By Shigehiro Shinozaki
Agriculture plays a critical role in economic growth, poverty reduction and food security. The demand for agricultural commodities is increasing, as the world’s population surges to an anticipated nine billion by 2050.
It is imperative, therefore, that we find ways to boost agriculture productivity nationally and globally. This cannot be achieved without improving the productivity of smallholder farmers, given that they produce over 70 percent of global food needs.Agriculture value chains can provide opportunities for smallholders to access high value markets, advanced technology and networks of various value chain actors such as processors, traders and service providers, as well as reduce the cost of doing business.
So, what is holding back the participation of smallholders in value chains? Poor access to finance is a critical pain point for smallholders. It makes it hard for them to survive and grow and impedes their participation in a value chain. In the Philippines, for instance, credit demand in 2014 for priority commodities such as rice, corn, coconut and sugarcane reached US $ 11.3 billion, while the bank credit disbursed for producing these commodities was only US $ 3.4 billion, leaving a credit gap of US $ 7.9 billion. Smallholder farmers face specific challenges in accessing finance. Lack of formal contracts, credit histories, production records and their unstable production and income make it difficult for financial institutions to identify risks associated with smallholders.
Also, smallholders are spread over rural and remote areas and their amount of financing they need for inputs and working capital is usually very small. Servicing these needs results in high transaction costs for financial institutions.
The question is how to fill the supply-demand gap in financing for smallholders to integrate them into a value chain and vitalize the agriculture sector.
Agriculture value chain finance provides a set of financial instruments that can be applied for agribusinesses at different stages, which helps smallholders access the financing they need to expand. There are several financing options besides bank and non-bank credit.
A good example is asset-based finance or using a firm’s valued assets such as accounts receivable, inventory, machinery and equipment as collateral or through sale or lease, while not depending on real estate securities and third party guarantees. Asset-based finance offers cash-in-advance with discount, typically faster than traditional bank credit. It provides various forms of financing, such as invoice discounting, purchase order finance, factoring and warehouse receipt finance but in reality these instruments are not accessible to smallholders as they are not well involved in value chains.
Digital finance, mainly through Internet banking and mobile banking, will bring more opportunities for smallholders and other value chain actors to access timely and low-cost financing.
A 2017 report by business intelligence firm GSMA estimates that out of over 750 million farmers in 69 countries, 295 million have a mobile phone and 13 million have a phone and mobile money account in 2016. The report sees as a potential business-to-person (B2P) market a large share of the estimated 350 million farmers who will have mobile phone in 2020. To integrate smallholder farmers into value chains, a balanced development of four key products (payment, credit, savings and insurance via online and mobile phones) will be needed, together with online trading platforms.
Among these products, online payment is a critical instrument to extend digital financial services to smallholders. In general, cash is king in rural areas. Most smallholders do not know what digital payment is and how to use it and are thus hesitant to go digital. Cash payments are often troublesome. Payments can be delayed if there are no bank branches nearby, which may trigger side-selling, selling their commodities to someone outside of a contract, by smallholders.
Benefits for smallholders
But once smallholders experience that digital payment allows them to conduct fast, easy, safe, low-cost transactions in small amounts on their mobile phones, they will start to trust other digital tools. This facilitates shifting from cash to digital.
Asset-based finance can benefit from digital technology. For instance, digital production records can fill the information gap between suppliers and financial institutions and can be used for invoice discounting. Digitizing warehouse receipts is another promising way to help smallholders raise funds, backed by transparent and traceable data on quality and quantity of crops. This system can allow smallholders to access post-harvest loans. Likewise, digital savings can be an important tool for smallholders. Given smallholder farmers’ unpredictable cash flow, a digital platform enables them to save ahead for input purchases and prepare for unexpected and urgent expenses, through branchless transactions via mobile networks.
Digital insurance platforms offer reasonably low-cost crop insurance for smallholders. Users can register online and pay their premiums with their mobile phones. Weather-index insurance enables smallholders to effectively manage crop loss risks through automated weather stations and satellites.
Finally, online trade platforms can facilitate business connections between smallholder farmers and others on the value chain and further promote trade and supply chain finance.
The above are just some of the benefits for smallholders of using digital financial services so they can better participate in value chains. Meanwhile, still many issues remain to further promote digital value chain financing for agriculture.
Developing relevant digital infrastructure and agent networks needs relatively large upfront investment. Comprehensive policy and regulatory frameworks should also be in place to promote healthy digital financial services and digital finance literacy among smallholders is a must. By addressing these challenges, we can unlock the potential of digital finance to support smallholders on agricultural value chains.
(Shigehiro Shinozaki is Financial Sector Specialist (SME Finance), Sustainable Development and Climate Change Department of the Asian Development Bank)