Interfax-Ukraine, Kyiv, Ukraine, Friday, October 27, 2006

11. SERIOUS NEGATIVE CONSEQUENCES OF THE YANUKOVYCH
GOVERNMENT'S DECISION TO RESTRICT GRAIN EXPORTS
Ukrainian International Agricultural Newsletter
Kyiv, Ukraine, Monday, January 29, 2007

12. UKRAINE: INVESTORS COUNCIL SET UP UNDER CABINET OF
MINISTERS, TO BE HEADED BY PM VIKTOR YANUKOVYCH
Liudmyla Martynova, Ukrainian News Agency, Thu, January 25, 2007

13. UKRAINIAN NSDC SECRETARY VITALIY HAIDUK DISCUSSES
ENERGY AND DEFENSE ISSUES IN WASHINGTON
U.S. President Bush invited to visit Ukraine
Interfax Ukraine Business Express, Kyiv, Ukraine, Tue, Jan 23, 2007

14. U.S. AMB TO UKRAINE SAYS ANTI-MISSILE BASES IN POLAND
& CZECH REPUBLIC NEEDED TO PROTECT EUROPEAN COUNTRIES
Ukrainian News Agency, Kyiv, Ukraine, Tuesday, January 23, 2007

15. RUSSIA MUST OBEY COURT ORDER AND RETURN CRIMEAN

LIGHTHOUSES FOREIGN MINISTRY DEMANDS
Associated Press (AP), Kiev, Ukraine, Thu, January 25, 2007 8:40 a.m.

16. IMF SAYS A MORE FLEXIBLE CURRENCY WOULD HELP
UKRAINE CONTROL INFLATION
Dow Jones Newswires, Washington, DC, January 22, 2007.

17. PROPOSED MONOPOLISTIC MEGA ALUMINUM MERGER

SEEMS TO BE TAKING UKRAINE OFFICIALS BY SURPRISE
By John Helmer, Mineweb.com
Cape Town, South Africa, Tuesday, January 23, 2007

18. UKRAINE: PLANS UNDERWAY TO INVEST $60 MILLION IN

ALPINE SKIING TOURIST COMPLEX IN CARPATHIAN MOUNTAINS
Ukrainian News Agency, Kyiv, Ukraine, Friday, January 19, 2007

19. NEW PUBLIC HEALTH FOR THE NEW UKRAINE
National University of Kyiv Mohyla Academy School of Public Health
ANALYSIS AND COMMENTARY: By David L. Nordstrom
The Ukrainian Observer magazine, Issue 227
The Willard Group, Kyiv, Ukraine, January 2007

20. KYIV MOHYLA ACADEMY SEEKS SUPPORT OF UKRAINIAN
AMERICAN COMMUNITY AND FRIENDS OF UKRAINE
IN THE UNITED STATES
One-million dollar 2007 fundraising program to be launched in five cities
Marta Farion, Executive Director
Kyiv Mohyla Foundation of America, Chicago
Action Ukraine Report (AUR) #810, Article 20
Washington, D.C., Monday, January 29, 2007
========================================================
1. TONS OF UKRAINIAN GRAIN ROTTING AND BEING THROWN

wheat prices have risen to HRN551/t from HRN485/t over the same period.

Indeed, global prices have risen in response to poor harvests in many
countries in the last two years.

Consequently, Ukrainian grain producers have increased exports: according

to data from the agriculture ministry, grain exports in the first four months
of the marketing year (which began in July) amounted to 5.7m tonnes, which
is up 30% year on year.

The rise in prices frustrated the government's belated efforts to build a
strategic grain reserve, comprising 400,000 tonnes of bread-quality wheat.
The responsible state agency was unable to make the purchases at the target
price.

According to a Financial Times report, state officials then sought to force
grain traders to sell their stocks at a US$20/tonne discount, but were
rebuffed.

Instead of agreeing to pay more, the government on September 28th introduced
without warning a new licensing regime for exports; its complexity and the
lack of preparation time sharply curbed grain exports.

Following industry protests, this was replaced on October 11th by export
quotas to the end of the year. The overall grain export quota was set at
1.6m tonnes, comprising: 600,000 tonnes of maize; 600,000 tonnes of barley;
400,000 tonnes of wheat; and 3,000 tonnes of rye.

The quotas have been successfully challenged in court but remain in place.

Indeed, confusion over the legality of shipments under the new arrangements,
and the required licensing, have all but halted grain purchases for export.

