelywell trained professionals in a number of technical areas of importance to Armenian agriculture.However, information to farmers to a large degree continues to be seen as adjunct and supportive to thestate guided production system. With the move to privatization and a market economy, the currentsystem in place for managing agricultural information is not workable nor financially sustainable. Thebreakdown of the state ordering system and the independence of agricultural producers are giving riseto new demands for agricultural information that did not exist a few years ago.

5.79 Information resources are as important as the classical resources of land, labor andcapital. Restructuring, government interventions in agriculture, and the privatization of agriculture, giveimportance to the development and management of information resources for agriculture. Informationis needed by farmers on a wide range of topics including: new technology, such as new varieties, smallscale machinery; best practices developed by farmers themselves; market and price information; practicalon-farm principles, such as mixing feed ratios; and farm management.

5.80 An improved and re-oriented extension service should be based on the following mainprinciples: (a) the delivery system for advice should be cost effective and competitive; (b) the service

Competitive Linkages for Privatized Agriculture 61

should be demand driven by the potential customers; (c) to reach small scale farmers, extension groupsneed to be established, and the extension service has to work with farmers' organizations andcooperatives; (d) Government's financial contribution should be tailored to the needs of the most efficientproducers; and (e) the role of the MOA should be reduced to a minimum.

5.81 Since the main focus and emphasis of the extension system would be on the private sector,the role of MOA would be minimal but it will be responsible for monitoring extension activities carriedout by associations of farmers' organizations and cooperative federations, provide guidance on new MOAstrategies related to extension, and provide vital links with the agricultural research and educationestablishment. MOA would also be responsible for administering the state budgetary support for theservice.

5.82 Armenia requires assistance in the following fields for the implementation of the proposedextension service: (a) support for strengthening of MOA's capacity to facilitate the implementation ofthis service; and (b) assistance to farmers' associations and cooperatives which are potential agencies forthe delivery of extension services.

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CHAPTER 6

IMPROVING AGRICULTURAL EFFICIENCY AND SUSTAINABILITY

6.1 The successful transition to a new agricultural system requires not only changes in thepresent policy environment and incentive framework, but also should be supported by policy measuresto increase the efficiency of production and by investments in physical capital. Irrigation facilities,management, and crop and livestock production have to adjust to the new conditions of private agricultureand the market system, especially in the form of improvements in production efficiency and managementpractices.

A. IMPROVEMENTS IN IRRIGATION

6.2 Due to the fact that much of Armenia's agriculture is based on irrigation, the availabilityof water and the national use of water resources have a crucial importance. The irrigation system in thecountry is in deteriorating physical condition. Some of the irrigation facilities are in critical need ofrepair and at present their deteriorating state can cause extreme environmental damage. Furthermore themanagement of the irrigation system needs to be adjusted to the needs of private fanning. Therefore,the rehabilitation of critical water infrastructure facilities and adjustment of irrigation managementpractices should receive very high priority.

6.3 Irrigation has been practiced in Armenia for 3000 years as is evident from archaeologicalfindings. Among the agro-ecological conditions of Armenia, irrigation is an essential precondition forproductive crop/horticultural production. Records from the 4th century A.D. indicate that about 100,000ha were being irrigated at that time. In 1920 this area had decreased to about 61,000 ha but wasexpanded to about 320,000 ha in 1990 at an average rate of 2,900 ha/year from 1970 to 1990. Withprivatization of lands in 1991/92, the irrigated areas were reduced to 286,000 ha or about 50% ofcultivated lands, due to re-classification of snow-melt irrigated lands to rainfed lands.

6.4 Armenia has substantial water Water Resources Inventory (Billion m').resources available for irrigation and other usage. Annual VolumeBox 6.1 summarizes all water resources, Type of Water. Resourceincluding rainfall. Total use of water in 1990 Billion m3amounted to about 4.1 billion m3 . Irrigation was RainfJl 18.4the largest user with close to 2.5 billion mn3,followed by public water supply (which included Run-off through rivers 7.4irrigation of gardens) with 760 million m3 and Groundwater (+ springs) 4.2industrial water supply with 310 million m3 .

Nearly 50 % of the water fed through the Source: Armenia's Water Plaunlng Insruteirrigation system is lost. Potentially, with largesavings along the existing irrigation systems andthe development of new. unutilized water Box 6.1resources, much more land could be irrigated.

64 Chapter 6

6.5 Several steps might be taken to improve the efficiency of the irrigation system. Pilotprojects should be set up to test alternative delivery unit sizes, water meters, and field distributionsystems. Over time, water users' associations (WUAs) should be organized. These should be givenresponsibility for operating and maintaining facilities associated with their members' farms. Allinstitutions related to irrigation use should also be directed to improving their services to the water users.A more detailed discussion of the irrigation system can be found in Chapter 8.

B. IMPROVEMENTS IN CROP PRODUCTION

Cropping Patterns and PerformanceRect Cblsgea in Cropp4ng Pattens

6.6 Armenia has favorable (000ha) 1990 1992 1993conditions for production of a variety of 93/90

crops, including, in the agro-climnatically 1 1, ~~~~~~~~~~~~~Grain 138 181 208 +49

most agreeable parts of the country, suchhigh value crops as grapes, fruits, vegetables, vcgtabWe IS 26 19 +5

tobacco and geranium (a monocotyledon Potat 22 29 31 +41

containing aromatic oils). Generally low Forage 251 156 127 49humidity and high sunshine hours during thegrowing season create a pleasant environmnent Grapes 29 24 25 .14for crop growth, with relatively lowincidence of pests and diseases.

