Supply Chain Financing: Scope for Rural Finance Interventions

‘Rural Finance in Afghanistan and the Challenge of the Opium Economy’

Kabul, Dec 13-14, 2004

Douglas Pearce Head, Financial Sector Team Department for International Development (DFID), UK

Supply Chain Financing Globally = the Principal Source of Credit for Agricultural Production

50% of the rural popn. in El Salvador that accesses credit, does so from wholesaler, retailers, processors

Leading companies in Southern Africa provided $91m in credit to 530,000 households 2001-2003

Kenya Tea Devt. Agency: 400,000 small farmers in fertilizer credit scheme, disbursing $15m annually

270,000 smallholders received input credit from tobacco & cotton companies in Mozambique 2002/03

Supply Chain Finance/Agribusiness Credit: Principal Mechanisms

Contract Farming and Outgrower Schemes Buyer (trader, processor, wholesaler,

exporter…) provides inputs on credit, linked to purchase.

Trader/Supplier Credit Inputs on credit, or Advances during growing season for range

of uses (in cash or in kind)

Inputs on Credit Produce

Examples of Supply Chain Financing

Hortifruti, Costa Rica [Contract Farming] Specialist wholesaler for supermarket chain Technical assistance & information, calendar of

production, financing etc to pool of growers Aim = to ensure quality, quantity, and timing

Salaam, Afghanistan (trader advances) Trader gives advance payment as loan against

future delivery of agreed amount of crop (e.g. opium)

Aim = to secure supply, and to reduce price risk for trader

Inputs on Credit Produce

Characteristics of Supply Chain Financing/ Agribusiness Credit

Credit linked to supply or purchase transactions Primarily input credit (seasonal credit or short-term

advances), not financing for other uses Credit alongside inputs, advice, market access Interest rates not always applied Delinquency & default can be

a problem (side-selling) If traders have too much market

power, can abuse position

Can we build on Supply Chain Finance to extend Rural Finance?Agribusiness credit has key advantages to offer: Outreach Client Knowledge Reduced Risk

And has deficiencies that merit interventions: Narrow Product Range Scale of credit operations limited by access to credit, technical

know-how, market linkages etc Side-selling Access for smaller and more marginal farmers can be limited Abuses of market power (unfavourable terms, indebtedness

leading to loss of land)

Possible Donor Interventions

1. Facilitate the entry of financial institutions Support the development of brokers/agents Assist traders/processors to set-up finance companies Small Farmer Associations

2. Assist Traders/Processors to learn from microfinance: Upgrading client-monitoring systems Sub-contract lending activities,

leaving scope for other types of loans? Adopting microfinance techniques

3. Improve the enabling environment

for rural finance

Linkage Model: Broker or Loan Service Agent

Specialist intermediaries that can lower the risk and cost of dealing with small farmers

Loan service agents (for agri-business or financial institutions)

Brokers, that link farmers to financing

[NB have to face thorny question of working with rural hawala dealers]

Inputs

Loan

Produce

Selection & Monitoring

Broker or

Service Agent

Repayments

Fees

or

Trader/Processor Finance Companies

Processors or wholesalers can set-up finance companies to conduct credit operations

Better-placed to improve and widen credit products and increase efficiency and scale

Credit Facility

ProduceInputs

Small Farmer Associations

Donor support to specialized agencies that promote market-oriented associations

Associations can increase scale of production reduce costs for lenders facilitate TA and input provision Increase bargaining power of small farmers

$ Inputs Produce

Positive Policy & Enabling Environment Critical

Credit bureau

Instruments to reduce default risk

Collateral registration procedures/warehousing facilities

Transport and communications infrastructure

Market access and functioning supply chains are critical for viability of alternative crops

Opium-related Indebtedness – Additional Options

Use community mechanisms e.g. jirga, to negotiate debt restructuring, with additional loan/grant (re-)financing in severe cases

Loans or grants for buying back mortgaged land/assets? [NB need to monitor loan use, as money is fungible]

Remittances (from seasonal or longer-term migrants) also a key source of funds to break cycle and support alternative activities

For Donor Interventions to be effective

Build capacity of existing and potential traders/processors or agents, rather than creating new institutions

[Also NGOs as facilitators, not as market players]

Grant and technical assistance should be timebound, transparent, and open to >1 trader/processor/agent

Financial institutions better able to finance traders/processors, agents, or farmer associations, rather than individual small farmers

Better understanding & monitoring of financial flows needed

Don’t subsidize loans/inputs to farmers –

undermines financial sector/agricultural markets

Interventions should increase competition