Seaport grain shipments during November 1st-15th fell by 79% to 77,600
tonnes, from 373,850 tonnes during October 1st-19th. There is also
considerable confusion over the method by which quotas are to be allocated.

PM YANUKOVYCH IS UNAPOLOGETIC
Mr Yanukovych is unapologetic for the losses inflicted on Ukrainian and
foreign investors in the agricultural sector-which are likely to be around
several hundred million dollars.

He insists that the government had to act, in order to prevent bread prices
from doubling. Nor is the end necessarily in sight: Deputy Agriculture
Minister Petro Verbytskiy said on November 15th that the government might
impose an export quota of 1.8m tonnes for the first half of 2008.
CLUMSY AND OPAQUE
Several aspects of the grain-quota affair are noteworthy.

[1] First, the government has acted in an opaque manner. The licensing
requirements were introduced without warning, let alone any consultation,
leading to huge confusion.

Business plans have been wrecked by the cabinet's decisions, and the
paralysis of exports since the start of November is squarely a consequence
of confusion within the state customs service over how the new export

regime is to work in practice.

Perhaps most importantly, there is little or no clarity over how mechanism
for distributing quotas. Nor is it certain that the cabinet is moving
determinedly to resolve this problem-the longer it goes on, the lower
domestic grain prices will go.

On November 15th the authorities formally authorised the customs service to
resume exports, but simultaneously it suspended licenses that cover
approximately half the wheat and barley quotas.

[2] Second, it can be argued that the government has engaged in overkill. In
a joint public statement, the US, Dutch and German ambassadors to Ukraine
described the intervention as unnecessary because there are credible
estimates that the 2006/07 harvest will be in line with historical averages.
They added that there was insufficient clarity over the level of reserves
held by the government.

Even if action on wheat was necessary, to keep bread prices down, the
restrictions on barley and other grains are questionable. Volodymyr
Klimenko, the president of the Ukrainian Grain Association (UGA), has said
that his organisation is prepared to accept a 1.3m tonne quota for wheat
exports to mid-2007, but argues that barley and maize production this year
is sufficient to satisfy both domestic and foreign demand.

The UGA estimates that Ukraine can export 5m tonnes of barley and 1.5m
tonnes of maize in the 2006/07 marketing year without risking shortages on
the domestic market.
SAME OLD MEDDLERS
Most significantly, the affair reveals the economic philosophy of Ukraine's
current government-which is little different to that of most previous
Ukrainian governments. Nearly every Ukrainian administration has struggled
to establish and run the strategic grain reserve in an efficient manner.

Equally, they have failed to develop strategies and institutions to bring
stability to the grain market; instead, when faced with a crisis, they have
intervened directly. This mode of operating is not limited to Mr Yanukovych's
government, nor to the agricultural sector.

In 2005 the "Orange" government led by Yulia Tymoshenko responded to

rising oil prices in the country by blocking fuel exports and forcing the

country's oil companies to accept price caps.

If there was a hope that Mr Yanukovych's administration-with much more
experience of running the country-would be better at managing such crises,
it has been disappointed. The Ukrainian state's instinct to interfere, and
its inability to plan strategically or build effective institutions, remains
the same.

The implications of this are manifold, but two stand out: the highly
negative signal sent to [1] domestic and foreign business, and to [2] the
countries whose support Ukraine needs to join the WTO.

For businesses, the fact that a Ukrainian government has once again
intervened directly in the market, at the first sign of political trouble,
highlights the risks of investing the country.

No investor, foreign or Ukrainian, is likely to be reassured by the content
and tone of Finance Minister Mykola Azarov's justification for government
action.

Having claimed that traders wanted to buy grain "for nothing", he continued:
"The price that was set now is a normal market price, which covers all of
the expenses of the producers and creates a certain profitability. The state
cannot allow itself to buy grain at unrestricted prices."

Nor has the grain market intervention done Ukraine any favours in its WTO
bid. As the three Western ambassadors noted, foreigners have invested nearly
US$1bn in the Ukrainian agricultural sector but will probably lose several
hundred million dollars as a result of export restrictions.

Mr Yanukovych has expressed a hope that Ukraine's trade partners be
understanding and says that "in the future we will build normal relations."

However, Ukraine's governments have such an established track record of
interventionism, that it is not clear why anyone should give the current
prime minister the benefit of the doubt.