Box 6.2

6.7 The country's croppingstructure underwent a dramatic shift in recentyears (Box 6.2). The proportion of annual Table 6.1: Output of or Crop Products (1000 tons)food crops increased at the expense of forage 1985 1990 1991 1992 1993

crops, perennials and industrial crops. As a Grains 283 271 303 309 316

result, in 1992 and 1993, the production ofgrains and potatoes was significantly higher Grapes 315 170 211 139 135

than that of the 1980s. In contrast, the Other Fruits 246 214 217 153 49

production of fruits (including grapes),vegetables, and forage crops, was down Potatoes 305 213 267 325 414(Table 6.1). Armenia's yields of grains and Vegetables 609 378 425 481 410

potatoes continue to lag behind those in Tomatoes 388 219 175 232 142

Central Europe (Table 6.2). Yet, whileArmenian yields of vegetables and tomatoes Squash 60 27 36 42 33have declined sharply, they still are greater Forage Crops 1672 1359 920 637 523

than those achieved in Central Europe. Source: Ministuy of Agnculture

Profitability of Production

6.8 Farming for market sales in Armenia is problematic. Input prices, machinery hire, andtransport costs have all risen fast while output prices for produce for processing have risen far less, and

- -------- - --------- _

Improving Agricultural Efficiency and Sustainability 65

are further eroded by inflationbecause payment is delayed. The Table 6.2: Comparative Yields (tons/bectare)

real farm-gate prices for crops Armenia Central Europe

such as tomatoes and grapes arecurrently low because of the Product 1987 1990 1993 1994 1987 1990 1991contractions in the tomato paste Grains 2.01 2.0 1.50 1.19 2.92' 2.822 2.012

and winery/distilling industries andthe cone sequeintgreducti industries aPotatoes 14.8 9.5 13.8 15.0 18.5 2 19.83 16.83the consequent reduction inderived demand for raw product. Vegetables 31.0 21.1 25.0 23.0 22.02 22.13 22.03

At local prices (1992/93 season Tomatoes 40.0 27.4 24.9- 27.1 14.72 14.33 15. 1

output prices and expected inputprices for 1993 all expressed in Grapes 6.45 5.81 4.48 6.1

constant US$ terms) returns are 'preliminary data, 2 indicates Bulgaria, 3 indicates Poland.modest for most crops. Source: Armenian Ministry of Agriculture, USDA Economic Research

Service, and other country yearbooks.

6.9 Estimated netreturns per irrigated hectare (gross value of production less input, machinery, and water costs, butexcluding the costs of labor) are summarized in Table 6.3 for the main crops in lowland (Ararat valley)and middle altitude areas. Yields used in the calculation are those expected from the delivery of irrigationwater as currently designed and assume an overall water delivery efficiency of 50% between intake andcrop. They also assume the repair of the conveyance structures, pumps, and dams currently in the worstcondition. Yields, which are currently affected by a shortage of water, would then increase and farmerswould be more willing to invest in purchased inputs and landshaping. All prices of inputs which haveto be imported are evaluated at, or close to, world market prices. Output prices are taken to be thoseprevailing in country in1992/93. Net returns reflect netyields of output after spoilage(which is as high as 50% for Table 6.3: Net Return to Irrigated Agriculture (S/hectare)

vegetables). Crop Lowland Middle(Ararat 850 mal) (1200-1800 masil)

6.10 The analysis of CerealsCerals247 175

net farm benefits for thelowlands and midlands (some of Forage 349 279

which are presented in Table Potatoes 1142 1324

6.3) assume a continuation ofthe current blockade situation, Tomatoes 2920 2600

and are presented in terms of Fruits 1988 1995income per ha, per man-day, Grapes 1181 NA

and per cubic meter of water. 'Based on Local 1992/93 prices for outputs and world market prices for

The results show a similar inputs.benefit pattern for the lowlands 2meters above sea leveland midlands. Under the Source: World Bank, January 1994.

prevailing cost and pricestructure, the results are aspresented below:

66 Chapter 6

(a) highest net returns per ha are being achieved from vegetables, followed by fruits, grapesand potatoes; despite the conversion of forage into mnilk and meat, forage fares relativelypoorly, just somewhat better than wheat, which gives lowest returns;

(b) highest returns per man-day are coming from fruits, followed by vegetables and wheat;and,

(c) best returns from the cubic meter of water are from potatoes and vegetables, followedby fruits.

6.11 Thus, there is a good case for irrigated production in the Ararat valley and the middlealtitudes, where, given the low rainfall, the opportunity cost of the land for rainfed production is verylow; however, rainfed yields would be low and there would be substantial risks of complete crop failure.At high altitudes, net returns from rainfed fodder are higher than from most irrigated crops except whereirrigation water can be supplied at very low cost. In general, it must be concluded that irrigation in thehigher altitude areas serves largely a social rather than a purely economic role, although currently it isimportant to maintain staple food supplies locally. More than 25% of the rural population lives in highaltitude areas and about 30% of irrigated area lies in these areas. In the short term there is littlealternative to maintaining the irrigation schemes which serve these commnunities. In the medium and longterm, a concentration of both irrigated areas and population in the lower and middle altitude areas willprobably emerge.

