Demand_and_Supply_of_Short-Term_Credit_in_Agriculture_-_August_20_2011.pdf

Demand and Supply of Short-term Credit for Zimbabwe’s Smallholder Agricultural Commodity Value Chains

Zimbabwe Agricultural Incomes and Employment Development (Zim-AIED) Program

April 2011

This report was produced for review by Fintrac and the United States Agency for International Development under USAID/Fintrac Task Order #EDH-I-08-05-00007-00. It was prepared by International Relief and Development, Inc.

The views expressed in this report do not necessarily reflect the views of the US Agency for International Development or of the US government.

Contents'

EXECUTIVE SUMMARY

1. INTRODUCTION AND BACKGROUND

2. METHODOLOGY

3. THE AGRITRADE THEORY OF CHANGE

4. BANK ESTIMATED DEMAND AND SUPPLY OF AGRICULTURAL CREDIT

4.1. AGGREGATE DOMESTIC SUPPLY OF CREDIT

4.2. BANK ESTIMATED DEMAND AND SUPPLY OF SHORT-TERM CREDIT TO AGRICULTURE

4.3. FACTORS AFFECTING SUPPLY OF CREDIT TO SMALLHOLDER AGRICULTURE

4.4. FACTORS AFFECTING DEMAND FOR CREDIT FOR SMALLHOLDER AGRICULTURE

4.5. TYPES OF CREDIT FOR FACILITATING SMALLHOLDER AGRICULTURAL DEVELOPMENT

5. INPUT CREDIT SUPPLY AND DEMAND SITUATION ON MAJOR CROPS

5.1. INPUT CREDIT FOR FINANCING SMALLHOLDER MAIZE PRODUCTION

5.2. SUPPLY AND DEMAND FOR INPUT CREDIT FOR OTHER RAIN-FED CASH CROPS

5.3. SUPPLY AND DEMAND FOR SHORT-TERM INPUT CREDIT FOR IRRIGATED CASH CROPS

6. CREDIT FOR COMMERCIALIZATION OF KEY AGRICULTURAL PRODUCES

6.1. PROJECTED 2011 CROP OUTPUT AND COMMERCIALIZATION BY CROP

6.2. CREDIT FOR COMMERCIALIZATION OF LIVESTOCK FROM SMALLHOLDER SECTOR

7. POOL OF CLIENTS FOR AGRITRADE REVOLVING FACILITY IN 2011

6.1 FRONTLINE RURAL AGRO-TRADERS IN AGRITRADE

6.2 NATIONAL AGRO MERCHANTS IN AGRITRADE

6.3 AGRO PROCESSING SME’S COMPANIES IN AGRITRADE

6.4 RURAL LIVESTOCK BUYERS IN AGRITRADE

8. CONCLUSIONS AND RECOMMENDATIONS TO ZIM-AIED

9. ANNEXES

Executive)Summary)) The supply of short-term credit for the 2010/2011 agricultural season falls short of demand by an estimated $191.58 million for smallholder agriculture. The estimated shortfall is composed of $75.88 million for commercialization of produce and $115.7 million for agricultural inputs. On the commercialization side the estimated shortfall is based on conservative percentages of commercialization of smallholder farmers’ produce with the commodities with the highest shortfalls being maize ($46.4 million), followed by groundnuts ($10.4 million) and livestock ($7.48 million). In the case of inputs, the study considers the requirements for high potential smallholder farmland accounting for 25% of smallholder landholdings with high enough yield potential to service potential input loans. Smallholder farmers occupying these high potential farmlands have high demand for input credit for maize production estimated at $76 million. Other more profitable crops than maize - beans, chilies, groundnuts, and vegetables – grown under contract or independently would require an additional $36.7 million input credit facility to meet demand from high potential farm areas.

The study examines the current capacity of commercial financial institutions to provide short-term credit and the need for development assistance programs to facilitate domestic banking and financial markets to provide market oriented credit facilities for sustainable smallholder agricultural development. Present levels of domestic saving deposits are failing to stimulate an adequate supply of credit for some parts of the economy. According to the banks’ assessment, they managed to supply $326 million credit to the agricultural sector out of $549 million approved agricultural project proposals. Only the large agribusiness corporations involved in tobacco, cotton, and hybrid seed production and processing are able to purchase an adequate credit supply to satisfy their requirements. In an effort to address this problem, the Government of Zimbabwe and other donors provided $85 million dollars towards free input support programs which benefitted over one million smallholder families with a one-time alternative to using input credit. Taking an alternate approach, USAID approached the problem through the formal credit markets with the USAID funded $20 million Credit Guarantee Facility through Standard Chartered Bank which is believed to have leveraged $49 million worth of credit for large corporate agricultural firms to recapitalize their operations.