If Mr Yanukovych is forced to choose between keeping bread prices low and
bringing Ukraine into the WTO, it seems he will opt for the former without
hesitation. -30-

quota system as soon as possible. -30-
------------------------------------------------------------------------------------------------
* The note has benefited from comments and contributions by: Riccardo
Gucci, Oleg Nivyevskiy, and Heinz Strubbenhoff (all IER, German Advisory
Group) and Asad Alam, Matthias Grueninger, Ruslan Piontkivskiy, Lee
Travers and Peter Thomson (all World Bank).
-------------------------------------------------------------------------------------------------
[1] IS THE QUOTA JUSTIFIED TO ENSURE DOMESTIC FOOD
SECURITY?
The imposition of a quota only affects prices if the quota is in fact
binding. The quota for grain exports introduced in October amounts to a
total of 1.603 million metric tons (MMT), with 0.6 MMT respectively for
barley and corn, 0.4 MMT for wheat and 0.003 MMT for rye. The quota is
currently valid for the remainder of 2006.

A new draft Cabinet of Ministers resolution published 22 November would
bring the quota for the year to 2.873 MMT for the 2006/2007 marketing year,
with 0.73 MMT for wheat, 1.3 MMT barley, 0.84 MMT for corn, and 0.003
MMT for rye. Government sources expect Ukrainian grain exports in the
2006/07 marketing year to amount to 9.5 MMT. What this implies for further
relaxation of the quota during the course of 2007 remains unclear.

How do these numbers compare with production and net export data in recent
years? Official data on wheat production, net exports and in particular
storage are incomplete, often published with considerable lags and
considered unreliable by many market participants.

This lack of quality statistics is in itself a significant hurdle for the
operation of grain markets. A series of private data sources are available,
as well as data from the United States Department of Agriculture. In this
paper, we use data from the private market information agency
UkrAgroConsult.

Table 1 tracks the supply and demand (S&D) estimate for Ukraine for the last
three marketing years plus the current 2006/07 marketing year. The S&D
estimate for wheat is attached in Table 2. The total 2006/07 grain crop of
Ukraine is estimated to amount to approximately 35 MMT. This is below last
year's crop of 36.6 MMT, but nevertheless well above the ten year average
and much higher than the low 2003/04 crop. (NOTE: To see the tables
referred to in the article click on: http://www.worldbank.org.ua]

Moreover, grain stocks at the end of the 2005/06 marketing year were large.
Thus, the total supply of grain in Ukraine - ending stocks of the last
marketing year plus the year's crop and grain imports - is very large: 37.8
MMT. The total domestic use of grain is expected to increase to 24.4 (last
year: 23.3) MMT, especially due to growing demand from the livestock sector.

This would, however, still allow for total exports considerably above the
Government's forecast of 9.5 MMT. Indeed, assuming exports stayed at the
levels of 2006/2006, which was a record year, there would still not be any
shortage on the domestic market, while taking a more conservative export
forecast of 10.2 MMT provided by UkrAgroConsult endyear stocks of grain
would actually increase.

The situation is quite similar for the wheat S&D statistics, which are part
of the total grain S&D statistic. The 2006/07 wheat harvest was well below
previous years due to the dry autumn last year and some winter kill, which
reduced both harvested acreage and yield.

However, a wheat crop of close to 14 MMT is still an average crop and
clearly much higher than the crop of 2003/04. Taking total supply and
forecast domestic demand (with a slight increase in the share of fodder
wheat due to insect damage), exports of close to 5 MMT would still be
possible. In fact, UkrAgroConsult forecasts wheat exports to total only
2.8 MMT, which is still well above the currently allocated quota. (1)

The lack of justification of the quota is most obvious for the case of
barley. The 2006/07 barley harvest reached a ten year high. And despite a
very large increase in domestic use to 6.4 MMT(last year: 5.3), exports
could increase by over 50% without exhausting stocks. Note in addition that
barley is mainly used for feedstock and thus a quota on barley exports has
no direct impact on food security.

However, the distinction between feed wheat and milling wheat is ultimately
a question of degree and price rather than kind. In bad years, millers will
accept lower quality wheat and can if necessary make up the difference
through purchasing supplements. Moreover, the quota makes no distinction
between flour and fodder wheat.

Until the end of September, when Ukrainian grain exports were stopped, the
country had exported 1.62 MMT of wheat and almost 2.2 MMT of barley.

Exports in October, which were already within the quota, amounted to 0.388
MMT of wheat and 0.496 MMT of barley. Thus, total exports for the 2006/07
marketing year to date are 2 MMT for wheat and 2.7 MMT for barley.