6.12 In addition tocalculating net returns under LOWLAND CROPPING PATTERNSthe current blockade SCENARIO WITH AND WITHOUT BLOCKADE

conditions, a scenario in %which the blockade is lifted 120

was also examined. In this 100

scenario the importation of 80 l l I I l I I Igrains is greatly increased asis the ability to export fruit 60

and vegetables in fresh and 40

processed form as well aspotatoes. Figure 6.1 20

illustrates the shift of cropping 0

patterns out of cereals and 1994 1995 1998 1997 1998 1994 1995 1998 1997 1998patm ou of crasndWith (Blockade) Withoutinto fruits, vegetables, andpotatoes. Associated with the _ Cereals 21 Potatoes O Vegetables

shift to higher value crops is o Forage (EE Fruit s Grape

an increase in annual incomeper farm of almost 50% in the sU- NI.U7 nf AeSO-uI

t.-r

lowlands (to $1750) and of Figure 6.1over 150% in the middlealtitudes (to $1200) using1992/1993 prices.

Improving Agricultural Efficiency and Sustainability 67

Change in Cropping Patterns and Technologies

6.13 The agricultural production potential of Armenia is under-exploited. Research results andcomparisons of production results of former socialist farms with those of private farmers havedemonstrated that a realistic production potential for most crops is almost double that currently beingachieved. With the availability of modern technology, yields of most of the main crops could beincreased substantially within two to three years. Introduction of advanced technology is desirable,particularly for small grains, potatoes, vegetables, fruit trees, vineyards and forage crops, as quickly asis feasible. However, the introduction of modern technology will greatly depend on a stable economicenvironment which would encourage foreign investment and technical assistance, and on the future farmstructure and size. Presently farm machinery and equipment, have to be adjusted to smaller productionunits than has been the case before land privatization.

6.14 Employing high quality seed, a reduced number of field operations with the assistanceof modern chemicals and machines, optimal rates of good quality fertilizer, and appropriate machines forseeding, crop protection and harvesting, are all essential to sustainable improvements in crop production.Advanced technology has to be coupled, of course, with professional farm management and a respect forthe optimum timing for field operations for each of the crops. From the technical point of view,availability of modern technology and provision of technical assistance for its introduction are keyelements in achieving sustainable productivity. Provision of modern technology has to fully take intoaccount cost and benefit parameters, and, equally important, the agroprocessing capacity, which in itscurrent state particularly in vegetables, fruits, and grapes might be a limiting factor to substantialexpansion of primary production.

6.15 Crop rotations used to be carried out in a rather rigid fashion during the times of thecentrally planned system. Each kolkhoz and sovkhoz was allocated a certain production target for eachcrop and was obliged to cultivate annually a predetermined number of hectares decided by centralplanners. With land privatization and the creation of a large number of small, private farms, croprotations must be flexible to facilitate soil conservation (erosion control) measures, faster adaptation tochanging market conditions, and possibly a wider representation in the rotation of profitable crops.

6.16 Reports indicate that the limited area of generally high quality land is being usedsuboptimally. It has been pointed out that particularly the orchard area, which has shrunk from 50,000ha in 1990 to about 30,000 ha in 1993, is grossly under-exploited by low productive, over-agedplantations, some of which are planted with obsolete varieties (in terms of market demands). Horticultureexperts in Armenia estimate that the total perennial crop area, which decreased from 90,000 ha in 1983to 54,000 ha in 1994, could be restored to some 75,000-85,000 ha by 1997. With introduction of modernvarieties and technology, the level of production could be increased, and more attractive produce couldbe offered to the market. Unproductive orchards should be gradually replanted with varieties respondingto present market demands, and more professional management should be introduced to improve bothfruit and grape yields, which are quite low when compared to real potential and international standards.

68 Chapter 6

C. ADJUSTMENTS IN THE LIVESTOCK SECTOR

The Role of Livestock in the Economy

6.17 Livestock production in Table 6.4: Contaction of LUvestock Sector Between

the late 1980's accounted for about 55% 1990-1993, Decline in Livestock Inventory (%)

of the output value of agricultural primaryproduction, and about 80 % of agricultural Sheep andimports, including yearly importation ofup to 800,000 tons of milk powder and Armenia 28 75 33 75

dairy products, 60,000 tons of meat, Belarus 13 12 10 2

400,000 tons of feed grains, and 100,000tons of protein meals, plus substantial Azerbaijan 11 67 11 22amounts of feed additives and veterinary Kazakhstan 3 21 5 11

supplies. The livestock subsector utilized Moldova 13 27 1 32about 80% of agricultural land, employedan estimated 75 % of the agricultural labor Russia 11 21 16 13

force, and represented a major source of Ukraine 6 19 20 16

nutrition and cash income for most Source: FAO, Rome

agricultural producers. Because of theimportance Government had attached to increasing per capita consumption of livestock products, the sub-sector was given high development priority in the 1970's and 1980's, when it received between 70 and80% of total investment in agriculture.Since 1988 the livestock sector hasundergone an unprecedented contraction Armeria Livestock PopLiationand in 1993, output was little more than (000 Animal Units)half (56%) of the 1988 level. Thesubsector share in total agricultural output 14m

