Value Chain (VC) involves the sequential linkages through which raw materials and resources are converted into products for the market.
Agricultural Value Chain (AVC) identifies the set of actors (private, public, including service providers) and a set of activities that bring a basic agricultural product from production in the field to final consumption, where at each stage value is added to the product.
It may include production, processing, packaging, storage, transport and distribution. Each segment of a chain has one or more backward and forward linkages.
Thus, with AVCs, we move away from a commercial, segmented form of agriculture in which many separate links operate in isolation, out of sync with each other, in which farmers produce in bulk, are exposed to price risks and capital needs and produce independently.
The AVC is based on integrated systems, differentiated production, risk management, information needs and interdependent farmers.
Agricultural Value Chain Finance (AVCF) is thus, the flows of funds to and among the various links within the AVC in terms of financial services and products and support services that flow to and/or through VC to address and alleviate constraints, and fulfil the needs of those involved in that chain, be it a need for finance, a need to secure sales, procure products, reduce risk and/or improve efficiency within the chain and thereby enhance the growth of the chain.
VCF is a comprehensive approach which looks beyond the direct borrower to their linkages in order to best structure financing according to those needs.
Financial inclusion in the conventional sense aims to bring in those households and enterprises that are presently unable to transact their service requirements through the formal financial institutions.
An examination of the African financial sector landscape shows that there is a significant financial intermediation deficiency, and the excluded households are more likely to be in rural areas, despite the vigorous growth of the institutional infrastructure and outreach of services.
The key features of the financial sector in Africa, and which also impact on the provision of VCF, especially among the low income countries in Sub Saharan Africa, include:
The small size of the sector, as measured by the absolute size of liquid liabilities and the ratio of liquid liabilities to gross domestic product (GDP). Many African financial systems are smaller than a mid-sized bank in Continental Europe,with total assets often less than $1 billion. This, among other things, can prevent banks from exploiting scale economies or undertaking large investments into technology, especially those with high fixed costs;
The shallowness of the sector: financial depth and efficiency, as measured by credit extended (private credit to GDP) is low. Ratio of liquid liabilities to GDP average 32 percent in Africa compared to 49 percent in East Asia and Pacific and 100 percent in high-income countries, while the ratio of private credit to GDP average 18percent in Africa compared to 30 percent in South Asia and 107 percent in high income countries. The low credit compels Micro, Small and Medium Enterprises (MSMEs) to rely less on bank financing than on internal funds and micro-credit;
The high exposure to economic and socio-political shocks, including crop failures, sharp changes in prices of traded commodities, civil unrest, and unexpected changes in Government or Government policies not only limit the time horizon of savers and investors alike, but also reduce the incentives of banks to lend long-term;
The high incidence of informality,especially lack of documentation and formal contracts in personal, professional and business transactions, which also accentuates information asymmetries already prevalent in the system, excludes many households and micro-entrepreneurs from the credit markets;
Governance and regulatory deficiencies, including weaknesses in the contractual framework, high degrees of corruption, risks of expropriation, lack of capacity of the regulatory institutions and inefficient bureaucracies as well as information asymmetries limit the extent to which the benefits from financial sector reforms can reach the majority; they also explain the focus on short-term transactions rather than long-term commitments.
Intermediation deficiency: the inefficiencies, high risks and lack of effective competition result in expensive banking services, reflected by high interest rate spread and margins, high minimum deposit requirements, and high lending interest rates. Meanwhile, banks, which dominate the system, remain highly profitable and liquid.
The dominance of the banking sector,which underlines the importance of encouraging banks to be involved in VCF. However, bank lending in general is still heavily geared towards the short end of the market for various reasons: bank balance sheets are dominated by short-term deposits; banks face acute problems of lack of information about creditworthiness of potential clients and difficulty of enforcing contracts and creditor rights that increase the risk of loan default. Weaknesses of the legal system (laws, registry, operation of courts),especially regarding property rights, limit the number of creditworthy borrowers and the capacity of financial institutions, and other deficiencies in the governance structure in many countries (high degrees of corruption, the risk of expropriation and inefficient bureaucracies).
As a result, small farmers, in particular, often borrow from informal sources (family, friends or moneylenders) that typically charge high interest rates and have limited potential to expand.
Besides, most credits flowing to agriculture, whether from formal or informal sector, have been short-term and to some extent medium-term. Generally, short-term finance does not have significant impact on farm cultivation and, therefore,does not improve overall output and incomes.
Low productivity,combined with very limited on-farm processing, forces farmers to sell their produce in unfavourable market conditions at low prices. At the same time, the smallest of farms do not have the resources to improve productivity and benefit from the different schemes of Government. In many African countries, India and some other developing countries, availability of bank credit is the gateway to avail several benefits such as interest subsidy on credit, investment subsidies linked to credit, crop insurance and participation in VCs.
Thus, inclusive growth is closely linked to financial inclusion for the farming community. A more important part of inclusion is the design of products and processes that match the needs of the farmers. These needs reflect the compulsions of the crop sector in which they are engaged and consequently, the VC activities.
Ordinarily,banks will not invest adequately in understanding the nature of demand and the nuances of the different VCs. This lack of information leads to the design of financial products that are not appropriate to most rural activities.
Thus, agricultural finance is more than just finance; financial services need to be linked or integrated with other services including input supply, post-harvest and storage, processing,marketing, research and technology, training and extension, among others.
VCs in agriculture play a vital role as an approach to minimising costs and risks of financing the agriculture sector. Thus, VCF is a potent tool for banks and financial institutions to design tailor-made financial services needed by the agriculture sector.
The benefits of VC financing approach to expand access to finance to the agriculture sector are, reduced transaction costs; improved product quality and delivery; safer, longer lasting relationships between players; and provision of a general framework to facilitate communication, problem solving, efficiency and improved market competitiveness.
On the supply side, AVCF can improve the quality and efficiency of financing agricultural chains by:
Identifying financing needs for strengthening the chain;
Increased funding coming from suppliers and agribusinesses directly involved in the chain;
Tailoring financial products to fit the needs of the participants in the chain;
Increasing credit worthiness, since participation in the chain can enhance the security of loan repayment;
Reducing financial transaction costs through direct discount repayments and delivery of financial services; and
Using value chain linkages and knowledge of the chain to mitigate risks of the chain and its partners.
Thus, the AVCF offers an opportunity to expand the financing space for agriculture by improving efficiency, ensuring repayments,and consolidating VC linkages among participants in the chain.
Dr Mugano is an author and expert in Trade and Competitiveness. He is a Research Associate at Nelson Mandela Metropolitan University and a Senior Lecturer at the Zimbabwe Ezekiel Guti University. Feedback: Email: firstname.lastname@example.org , Cell: +263 772 541 209.