Adding the unallocated amount of the proposed revised quota (0.35 MMT for
wheat and 0.8 MMT for barley), the resulting figures are still well below
the numbers which would lead to a decline in wheat and barley stocks. The
quota is therefore clearly unjustified from a domestic food security point
of view and very clearly highly binding.

[2] THE COSTS OF THE QUOTA: LARGE LOSSES FOR GRAIN
PRODUCERS, LOWER EXPORT REVENUES, POTENTIAL
NEGATIVE EFFECTS ON FUTURE INVESTMENT, INCREASED
RISK OF CORRUPTION
The imposition of quantity controls is under any circumstances a very
inefficient and blunt policy tool to achieve a stated objective. The losses
to an economy and society are always greater than the gains.

This basic principle is a widely accepted result in trade economics, and has
influenced the strong position taken for instance in the GATT Article IX,
paragraph 1, against the imposition of quantitative restrictions. Annex 1
explains the economic argument with the help of a simple diagram, which
shows that the losses suffered by domestic producers are always larger than
the gains to consumers.

How much are grain producers in Ukraine losing as a result of the quota? The
size of these losses depends on the impact of the export quota on farm gate
prices. Chart 1 provides information on wheat price developments since the
beginning of 2006 in Ukraine and on world markets.

Since mid-2006, FOB prices (Free On Board, in the US and the EU), which
represent the world market price level, have increased from roughly 140 to
200 US$/t.

These price movements have been driven by indications that world grain
production will fall short of consumption in the 2006/07 marketing year.
Rising demand for food production and biofuel together with lower than
expected grain production in the US and the EU and the devastating drought
in Australia have fuelled the sharp price rises. The Ukrainian export quota
has also contributed to higher world market prices in other countries.

Chart 1 shows that prior to the implementation of the quota, Ukrainian EXW
prices tended to mirror world market prices minus a margin of roughly 25
US$/t. Since the imposition of the quota, however, this margin has increased
to roughly 50 US$/t as Ukrainian grain price developments have been divorced
from corresponding world market price developments, and Ukrainian EXW
prices have remained essentially constant. (2)

The result is that 25 US$/t less is being paid for grain at the EXW level
than would be the case without the export quota system. It is safe to assume
that the resulting reduction in farm gate prices is at least as large.

Assuming that this reduction in farm gate prices is maintained over the
entire marketing year, wheat producers stand to lose a total of US$ 350
million in revenues (25 US$/t over 14 million t). If farm gate prices for
all grains fall by a similar amount, revenue losses of US$ 875 million could
result. (3)

At the same time, Ukraine as a whole is losing export revenues and the
corresponding foreign currency earnings as a result of the quota.

If the price relations prevailing in the first 8 months of 2006 are taken as
a guideline, FOB prices for Ukrainian wheat would have followed the
international trend and would be in the neighbourhood of 190-200 US$/t at
the moment, if not for government interference in the form of the export
quota.

Using this price, and a (conservative) average monthly export volume for
wheat before the quota in the order of 0.5 MMT (which corresponds to
slightly less than the average monthly wheat exports during the previous
four seasons), Ukraine is currently foregoing export revenues for wheat in
the range of USD 100 million per month.

For barley, similar calculations based on average exports of 0.4 MMT and a
FOB price in the neighbourhood of 140 US$/t suggest additional forgone
monthly export revenues of another USD 60 million. For corn, losses would
range around US$ 30-40 million.

Until mid November, these losses accrued fully because effectively no
official exports were taking place. Since then, limited exports have resumed
under the quota system. Nonetheless, based on the estimates in section 1,
we can safely assume that the current quota for grain exports until end 2006
effectively cuts grain exports to 1/3 or so of their level without quota.

The estimated total reduction in export earnings until year end would
thus amount as a minimum to approximately to US$ 300 million and

increase the current account deficit by 0.3% of GDP all else equal. (4)

Proponents of the export quota might object to these calculations by
pointing out that these export revenues are only temporary and can be
recouped later on, if the quota was to be lifted or relaxed and exports
re-allowed. This reasoning misses two important points, however.

First delayed exports result in a number of costs. The grain in question
must be stored in the interim, which leads to financial losses in the form
of bound capital, and quality losses in storage. Moreover, real economic
losses accrue to grain traders, who have hired transport ships, at the cost
of several tens of thousands of US$ per day.

Second, there are obvious limits to Ukraine's storage capacity, and given
the S&D statistics presented above, not all producers will be able to wait
things out. The opportunity costs of not being able to export today could
thus be significant, particularly for smaller producers without access to
their own storage.