12Wdeclined to 33.7% (Table 6.4). Estimates 10 Omon the January 1994 animal stocks soehowever, indicate a modest increase of 60111111111

about 5% compared to 1993. In 1993 the 200

sector showed signs of modest growth o _ _ _ _ _ _ _ 1 _(1.5%) compared to 1992. This is a sign 19s 19 19s 1939 l9919 1991 19B 1993

of the beginnings of sector consolidation(Figure 6.2). Figure 6.2

Livestock Ownership

6.18 Production of major livestock products have declined continuously since 1988 (Table6.5). As a result of the land reform of 1991, the share of private livestock ownership and productiongrew dramatically in the past several years. By 1993, more than 90% of all meat, 97% of milk, 95%of eggs, 97% of wool, and 83% of honey was produced by private producers and their cooperatives.In contrast, private producers and their cooperatives produced about 30% of all meat, 36% of all milk,33% of all eggs, 36% of all wool, and 55% of all honey in 1989/90. Roughly two-thirds of private,

Improving Agricultural Efficiency and Sustainability 69

1993 livestock inventories was owned byprivate farmers and individual householdprivaefarers one-tirdivda bouelognhol Table 6.5: Production of Principle Livestock Products,plots, the remaining one-third belonging to 1985-1993the new cooperatives.

Year Total Meat Total Milk Eggs(tons liveweight) (tons) (millions)

Livestock Perfornance 1985 169,500 545,700 573

6.19 Overall, livestock 1986 177,800 572,700 609production coefficients in Armenia in the 1987 174,400 576,300 6371980s were only about one-third of that 1988 181,100 565,900 618achieved in Western countries, butdropped further in recent years to 1989 167,400 491,200 561

currently no more than about 25% of 1990 145,100 431,900 518

Western standards. Productionperformance per animal unit has 1991 133, 412,00 485substantially deteriorated in recent years. 1992 110,900 394,900 253

Between 1987/88 and 1993, for example, 1993 81,000 387,500 189annual milk production per cow and ewe Source: Ministry of Agriculture

dropped by about 22%; fertility rates forcattle and pigs fell by 7% and 25%respectively; while average slaughterweights for cattle, pigs, and broilers decreased by 18%, 13%, and40% respectively, and egg production per hen per year by 28% during the same period.

6.20 Feed conversion ratios, the most important parameters in livestock production, arepresently only about 40% of those reached in Western countries, causing high "luxury" consumption offeed and low slaughterweights. On still functioning state broiler farms, for example, 75 to 80 day oldbirds reach only about 800 grams of liveweight, compared with "Western" broilers, which reach 1.7 to2.0 kg liveweight at 45 to 52 days. Similarly, pig fattening typically requires 12 to 15 months to reachabout 75 kg slaughterweights with lean meat carcass contents in the order of no more than 40 to 45%.

Profitability of the Livestock Sector

6.21 The most serious problem affecting livestock production is low profitability, particularlyin regard to large-scale, intensive poultry, pig, and dairy operations which, with few exceptions, haveshut down, drastically scaled down operations, are going out of business, or are big money losers. Highinvestment and operational subsidy levels and distorted prices have led in the past to production systemswhich: (a) overused feedgrains/manufactured feedstuffs, while neglecting cheaper feed resources, suchas pastures/meadows, forage crops, and agro-industrial by-products; (b) were capital-intensive and labor-extensive; (c) were wasteful in terms of equipment, energy and other inputs, such as veterinary supplies;and, (d) encouraged concentration of large numbers of animals, often causing managerial, animal health,and environmental problems, as well as high internal and external transport costs, and difficulties withthe operation of efficient feeding, milking, and manure/slurry removal technology. These productionsystems, combined with the current low productivity levels, cannot be sustained under the emergingrelative price structure.

70 Chapter 6

Future of the Livestock Sub-sector

6.22 The most immediate tasks to rehabilitate the livestock sub-sector and to adapt it to its newproduction environment will be to:

intensify crop production, as forage crops and agro-industrial by-products must generate the bulkof feedstuffs, particularly winterfeed reserves, under Armenia's comparatively difficult and erraticagro-ecological conditions. For that purpose, the country needs to substantially reinforce andmodernize its crop sub-sector by applying appropriate amounts of inputs (namely herbicides andseed of higher productive forage and crop varieties than the ones currently used), machinery andequipment, and up-to-date soil fertility sustaining crop rotations and cultivation technologies (suchas no- and minimtum-tillage), and soil conservation measures;

* immnediately initiate measures to combat overgrazing of the country's vast permanent grasslandresources;

* provide sufficient, good quality veterinary supplies and most essential feed additives at pricesaffordable to livestock producers; and

* reduce the cost of artificial insemination (A.l) to levels attractive to farmers, while providing A.l.services with sufficient operating funds for proper functioning.

6.23 The second most important task will be to at least stabilize and, simultaneously withexpected improvement in forage and pasture production, substantially increase ruminant production(particularly cows and sheep milk and lamb/mutton output), while emphasizing productivity and economicefficiency per animal unit, namely feeding efficiency. This will require investment and production credit,passing and implemiientation of grazing control legislation, and establishment of efficient livestock supportsystems.

6.24 Measures to arrest overgrazing and severe soil erosion while simultaneously improvinggrassland sward productivity should include: (a) grassland development and maintenance throughfertilization, liminlg, controlled and rotational grazing, reseeding, weed and shrub control, and drainageworks; (b) a substantial increase in presently only nominal grazing fees; and (c) most important and assuccessfully demonstrated by experience in other countries, the granting of clear-cut ownership or long-term (25 to 50 year) grazing rights to individuals or to small groups of individuals. For Armenia, suchrights should be given first of all for communal pasture areas surrounding rural settlements, coveringabout 340,000 ha; and, thereafter, also for the about 260,000 ha of higher-altitude summer pastures.Respective legislation would need to be initiated and passed as early as possible, and required staff forimplementation of proposed grazing control measures appointed.

