Key message: despite the enormous commodity potential in developing countries, agricultural finance has been decreasing steadily over the past 20 years and new modes of financing are needed.
Geneva, 27 April 2007 - The commodity sector is the mainstay of developing countries and LDC economies; it sustains their food security, export earnings and rural development. Prospects for increased world demand for agricultural products are good, yet in many developing countries, agricultural production has grown only slowly. This lack of competitiveness is often reflected by rising food import bills.
To become more competitive and carry out higher value-added activities, including through diversification, farmers and other commodity producers must have better access to finance, including through more efficient and innovative loans and other financial schemes.
Most developing countries have enormous untapped commodity potential. There is considerable scope for more effective use of resources and for higher productivity. A lack of finance makes it very difficult for operators to tap these potentials, however, let alone meet challenges such as more stringent global market requirements, adaptation to new technologies, and stiffer domestic competition because barriers to imports are being lowered to meet World Trade Organization (WTO) requirements. Financing problems also affect the broad environment in which farmers operate. Producers and processors do not have the funds to invest in proper equipment, which leads to unnecessarily high production and processing costs. And infrastructure in rural areas is often weak, leading to high transaction costs and larger risks for producers and financiers.
Indeed, financing constraints have worsened over the 10-15 years, particularly for agriculture and agro-processing. This is despite the fact that addressing financing obstacles is a major focus of rural development programmes. Agricultural finance has been decreasing since the 1980s. In the 1990s, there were steep declines in many countries, often as the result of commercial banks retreating from the sector. Where finance was available, it was mostly provided to large borrowers, thus excluding the majority of small producers from the formal credit system. In addition, external assistance to agriculture in the LDCs declined, with average annual official development assistance (ODA) falling by 20% between 1981-90 and 1991-99.
A renewed focus on commodity finance and rural development is needed.
In recent years, work and research, including by international organizations such as UNCTAD, on structured commodity financing has received more attention. New methods are proving to be successful. The main focus of such financing is based on viewing the borrower (whether a producer, farmers´ association, processor or trader) as part of the commodity supply chain. A supply chain approach is in effect the safest way to provide financing. Credits are based on the performance of the borrower in the chain, rather than on the borrower´s credit risk. This strategy also allows financiers to mitigate risk by grouping credits; they thus can be reimbursed through one or a few buyers rather than a multitude of small farmers. Also, the incentives for farmers to submit (and reimburse) under their supply arrangements are strong, and the risks that the financier runs are basically limited to crop risks - the risk that the farmer does not produce enough, or does not produce the required quality. It is also important to note that from the farmers´ point of view, supply chain finance reduces the cost of credit. These methods reflect emerging trends characterized by the increased integration of farmers, processors and traders in national or global supply chains (for example, farmers growing crops under contractual schemes with traders or exporters, or growing crops for sale under contracts with supermarkets).
Another risk-averse approach is "warehouse receipt and collateral management finance." With proper warehousing and collateral management systems in place, farmers can store their commodities, once produced, and obtain warehouse receipts (expressed in kilos and tons of produce that they have deposited in a safe warehouse). They can then pledge the respective warehouse receipts or draw on their accounts to obtain cash or buy inputs. This system allows farmers greater control over their marketing decisions, as they are no longer forced to sell directly after harvest at prevailing prices to meet their cash flow needs. Instead they can store their produce, wait for better times and prices, and obtain financing against their stocks.
Financing for agricultural commodities is much easier to achieve if mechanisms are in place to reduce risks pertinent to the commodity sector (for example, risks arising from natural causes, price volatility, and inadequacy of traditional collateral). The role of domestic banks is crucial in this regard. They can provide tools to mitigate these risks through, for example, the provision of catastrophe bonds, weather insurance, and price-hedging tools, and can provide credit according to the borrowers´ needs to improve production capacity, in this way enhancing the borrowers´ ability to repay loans.
For innovative structured financing mechanisms to work, institutional inadequacies must be overcome. This has been repeatedly stressed by UNCTAD, which has been advising developing country governments to provide the necessary legal and regulatory frameworks to encourage financing for the commodity sector. Experience has shown that institutional weaknesses in developing countries, coupled with a failure of governments to provide an appropriate legal environment, has led the banking sector to move out of agricultural finance. These shortcomings must be addressed.
There is also a need for private-public partnerships (PPP) in commodity finance. Poverty cannot be reduced without business partnerships. Such partnerships cannot be achieved without government policies that encourage such arrangements. PPPs can include investments in irrigation systems and warehouses in rural areas; improvements in roads and other transport infrastructure that link rural regions to ports; development and upgrading of ports and airports; and the building of grading and testing facilities.
Yet another important element is South-South trade. Importing and exporting of commodities between developing countries has expanded rapidly in recent years, but financial support for such flows is still lacking. Finding ways to strengthen South-South financing can be a win-win arrangement. It can reduce poverty, lower the costs of trade, enhance South-South investment, and bring attractive returns to those providing the finance. Several options can improve the situation, including the creation of a new, dedicated financing institution; strengthened cooperation among developing country Export-Import Banks and Development Finance Institutions (as is being done under the "Global Network of Export-Import Banks and Development Financial Institutions" -- GNEXID -- established by UNCTAD); strengthened trade-finance support organizations; and the creation of new financial capacity by setting up investment funds earmarked for South-South trade and investment.