In fact, if the purpose of the export quota - to lower consumer prices for
grain and grain-based products - is taken seriously, then over the marketing
year there must be some significant net reduction in exports (so that
domestic supply is significantly increased and prices are effectively
reduced). Hence, a reduction in net export revenues is the inevitable price
that Ukraine pays for implementing a binding quota.

These are only the immediate financial damages caused by the export quotas.
The indirect damages due to corruption, loss of investment and damage to
Ukraine's reputation could be significantly higher in the long term:

CORRUPTION: As a result of the difference between the domestic and
world market price, there is a great incentive to obtain export quotas.

For instance, if the difference between the domestic and international price
for wheat is around US$ 25/ton and if the allowable quota is 0.4 MMT for
wheat, then the value of this quota is US$ 10 million until the end of 2006.

This is a pure profit transferred directly to the enterprise that was able
to obtain the quota and represents a significant incentive for corruption.

If the government allocates the quota on a competitive basis, some of these
profits could be recouped through an auction. However, so far, the quota
system has been administered in a largely non-transparent way. (5)

LOSS OF INVESTMENT: The export quotas for grain make mockery
of government claims that it welcomes and wants to attract foreign
investment in agriculture. The total stock of FDI in agriculture amounted
to US$294 million as of April 2006, with significantly higher numbers in the
downstream food industry.

The de facto export ban hits firms that have been at the forefront of
efforts to modernize and transform Ukrainian grain production and marketing,
and have invested in upgrading grain storage, transportation and port
infrastructure.

This investment, the corresponding jobs and transfer of know-how are at
risk, if Ukraine's Government is perceived to be an unreliable partner.

LOSS OF REPUTATION: Ukraine is an important European grain
exporter. For international grain traders, reliability of supply is
important.

The introduction of the quota and the subsequent complete stop to grain
exports for a couple of weeks have not only imposed direct financing,
storage and shipping tonnage costs on producers and grain traders, but also
meant that some traders were unable to fulfill delivery orders at the other
end on time.

This has a price, too, and means that Ukrainian grain may henceforth be
traded at a discount to compensate for export and delivery risk.

The loss of reputation is naturally highest in the grain market, but it
could extend to other sectors where foreign investors may ask for a risk
premium to compensate them for the uncertainty surrounding government
policy.

This creates the risk that the grain is purchased by a trader and stored but
the quota is not obtained. This is clearly not in line with international
practices.

WTO MEMBERSHIP AT RISK: A final economy-wide cost of the
quota is that it may cause complications to Ukraine's WTO accession bid.
As noted above, under paragraph 1 of Article XI of the GATT, quantitative
restrictions are in principle ruled out.

Since this concerns an agricultural commodity, the rule can be waived if
the quantitative restriction is needed to support domestic agricultural
policies.

In fact, however, Ukraine would have a hard time justifying its stance on
acceptable principles. First, with the grain harvest at 35 MMT in 2006,
there is no real issue over food security that would justify an export
limitation.

In fact, Ukraine still applies an import tariff of 20 Euro per ton on corn
(6), rye and barley and of 40 Euro per ton on wheat. WTO members could
reasonably ask for this to be removed first, if the issue was one of
immediate food security (as provided for in the so called "safeguard
clause").

Second, from the point of view of supporting agriculture, the present quota
makes no sense at all, since the bulk of the costs are in the end borne by
grain producers.

However, we use the cautious formulation "may cause complications" above
because WTO members tend to be far more sensitive about import than
export restrictions.

Indeed, if anything, Ukraine is as a result of its export restriction
subsidizing grain exporters from Russia and Europe, who are gaining
market share and benefiting from marginally higher prices given the lack of
supply from Ukraine.

[3] WHO GAINS FROM THE QUOTA? FLOUR AND FEED
PRODUCERS, NOT CONSUMERS
Despite its large costs, proponents of the quota may still argue that these
costs are only borne by international grain traders and hence don't really
hurt average Ukrainians, whereas the benefits of lower domestic food prices
are widely shared and particularly welcome for the poor. This argument is
not borne out by evidence.

As Chart 2 suggests food prices have on the whole tended to dampen rather
than push consumer price inflation over the most recent 12 months. Flour and
bread represent 0.54% and 3.87%, respectively, of the consumer price basket.

Thus while the price of bread has an important symbolical value in a country
that experienced one of the worst famines ever recorded in the 1930s, it is
not a major contributor to the cost of living.

Even if the recent rise in international grain prices had been fully passed
through to domestic consumers this would have led only to an increase of
1.75 percentage points in the CPI.