D. ENVIRONMENTAL SUSTAINABILITY

6.25 Of the many environmental issues facing Armnenia today, the most critical ones affectingagriculture include: (a) soil erosion, which has been progressing at an alarming pace; (b) salinityproblems; (c) runoff and contamination of surface water caused by improper use of agricultural chemicalsand improper treatmenlt of wastewater; (d) disruption of the ecological balance and pollution of the watersupply of Lake Sevan; and (e) deforestation due to illegal wood harvesting.

Improving Agricultural Efficiency and Sustainability 71

6.26 Soil Erosion. More than 60% of Armenia's agricultural land is eroded to some degree,and this represents more than 44% of all public lands in the Republic. The annual loss of fertile soil toerosion amounts to 8 million tons', and the use of more than 25% of agricultural lands have been lostto erosion during the past 25 years2. The rate of loss of this fundamental topsoil resource is alarming,and effective responses must be initiated.

6.27 The causes of this erosion are several, and the erodible nature of Armenia's geographicrelief demands that they all be addressed. Uncontrolled overgrazing of pasture lands is a primecontributor, particularly on lands considered common areas. The current decrease in livestock causedby the blockade has provided some relief, but residual problems caused by earlier overgrazing, continuinglocalized overgrazing practices, and future threats of overgrazing that will occur after the blockade mustall be addressed. Poor cultivation practices on unstable lands are another prime contributor, and onceravine erosion begins it accelerates with time if left uncontrolled.

6.28 Salinity Problems. About 42,000 ha located in the Ararat valley have soil salinityproblems, of which 9,000 ha are classified as severe (soil pH > 9). Until 1960 little drainage work orreclamation of saline soils was done. Since then about 60,000 ha have been drained and 4,000 hareclaimed (including drainage) - most of the area being located in the Ararat valley. About 34,000 hahave underground clay pipes, 12,000 ha vertical drainage systems and the remainder open drains.

6.29 Contamination of Surface Water. No legislative basis for the control of pesticide useexists in Armenia. It is recommended that standards for storage and application of these materials bedeveloped and enforced. The Ministry of Agriculture contains an administrative structure and monitoringlaboratory system concerned with chemical use and contamination, but it is sorely underfunded.Sampling and analytical equipment are inadequate, for the most part relying on basic wet chemistrymethods. It is recommended that the Ministry of Agriculture seek western technical assistance in thisarea, including upgrading of analytical capabilities and expert advice regarding the structure of a nationalmonitoring system, analytical techniques, and development of advisory services regarding chemical use.

6.30 The surface water in Armenia is also affected by the centralized flows of untreated wastewater from towns and rural users. The annual use of irrigated water is in the neighborhood of 2,500mm3, of which 750 mm3is untreated waste water. In order to reduce pollution, investment is needed bothfor the construction of urban water treatment (sanitation) stations and the maintenance of existingfacilities. It is also imperative that qualitative sanitary norms be established before waste water isreleased.

6.31 Lake Sevan. Lake Sevan is the largest high altitude freshwater reservoir in theTranscaucasus and one of the highest lakes in the world. In the 1930s, the large volume of the lake andits 1,100 m head above its only surface outflow, the Razdan River, were viewed as resources to be usedfor energy generation and irrigation of farmlands in the Ararat Valley. Water withdrawals have resultedin a drop of the lake surface by 18.5 m over the next several decades, and the first signs of ecologicaldisturbance were noted in 1963 during studies of the lake's phytoplanktonic community. Since then, the

I Source: Abovian, lu.1. 1988. The ecological situation of the Armenian SSR and the concept of nature protection.

2 Source: Information sheet provided by Ministry of Agriculture.

72 Chapter 6

process of cultural eutrophication has been observed3 . There are also reports of contamination bypesticides and heavy metals, including copper, zinc, nickel, and cobalt, but this is not confirmed bytesting because of inadequate instrumentation. Mass mortalities of the local salmonid fish, the "sig," areattributed to this contamination. The Government is considering various options to restore the level ofthe lake by at least six meters. This will obviously have a positive effect on water quality. Water forirrigation can be found from sources other than the lake.

6.32 Deforestation. During last winter's blockade-induced energy crisis, the populace illegallyharvested 300,000 m3 of wood for heating, five times the normal annual harvest. More than 550 ha wereheavily harvested, in some areas causing serious land erosion concerns. The most seriously affected areaswere replanted in the spring with 4-6,000 seedlings/ha. Plans are in place for a controlled increasedharvest (100,000 m

3 ) and for collection of natural forest fall (200,000 in3 ) to supplement next winter'sfuel needs. Because of gasoline shortages, however, distribution of this wood will be problematic.

