The need for new partnerships for bolstering agri-finance, and opportunities
The conference focus will be on the strategic use of international and national development finance and philanthropic funds to mobilise private capital flows into smallholder-inclusive agricultural value chains in developing countries.
Smallholder agriculture in developing countries is massively under-funded.
Less than a quarter of the financing needs of smallholder farmers in developing countries are met, leaving an annual financing gap of more than US$150 billion. Around 88 million smallholder farmers (around one-third of all smallholders) who are engaged in loose value chains are facing unmet financing needs (US$84 billion). These farmers are able to reliably produce surpluses and sell them in the market. Smallholder farmers operating in tight value chains (around 7% of all smallholders) mostly produce cash crops and often have contractual relationships with buyers under which they receive inputs and credits. As much as 40% of their short-term financing needs are met by their value chain partners, and another 12% by commercial lenders. Still, alongside almost half of their short-term financing needs, virtually all of their long-term financing needs remain unmet, with the total gap adding up to US$52 billion. Looked at from another angle, the bulk of financing needs (as much as 90%) is in local markets that trade in crops like wheat, maize and cassava.
At current trends, this financing gap will remain largely unfilled over the next decades.
In fact, if a significant part of the 161 million smallholders who currently rely largely on subsistence farming start producing for the commercial market (whether to meet national, regional or global demand), their increased financing needs will fully absorb all the increases in agricultural finance. The gap is not the result of farmers being unable to use the money they need profitably: there is much research that shows that with extra finance, farmers can improve their revenues beyond the costs of such finance. Particularly in Africa there is a large yield gap, that is to say, a large potential to raise productivity to global levels through relatively small investments in inputs and improvements in farm practices. Rather, the gap is linked to the risks that private financiers perceive in agricultural lending.
Public finance is currently the main source of bank lending to smallholders.
Total lending to smallholder farmers amounts to US$56 billion, of which US$25 billion is by informal/community-based financial institutions, and US$17 billion by value chain actors (who in turn finance their loans partly from their capital, partly from lending from public banks, and partly from the private market as either bonds or loans). Lending by formal financial institutions is only US$14 billion, with around US$9 billion coming from state banks, US$3 billion from micro finance institutions (MFIs), US$1 billion from commercial banks (mostly through value chain and warehouse receipt finance), US$350 million from social lenders, and non-governmental organisations for a smaller amount.
This implies that those responsible for providing public funding (international agencies, governments, foundations) achieve, on average, close-to-zero leverage.
When it comes to bank lending, on average, every dollar of public funding unlocks, even in the most optimistic of assumptions (that private financiers would not have funded agriculture at all had it not been for the support of public finance) only 10 cents of private finance. More likely, commercial banks would have provided the little agricultural lending that they did anyway, and in net terms, public funding may even have displaced commercial finance (for example, because subsidised rates make it impossible for banks to compete). There is also no indication that currently public finance plays any significant role in incentivising value chain companies to fund smallholders.
Using public finance more effectively can be the key to addressing the financing gap.
While public finance now provides a major part of formal-sector agricultural bank lending, its growth is constrained. Under current trends, the growth of private sector finance is insufficient to meet the growing demand for finance from farmers. This means that if one wants to seriously tackle the problem of underfunding for smallholders, one needs to change the trends. While this will require action on various fronts, a major opportunity to drastically speed up the growth of agricultural finance lies in the more efficient use of public finance – in particular, make it into an effective means to leverage private sector funding. More specifically, it should focus on risk management.
In the broader area of development finance, much recent attention has been given to the possibilities for using public finance to leverage other funding.
The idea that public funding, rather than being used to finance all of a project or transaction, can be more efficiently used to unlock private sector finance – thus achieving leverage – is not new. In infrastructure, the concept (often under the guise of public–private partnerships) was developed actively from the 1990s onwards. Under the new name of blending, it received a boost in recent years with the work of the Organisation for Economic Co-operation and Development (OECD)/World Economic Forum “ReDesigning Development Finance Initiative” (RDFI), which promoted blended finance as public–private cooperation to “catalyse domestic and foreign capital at much greater scale by mitigating the risks that impede investors from pursuing otherwise attractive infrastructure and industrial investment opportunities”. RDFI identified 2016 as the year to “operationalise blended finance activity and opportunities”.
Any kind of public finance can be structured to achieve leverage – whether it’s from international organisations, governments or foundations and for agricultural finance it makes sense to cover all these public financing sources.
RDFI defines blended finance as “the strategic use of development finance and philanthropic funds to mobilise private capital flows to emerging and frontier markets, resulting in positive results for both investors and communities”. Blended finance aims to achieve leverage and impact, while allowing private sector partner financiers to receive reasonable returns. This is the definition adopted in this concept note, however with one important proviso. RDFI limits its discussion to development finance coming from outside of the target countries of the investors (e.g., RDFI focuses on international and bilateral development finance institutions, DFIs, as well as private foundations). In this concept note, development finance is taken to include also concessional finance provided by national governments within their countries, for example through central bank facilities. Furthermore, in this concept note blended finance is taken to cover both investment and working capital/trade finance, as from the perspective of farmers and other actors in the value chain the two are complementary, and the logic of blending can be equally applied to both.
Blended finance in the agricultural sector deserves its own debate.
Most discussion of blended finance has been on healthcare, financial services and infrastructure, in line with the major activities funded in this manner. In its 2015 survey, OECD/WEF found that among respondents, only 4.7% of blended finance had been for food and agriculture. Given what was noted earlier on the role of public funding for smallholder finance (and also, the new interest of the European Union in blended finance for agriculture, through its AgriFI initiative), it makes sense to engage in a specific debate on how blending tools can be used to leverage finance for agriculture. This debate should learn from other sectors, and involve not just international public financiers, but also developing country governments as well as the entities that are able to cross the distance between international financiers on the one hand, and farmers on the other. Best placed are developing country commercial banks, value chain actors and NGOs active in agricultural value chain development.