In fact, since the imposition of the grain quota, flour and bread prices
have increased, by 2.3% and 2% respectively in the month of October. This
has happened although the domestic price of wheat has been constant since
the summer. Hence, whatever benefit has been derived from keeping grain
prices low has not been passed on to consumers so far.

One reason why this is the case is that the price of flour and bread
reflects a host of factors, including the price of energy, wages,
transportation to market and a retail margin.

Energy prices, for instance, have increased significantly in the domestic
market since the summer and this may account for higher flour and bread
prices.

In some instances, even abstracting from other cost factors, the impact of
lower grain prices on consumer food prices will be effectively nil in the
short run. Take the livestock feeding sector as an example. Since the stock
of animals to be fed is more or less fixed in the short run, the demand for
feed grain is also more or less fixed.

Thus should feed grain prices fall, this will have no immediate impact on
the supply of meat and cattle and hence no immediate impact on meat and
dairy prices (a somewhat price elastic supply curve may exist in the poultry
sector).

Furthermore, in particular in the pig and poultry industry meat and
feedstock production are vertically integrated and relatively highly
concentrated.

In the absence of competition there is no reason why meat or feed
producers should pass lower costs on to their customers.

There is every reason to fear, therefore, that the net impact of export
quotas will largely be to tax farmers at one end, and inflate the profits of
meat producers and feed and flour mills at the other, with little or no
noticeable impact on consumer prices, at least in the short run. (7)

At the conceptual level, export quotas are an exceedingly ill-targeted tool
to help consumers who are truly threatened by food price inflation.

To the extent that export quotas for grain really do result in a measurable
reduction in food price inflation, all consumers benefit; rich and poor.
There is no denying that increasing food prices could represent a
significant burden to poor Ukrainians.

But certainly not to all Ukrainians, many of whom have benefited from
increasing real incomes over the last five years of economic growth. A
significant share of whatever benefits the export quotas generate will not
go to help poor consumers but rather be 'wasted' on consumers who can
actually afford to pay more for food.

In summary, the argument that export quotas are designed to support
consumers is weak. Experience with similar interventions in Ukraine and
elsewhere shows that it is often instructive to consider whether perhaps
there are other 'hidden' beneficiaries, who are using populist arguments as
a cover for other motives.

In particular, anyone who manages to export despite the export quota system
(i.e. smugglers or those who succeed in bribing officials) will profit
handsomely. Based on the price data presented in Chart 1 above, the margin
between the world market price for wheat and the corresponding EXW price in
Ukraine is currently roughly 25 US$/t higher than is usually the case.

We noted above that for wheat alone this provides a pure profit to anyone
able to export totaling US$10 million until end 2006. This profit provides
both a powerful incentive to get around the export quota system, and the
financial means of 'persuasion' to do so.

Indeed, many observers suggest that the underlying purpose of the export
quota system is not to reduce exports but rather to make them more lucrative
(at the expense of Ukrainian farmers) and to redirect the proceeds into
certain pockets.
4. POLICY RECOMMENDATIONS
The grain quota is a costly tax on producers and investors in the
agricultural sector. It is an ill-advised policy instrument, giving rise to
fears of corruption and damaging Ukraine's reputation.

Moreover, taxing farmers to help consumers (even if it were more effective
than we show to be the case presently) is clearly inconsistent with the
stated policy goal of supporting agriculture in Ukraine.

Indeed, according to the draft 2007 budget, 7.3% of total public expenditure
will be channeled towards agriculture, the equivalent of 1.8% of Ukrainian
GDP.

It is contradictory to give this money to agriculture with one hand, and
take it away via export quotas with the other. Clearly, it would make more
sense to reduce farm subsidies and use the resulting fiscal space to reduce
taxes (thus helping consumers) and/or provide consumers with direct income
transfers to help them cope with increased food prices.

The main policy recommendation that follows from the analysis in this short
note is to abolish the export quota as soon as possible. Time counts,
because of the costs that even a temporary quota imposes both financially to
grain producers and traders and by damaging Ukraine's reputation.

The gains, as this note argues, are skewed to the benefit of flour and feed
mills as well as meat producers rather than consumers at large, and in any
case an export quota is a particularly blunt and distortive instrument to
shield consumers from the effects of rising world grain prices.

Nonetheless, it is important to realize that grain prices may play an
important political role. Indeed, interventions into the grain market are
not new in Ukraine and have been justified in the name of food security in
the past.