E. MODERNIZING HIGHER EDUCATION, RESEARCH AND EXTENSION

6.33 Agricultural Research. There arenine research institutes and four research stationunder the Ministry of Agriculture and Food (see Armenian Agricultural Researc and Educaton Box 6.3). All these Institutes have drastically ysemreduced their research activities due to budgetary Research Institutesconstraints. Traditionally, research has been Agricultural Research lnstitute, Cropfinanced from budgetary allocations, contributions Protection Institute, 2 Wine and Grapefrom state and collective farms, and the sale of Research Instittes, Soil Science and Agroproducts produced by the relatively large farmns Chemistry Institute, Vegetable Cultureattached to the research institutes. In the past Institute, Water Management andtwo years, however, public funding has been Hlydrotechnology nitute, Economictwo yea, . Research Institute, reternary Diagnosticsignificantly reduced and state/collective farm Laboratory, and Institute forcontributions have ceased. Presently available Zootechnology.funding just about covers salaries and wages andconsequently, does not permit any meaningful Research Stadonsresearch work. If the country's agricultural Apiculture, Oil Seeds, Tobacco, andresearch infrastructure is to respond to the Forestry.requirements of the emergent, new farmers,substantial funding and reorientation- Institutes for Higher Education

Agriculture and Veterinary University, 10intensification of research activities is required. Technical Colleges

6.34 The most important problems ofthe institutes are the lack of access to research Box 6.3results, technology, and methodology of adaptiveresearch in other parts of the world. Basically the institutes lack funds to provide training of Armenianscientists abroad, to invite expatriate visiting professors to Armnenia, or to establish an up-to-dateagricultural libraries, including subscription to essential scientific journals and literature, and

3 Eutrophication is a natural process; when accelerated by man it is called cultural eutrophication. Eutrophication istypically a process of nutrient enrichment, vigorous phytoplankton growth, oxygen depletion, and sedimentation.

Improving Agricultural Efficiency and Sustainability 73

comprehensive variety of field testing and demonstration work on farmers' fields. It has been noted thatparticularly forage and pasture improvement research has been neglected in the past, but also researchin farm economics, farm management, marketing, and agricultural policy analysis is not suitable to thecontemporary changes that include privatization of the sector.

6.35 Training. Education in agricultural matters is carried out in ten agricultural colleges fortechnical level education and in one Agricultural and Veterinary University. The latter is the result ofthe merger in August 1994 of the Agriculture and Livestock Institutes. The University and colleges haveabout 3,000 resident students each, in addition to non-resident students who study through correspondencecourses. Overall there are about 1,200 faculty members and some 700 support staff as of August 1994.Recently a three-year vocational school has been introduced to cater mainly to farmers and other farmworkers. The education system is now in crisis because of the reduced demand for graduates by theState, which in the past was the main employer. The Parliament has passed an act to reform highereducation to enable the institutions to provide B.Sc., M.Sc. and PhD degrees. Previously, the twomerged Institutes provided only one certificate after five years of study.

6.36 Training is not reoriented to meet the challenges of privatized agricultural and livestockproduction. This means that there is not sufficient emphasis on cost-effective, smaller-scale productionsystems, appropriate natural resource management, farm management economics, and produce marketing.In this context, there is also insufficient relevant training provided to researchers, teachers, and extensionpersonnel. Moreover, the agricultural and livestock production training facilities of the country shouldbe reviewed and streamlined, especially as regards the number of training facilities and the number ofgraduates required, their orientation and funding. A major issue to be dealt with is justification of theapparently increasing number of higher-level graduates, considering increasingly scarce employmentopportunities in agriculture in the years ahead.

6.37 Upgrading Education and Research. Armenia's agricultural education and researchsystem is in difficulty. If agriculture is going to be responsive to the country's needs it must be currentwith international scientific and technological developments: the system is now out of touch, indeedisolated. Scientists are also out of touch with the evolving needs of domestic farmers. They need morecontact to ensure the relevance of their work, and to develop a constituency that will ensure long termfinancial sustainability for the system. Attention needs to be given to the system's ability to be creative,promote excellence, encourage entrepreneurship, and foster agility in the use of scientific resources. Forexample, linkages with other institutes need to be developed in order to ensure the relevance of researchagendas for the agricultural reform process and long term financial support.

6.38 The agricultural universities and the research institutes are undergoing an unprecedentedperiod of budgetary stress that threatens their core. Their most important asset, the human capitalembodied in scientists and faculty could be lost if the situation is not corrected soon. A two phasedapproach to the needs of the agricultural university and research institutions is called for. As a quickresponse, to forestall irreversible damage to the institutions, as well as to initiate some of the moreimmediate modernizing requirements, the first phase would aim at immediate repair and maintenance ofinstrumentation, and ending the professional isolation of the universities and research institutes from theirinternational peers. Resources need to be augmented to support collaborative research and attendanceat international professional meetings, to provide access to, and modernization of, information systems,and to develop new course offerings and updated curricula.

74 Chapter 6

6.39 A second phase would focus on the institutional and policy reforms necessary tomodernize the higher education and research system. This would require a comprehensive study ofalternative models for modernizing higher education, research and extension. Given the importance ofharnessing the inherent synergy between research and higher education, a strategic issue that should beconfronted is how the agricultural universities and research institutions can be better integrated.Associated with this issue is the need to rationalize the allocation and utilization of resources availablefor research and in the agricultural university system. The respective roles of public and private researchshould be defined to encourage the most cost effective use of limited resources. Ultimately this processhas to lead to some hard decisions with respect to the reallocation of research resources, including largescale downsizing, privatization, and the allocation of time by faculty to research, teaching and/orextension.

6.40 Universities and research institutes should be encouraged to establish performance criteriaand evaluate scientists and faculty to ensure promotion based on the quality and relevancy of their work.Recruitment criteria will need to be reviewed and updated to ensure a heterogeneity of training andresearch methods of faculty and prevent "inbreeding."

