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Rural Finance and Agricultural Development

Agricultural transformation in the current era involves a world of rapidly changing agrifood systems. In particular, the changing nature of retail systems, with the rise of supermarkets, and the global food chains that supply them have created many opportunities as well as potential problems for the world’s smallholders as well as many finance-related issues (for useful references see Reardon et al. 2003; Swinnen and Maertens 2007; McCullough et al. 2008). Some of the related finance issues are discussed in this section.

The literature that deals with finance in the context of agricultural transformation and development (for recent surveys see Conning and Udry 2007; Karlan and Morduch 2010) has highlighted several pertinent issues:

  • • Financial market imperfections that limit access to finance is key to agricultural and overall development.
  • • Access to finance is not easy to measure. Financial access by agricultural households is limited in Low-Income Countries (LICs) and Emerging Market Economies, and barriers to access are common.
  • • Different financial services are required by different groups of farmers. Risk management and mitigation are of paramount importance for the poorest.
  • • Insurance cannot be separated from credit.
  • • Access to finance is both pro-growth and pro-poor. Spillover effects of financial development are likely to be significant.
  • • Provision of financial services to the poor will require subsidies.
  • • For the rural smallholders (about 450 million worldwide), credit is not the only service needed, but also savings and payment systems.
  • • Multinational buyers increasingly rely on smallholders for procurement of supplies. The chief obstacle is a largely unmet need for formal value chain finance.

The size of the unmet demand for rural smallholder finance is huge. A report by Dalberg (2012) estimates the demand for smallholder finance in the foreseeable future to be on the order of US$450 billion per annum, of which only about 2 percent is currently met by “social lenders” defined as impact investors, who seek a combination of market returns and social impact. Impact investors generally accept lower-than-market rates of return in exchange for achieving social or environmental goals not easily quantified by the market. Microfinance institutions are, for instance, a form of social lending.

The above estimate is based on the rather dubious assumption that of the 450 million smallholders, 225 million are subsistence farmers who do not currently need finance, while the other more “commercial” smallholders need on average US$1000 short-term finance per annum and US$1000 longer-term finance amortized over several years. However, even smallholders have financing needs, and clearly if one adds the financing needs of smallholders, which do not amount to zero, the numbers are considerably larger.

Social lenders have established a successful model for providing shortterm export trade financing to producer organizations and agricultural businesses that reach smallholder farmers. This is where the bulk of financing for agricultural smallholders goes. However, given that only 10 percent of smallholders belong to producer organizations, social lenders could currently address only US$22 billion of the short-term total financing demand or only 5 percent of the total demand. Of that, 90 percent is for export trade finance, and this overlooks the huge demand for finance of staples, which comprises more than 90 percent of total demand for finance.

The Dalberg report proposes five distinct strategies, or “growth pathways”, for deploying investment that meets smallholder finance demand:

  • (i) replicating and scaling existing social lending financing models,
  • (ii) innovating into new financial products beyond short-term export trade finance, (iii) financing through out-grower schemes, (iv) financing through alternate points of aggregation, and (v) financing directly to farmers. These pathways map to particular value chain typologies, geographic focus, and cost structures. In particular, the efficiency of capital varies for each market pathway, because each involves a particular mix of the following costs:
  • • R&D costs, for developing and piloting models
  • • Marketing costs, for acquiring and educating customers
  • • Operating costs, for handling and servicing customers
  • • Risk management costs, accounting for volatility and the cost of capital

Each of these five growth pathways is discussed briefly below.

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