Should the government be genuinely concerned about the impact of rising
grain prices on the poor, the first best policy would be to a cash transfer
system targeted to the poorest segments of the population.

As the government deals with the social impact of administrative price
increases for energy and municipal utilities, adding a small cash transfer
program calibrated on developments in domestic food prices would not
represent a significant additional difficulty.

Such transfers should ideally be funded from general government revenue
(and, indeed, fiscal space for them could be easily created by limiting and
reorienting wasteful agricultural subsidies).

In the extreme case of an acute revenue shortage, an export tax on grain
would still be preferable to the quota system since it does not create the
same risks of corruption, whilst generating the same effect of lower
domestic prices.

However, because Ukraine has no market power in the international grain
market, it will still lose significant export revenues from an export tax,
which will translate into lower producer incomes. As we have argued in this
note, the current supply and demand situation in Ukraine's grain market
hardly justifies any government intervention.

The abolition of the grain export quota is one way for the Ukrainian
government to reconfirm its market orientation and reformist credentials.
The sooner this happens the better for average Ukrainians.
-----------------------------------------------------------------------------------------------
ANNEX 1 THE ECONOMIC ANALYSIS OF QUOTAS
A quota is essentially an intervention into the market through quantity
controls with the aim to affect the domestic price. In the case of an export
quota, the government aims to lower domestic prices below the world market
price, which is taken as given in most instances - this is certainly the
case for grain. If the quota is binding, domestic prices should fall to the
benefit of domestic consumers of grain.

At the same time, however, producers of grain (and those companies involved
in the export of grain since Ukraine is a net grain exporter) lose out. How
do these gains and losses compare? This section shows using a simple diagram
that the imposition of a quota generates overall welfare losses - in other
words, the losses of producers are larger than the gains of consumers.

Chart 3 explains why. The diagram shows the supply and demand for wheat in

a price quantity space. The supply curve is vertical, since grain is an annual
crop the supply of which in the short run cannot be altered by policy.

Before the imposition of a quota, the demand curve is downward sloping (the
lower the price, the more is demanded), but kinked at the world market price
P(world). This is because at the world price, producers are indifferent
between selling domestically or abroad and the demand curve becomes the
world demand curve. The domestic economy consumes at a, and total exports
are ae.

If the government introduces an export quota, ab, then domestic producers
will supply domestic demand a, then export the amount allowed by the quota
ab, and after this will be forced to sell the remainder of the harvest on
the domestic market. Hence, after b, the demand curve slopes downward again,
until it cuts the supply curve at point d. This corresponds to a domestic
equilibrium price P(dom) below the world market price.

The welfare effects are simply calculated. As a result of the quota, the
consumer surplus (the area below the demand curve and above the domestic
price level) increases by abcd. However, the producer surplus (the area to
the left of the supply curve and below the domestic price level) falls by
acde. A net welfare loss is created by the imposition of the quota, equal to
bde.

We provide approximate estimates of the size of this welfare loss in the
next section. Suffice to note here, that the size of the area bde is a
function of the gap between the domestic and the international price for
grain, which in turn depends on the size of the quota relative to exports
under free trade and the elasticity of demand (which is represented
graphically by the slope of the demand curve).

However, here it is important to note that there are additional welfare
losses associated with the quota system. This is because, as a result of the
difference between the domestic and world market price, there is a great
incentive to obtain export quotas. Every exporter has an incentive to
allocate additional resources to obtain the quota (the literature calls this
"rent seeking behavior") and these additional resources are a net loss to
social welfare.

The size of this welfare loss depends on the mechanism for allocating the
quota. If this is through competitive and transparent auction, then rent
seeking is minimized. However, usually other means of allocation (nepotism,
patronage, discretion etc.) dominate, and the size of rent seeking expenses
may in fact far exceed the total value of the quota and thus welfare losses
multiply. -30-
-------------------------------------------------------------------------------------------------
FOOTNOTES:
(1) The argument is sometimes made that due to the lower quality of the
wheat harvest, available milling wheat may not exceed domestic demand by