6.41 Agricultural economics, farm management and marketing should receive priorities bothin higher education and research. There is an urgent need for training positions for teachers as well asincreased access to shorter and longer study tours and training. Books and periodicals in these subjectsare also needed. Armenian agricultural economics and other agricultural related social services such asrural sociology have to be reintegrated with the mainstrearn of international science. Marketing research,studies on new product development to meet new market opportunities, and trade policy options forArmenia under the new conditions should be supported. Research and study on the social impacts ofthe ongoing reforms in agriculture is also critical.

6.42 It is essential that Armenian agricultural research establish in the shortest possible timeclose contacts with international and other relevant national organizations, above all with FAO and withthe CGIAR group of intemational research institutes, to benefit quickly from exchange of informnationand genetic materials.

F. INVESTMENTS IN FOOD AND AGRICULTURE

6.43 The completion of land reform, enterprise restructuring, and privatization are importantpreconditions for the improvement of the efficiency of primary production, processing and distributionof food and agricultural products. Appropriate policies are also needed to support investment to introducenew technologies and methods of production. The improvements in production techniques and methodswould be reflected through improved crop and livestock yields at constant levels of input use, oralternatively, receiving the same yields at lower input levels. Competitive and profitable production andexport of agricultural products requires substantial investments in product quality as well as ininternational marketing.

6.44 Based on the review of the current situation and the major tasks of transition, theinvestment priorities can be listed as follows:

(a) rehabilitation of irrigation facilities and their adjustment to the needs of private farming;

Improving Agricultural Efficiency and Sustainability 75

(b) development of physical facilities to create a working market for agricultural productsand inputs for agriculture;

(c) capitalization of the emerging new farming structure;

(d) reconstruction and major modernization of support services (industries such as seedindustry, machinery maintenance) and agroprocessing;

(e) development of education, research and extension potentials.

(f) promotion of environment friendly methods in irrigation practice and agriculturalproduction; and,

6.45 The investments needed to keep the existing irrigation infrastructure operative for theshort-term include: (a) establishment of Water Users's Associations and general improvement inoperations and management; (b) repair of high risk dams; (c) repair of deteriorated canals, and (d)replacement of pipes and tubewell pumps. For the medium to long term the options include: (a) repairof medium risk dams and rehabilitation of about 7,100 km of canals; (b) modernization of on-farmdistribution systems; (c) increase of irrigation water supply and delivery; (d) rehabilitation andimprovement of drainage systems; (e) reclamation of saline soils; (f) completion of irrigation schemes;(g) conversion of pumping schemes to gravity schemes; (h) contribution of new public schemes; and (i)the repair of Getik scheme main canal and completion of dam construction. Investment in irrigationshould be based on cost-benefit margins and careful environmental assessment.

6.46 At this time, the need to create a competitive market structure for food and agriculturein Armenia should receive high priority. The development of a new market structure should includeimproved facilities such as auction halls, city markets, regional cooperative or private packing and storagefacilities, and transportation equipment. Market information services for farmers should also be madeavailable, through radio and television programs and farm newspapers. All of this requires investmentat a relatively early point in the reform.

6.47 Armenia has experienced a decline both in production and demand for food. Investment,especially in replacement and more suitable machinery, is needed to stabilize production during thecritical first period of transition. No doubt as a result of land privatization, a large amount of farmequipment and buildings have become unsuitable for the new system, or require substantialreconstruction. Though it is very difficult to estimate the magnitude of new investment requirementscreated by the land reform in Armenia, investment requirements will be considerable.

6.48 The relative technical backwardness of the processing sector is an extremely serioushandicap for the agricultural sector as a whole. The level of processing is crucial to exported productssince it determines their quality and price and, indeed, whether they can be sold at all. It cannot beoveremphasized that world market food processing standards will only be attained if a much moredeveloped level of processing is introduced. The development of food processing in a way that is clearlylinked to export strategy is an indispensable condition for competitiveness and the improvement of exportefficiency. More demanding processing is also becoming increasingly important for Armenia consumersas well.

76 Chapter 6

6.49 Agricultural universities, research institutes and the yet to be created farmadvisory/extension services, i.e., the agricultural informnation knowledge system, will be of strategicimportance. Preparing the next generation of agricultural professionals is vital. As the full effects ofeconomic reforms play out, it will be important to be able to identify, adapt, and/or develop technicalinnovations to increase factor productivity and underpin competitiveness. Therefore, investment in humnancapital should be a high priority.

6.50 Increased environmental protection requirements mean, above all, that greater scope mustbe given to technologies that economize on materials and energy and that protection of the soil and thesafeguarding of its quality must become a fundamental criterion of agricultural production. Otherprincipal aims are prevention of environmental pollution by harmful by-products and the spread ofenvironment-friendly packaging materials made from "natural" materials. As a result, the proportion ofwaste-free or recycling technologies should be increased, technologies preserving the original propertyof the basic material and foods made with these technologies must be given greater emphasis, and thereduction and elimination of the use of chemicals should become an increasingly important consideration.

6.51 The private sector should play a decisive role in future investment in agricultural asprivatization proceeds. The Government role is to provide an enabling environment, including anincentive framework that creates the right motivation for private investment in primary agriculture as wellas in agricultural processing and distribution. Public investment needs to be directed at improving humanand physical infrastructure, and to be linked to the implementation of a program of further reforms whichset clear priorities.