much and hence the quota on wheat exports (particularly if increased to 0.73

MMT) is adequate.
(2) The Ukrainian FOB price in Chart 1 is, since the implementation of the
quota, essentially a fictional price, as no (official) trade is taking place
at the moment.
(3) The impact on poverty would depend on the distribution of agricultural
revenues across the rural population, on which we know little. The household
budget survey does show that the poor are more likely to live in rural
areas, and average agricultural salaries are well below the national
average.
How revenues are distributed within farms is something that would require
deeper analysis, but it is plausible that the reduction in revenues could on
balance hurt the poor in rural areas and thus may actually increase overall
poverty.
(4) Estimated exports from Oct-Dec without quota 1.5 MMT wheat, 1 MMT
barley. Losses if quota is fully utilized are 1.1 MMT of wheat * USD200, 0.4
MMT barley * USD140, totals USD 304 million.
(5) Initially, the Ministry of Economy favored an allocation on a
first-come, first-served basis. Later, the idea of an auction was floated.
In the event, general regulations were issued in mid-November, which would
appear to leave significant room for discretion and also require any
applicant to have grain in storage by the time of the application.
(6) The tariff on corn is 20 Euro/ton or 25% ad valorem, whichever is the
lower.
(7) Note that one of the stabilizing factors for meat and poultry prices in
2006 has been the export ban on Ukrainian meat imposed by Russia. However,
no one has argued so far for keeping this ban in place to stabilize domestic
meat prices.
--------------------------------------------------------------------------------------------------
NOTE: To see the several charts referred to in the article click on:
http://www.worldbank.org.ua
---------------------------------------------------------------------------------------------------
Institute for Economic Research and Policy Consulting in Ukraine
German Advisory Group on Economic Reform
Reytarska 8/5-A, 01034 Kyiv, Tel 38044 278-6342, 278-6360, Fax 278-6336
E-mail: institute@ier.kiev.ua, http://www.ier.kiev.ua
World Bank Country Office Ukraine
1, Dniprovskiy Uzviz St., 01010 Kyiv, Ukraine
Tel: (+38044) 490 6671/72/72, Fax 490 6670, http://www.worldbank.org.ua

of Ministers cancel the quotas for export of grain. The IMF announced this

in a statement.

"The temporary introduction of a quota for export of grain and the
reappearance of the problem involving timely refund of VAT are negative
signals that need to be reversed in order to persuade investors that the
business climate is being corrected," the statement said.

The IMF stresses that despite the Cabinet of Ministers' declared intention
to create a market economy that is open and really works, several of the
steps that have been taken in the past few months do not correspond to the
declared intentions.

The IMF believes that improvement of the investment climate in Ukraine is
one of the main tasks of the government. In this context, the IMF believes
that adoption of non-market decisions in various sectors is inappropriate.

As Ukrainian News earlier reported, the Cabinet of Ministers recently
introduced a mechanism for setting quotas for export of grain. The

mechanism came into effect on October 17.

The total export quotas for 2006 are 400,000 tons for wheat and
wheat-and-rye mixture, 600,000 tons for barley, and 600,000 tons for

corn, and 3,000 tons for rye.

Prime Minister Viktor Yanukovych has said that the Cabinet of Ministers
intends to cancel the restrictions on export of grain after completing grain
purchases into government and regional government reserves.

The Cabinet of Ministers introduced licenses for export of wheat and
wheat-and-rye mixtures in September until the end of 2006.

Grain-market experts have said that grain prices are falling on the domestic
market due to the introduction restrictions on grain exports. -30-

and Dutch ambassadors. Taylor said the "damage is being done to WTO

prospects, to (the) investment climate, not just in the food sector."

Ukraine, once known as the breadbasket of the Soviet Union, is the world's
sixth largest grain exporter. In September, Ukraine's government put limits
on how much wheat could be exported.

A court has frozen the export limits, but authorities continue to defend the
restrictions, saying they must ensure the country has enough wheat to supply
Ukrainians with bread. Rising bread prices in the past have sparked strong
public protests in Ukraine.

The Agriculture Ministry forecasts wheat yield this year at 14.4 million
tons, compared with 18.7 million tons in 2005. Bad harvests have been
reported worldwide, increasing demand for wheat.

The ambassadors argued, however, that credible estimates indicated Ukraine's
wheat harvest this year was in line with normal historical averages and was
nothing to be concerned about. They also said it was unclear how much grain
the State Grain reserve currently has in storage.

Additionally, the diplomats complained that the restrictions were not
enacted in a transparent manner. "In fact, we are talking about the
cessation of grain exports from this country," German Ambassador Reinhard
Schafers said.

The ambassadors said that grain traders from their countries had invested
nearly US$1 billion (EUR790 million) in the Ukrainian economy and were

now facing losses in excess of hundreds of millions of dollars (euros).

"Investors...will think twice if they see the government intervene in the
market," Taylor said. President Viktor Yushchenko has made joining the

WTO a priority, and Prime Minister Viktor Yanukovych said he hoped

Ukraine could join by February. -30-

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