CHAPTER 7

EXTERNAL ASSISTANCE

7.1 Armenia has embarked on an historic and courageous effort to transform its economyfrom a centrally planned to a market-oriented system. There are clear signs of significant progress inthe agricultural sector. These reforms will, under the best of circumstances however, be a long processinvariably accompanied by economic, social and political difficulties. External assistance can supportthis transformation by making it as efficient and effective as possible and alleviate many of the transitionalproblems the sector faces. Additional external assistance should take the form continued food aid bybilateral donors for the duration of the blockade. In the agriculture and food processing industries theassistance most needed in the short and medium term includes:

* balance of payment support for critical inputs for agricultural production;

* technical assistance to the Ministry of Agriculture to help implement a consistent transitionprogram in food and agriculture;

* development of institutions and support facilities needed for a market-based privatized agriculture;and,

* capital investments for the development of competitive production, processing and marketing andrelated infrastructure (especially the irrigation system).

A. CRITICAL INPUTS FOR AGRICULTURE PRODUCTION

7.2 The supply of farm inputs is declining because of the lack of foreign exchange,disruptions in the domestic supply network, and the absence of a well-developed distribution system forserving smaller and more numerous farms. Shortages of pesticides, herbicides, fertilizers, veterinarymedicines, concentrate feed, feed additives, and spare parts for agricultural and transport equipment arecritical. Emergency measures may be needed to supplement supplies for several planting seasons.

B. TECHNICAL ASSISTANCE AND INSTITUTION BUILDING

7.3 Many difficult policy, technical, and institutional issues are emerging during the transitionfrom a command to a market economy, and skills generally not available within the country are neededto deal with them effectively. Technical assistance and training covering broad areas of food andagricultural sector policy are needed to facilitate this transition. The topics identified below are indicativeonly of technical assistance needs in Armenian agriculture. In many of these areas a number of multi-lateral institutions, foreign governments, and private organizations are already involved, but their supportso far meets only a small fraction of the need. Also, the coordination of technical assistance activities,to ensure their relevance, usefulness and cost effectiveness is a high priority. TA is especially neededin the following areas: (a) policy development; (b) land reform, technology, and marketing; (c)enterprise privatization; (d) research, education, extension; and (e) rural financing.

78 Chapter 7

C. NEW INVESTMENT

7.4 The guiding principle for all new investments should be whether they are likely to beeconomically efficient and whether they contribute to the social goals underlying the transformation toa market economy. Ideally, investments would then be directed toward projects that facilitate privatefarmers who adjust their production systems to real factor and product market conditions and toward thephysical rehabilitation of agroprocessing and distribution of agricultural products. Public investmentshould focus on the rehabilitation of physical (e.g., irrigation) and human (e.g., extension, research, andeducation) infrastructure.

D. THE BANK ASSISTANCE PROGRAM

7.5 The broad objective of the World bank assistance program is to help Armenia to stabilizeoverall macroeconomic conditions and, on the basis of a conducive macroeconomic framework, to supportthe realization of the full potential of the agriculture sector in the economy. The immediate constraintsfacing the country are the blockade caused by the political conflict with Azerbaijan which exacerbatesfood supply to the population, and a long period of neglect in the maintenance of the agricultureinfrastructure, which also impairs the capacity of the sector to maintain its present production levels.

7.6 In the short term (within the next three to four years) the first priority should be to focuson the rehabilitation of irrigation infrastructure. The agriculture sector is heavily dependent on irrigationbecause of low precipitation in the main production area of the Ararat valley. Without massiverehabilitation efforts, the infrastructure is likely to disintegrate in a relatively short period, leading to asubstantial decrease in food production and further dependence on food imports. The irrigationrehabilitation project, already in implementation, would help arrest the ongoing decline in agriculturalproduction, improve the efficiency of water use, and start the process of establishing the much neededwater users' associations for effective operation and maintenance and cost recovery.

7.7 In the medium term the Bank assistance program should focus on the continuation of landreform, the development of a conducive agricultural policy framework for private farm development, andon restructuring and privatization of the institutional infrastructure. Despite significant progress in landreform, there has been very little progress in reforming marketing, input distribution, or processing ofagriculture production. The state is still the predominant actor in these areas. Since there are now aboutthree hundred thousand private farmers in Armenia, compared with about 800 state and collective farmsduring the Soviet regime, the state is unable to handle the marketing for such a large number of privatefarmers and is also unable to effectively handle the input distribution. The next Bank agricultureassistance program should therefore be designed to assist in the restructuring and privatization of the foodand agricultural marketing. This should be combined with a technical assistance loan to provide policyassistance to ensure that private farmers operate in an effective incentive framework.

7.8 The second assistance priority in the medium term should be to assist private farmers bystreamlining services to the sector. While land reform created many private farmers, the state hasstopped providing even the most rudimentary services, thus leaving a service gap. The new farmerscould be organized to form rural service cooperatives, for joint purchase of inputs, or for marketing theirproducts. Other rural service functions could include savings and credit facilities, the development ofa commodity exchange, extension and training services, and development of market information facilities.The Bank could provide resources to develop these institutions.

External Assistance 79

7.9 The third assistance priority should be to reduce environmental problems. Of the manyenvironmental issues facing Armenian agriculture today, several are of urgent priority: (a) developmentof programs to improve control of soil erosion, including reforestation (due to the blockade many treeswere chopped down and used for heating); (b) installation and operation of adequate pollution controltechnologies in Armenian industrial facilities and treatment and disposal of industrially-derived hazardouswastes; (c) treatment and disposal of municipal wastes; (d) reduction of automotive emissions in urbanareas; and (e) protection and restoration of the ecological integrity and water supply value of LakeSevan.

80 Chapter 7

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