The study examines how, in addition to country risk factors affecting aggregate liquidity and the cost of borrowing in Zimbabwe relative to neighboring countries, company specific risk factors affect access to, and the cost of credit to individual firms. The study finds that the most important factors limiting supply of credit to individual smallholder agricultural value chain players is the low supply of liquidity, the high opportunity cost of lending to smallholder agriculture relative to other sectors of the economy, high transactions costs of supplying credit to nontraditional borrowers, the lack of reliable actuarial data concerning both sector risk and individual borrower risk, and statutory regulations about lending capacity of relatively small banks. On the demand side of the spectrum, incomplete information, a generalized distrust of the financial sector as a source of credit, and limited profitability of enterprises limit demand from specific potential borrowers. The high interest rate and risk premium banks levy non-traditional smallholder agricultural value chain borrowers, stringent collateral requirements, and access to free inputs from humanitarian relief agencies dilute demand for credit among small holder farmers and private traders engaged in commercialization of smallholder produce.

Finally, the study examines the approach of the AgriTrade facility of Zim-AIED; a revolving credit facility that provides short-term credit to agribusinesses along profitable value chains starting with production up to marketing. Through the analysis of different potential groups of borrowers, the study concludes that during the first year of its operation, AgriTrade faces demand for a $17.24 million revolving credit facility from its $10 million credit facility. In addition to specific recommendations for AgriTrade programming, the study provides the following strategic guidelines for Zim-AIED

Agribusiness financial initiatives: (a) Zim-AIED financial initiatives should be to specific groups of commercially credible borrowers along the smallholder value chains, prioritizing middlemen traders and contract farming companies that will act as conduits for interlocking input credit provision to high performing smallholder farmers most capable of meeting the crop demands of the contracting companies;

(b) exercise great caution in providing credit directly to smallholder farmers under the present political economy; instead give priority to farmers linked to specific buyers from whom buying contracts can be obtained and who may already have an established banking culture and/or credit history through microfinance institutions; (c) phase credit products to different target group of borrowers along the value chain beginning with trading of agricultural commodities coming from the smallholder sector, which involves relatively low risk and quick turnaround activities as an assured way of quick injection of liquidity into the sector.; and (d) assist lending institutions build flexibility into their product designs and contractual obligations in order to continuously adjust to the changing domestic economic environment and to accommodate lessons learned during the implementation of Zim-AIED and AgriTrade.

1. )Introduction)and)Background) Access to credit is important for the transition of smallholder farmers in Zimbabwe from semi-subsistence to more commercially oriented agricultural production. The majority of the smallholder population has been relying on free agricultural input schemes to sustain a low value semi-subsistence maize based farming system that frequently falls back to food aid. Transition to market-oriented higher value agricultural crops and market organization is required to stimulate the rural economy and increase rural incomes and employment. Ready access to affordable credit is a key ingredient that is currently missing from smallholder agriculture value chains needed to start this transition.

With its renewed emphasis on market liberalization and its limited funding of state owned agricultural credit providers and marketing boards, the Government of Zimbabwe (GOZ) is relying upon the private sector to finance smallholder agricultural marketing activities. Yet domestic financial markets responding to the rising demand for credit from the smallholder agricultural sector face dramatically incomplete information about smallholder agricultural value chains. Discounting this incomplete information, risk averse lending institutions have put a high risk premium on loans to the smallholder farmers and other agribusiness players engaged in (often potentially lucrative) smallholder agricultural commodity value chains. Similarly, imperfect information has also kept many of the small scale traders most active in the smallholder agricultural value chains away from commercial lending institutions because of their continuing distrust of formal banking and financial institutions resulting from Zimbabwe’s recent financial and macroeconomic crisis. Thus, limited access to credit markets remains a major constraint for innovative agribusinesses seeking credit financing of their plans for business growth through the strategic integration of smallholder agricultural production into their trading and agro processing ventures.

Understanding the dynamics in the domestic banking and financial sector that influence lending to smallholder agriculture is of strategic importance to Zim-AIED program – especially given its goal of increasing incomes of smallholder farmers and generating rural employment through increased production and value added processing.

This study assesses the state of supply and demand for short-term credit among agribusiness players engaged in smallholder agriculture. On the supply side, the study examines the current willingness and capacity of financial institutions to provide short-term credit to different entities engaged in smallholder agriculture. It also examines financial institutions’ practices of rationing limited resources between competing sectors. In addition, the study identifies issues that limit the potential for leveraging additional funds towards short-term lending to smallholder agricultural value chain players. Finally, the study observes the growing interest of insurance companies in providing weather indexed insurance products that offer the greatest prospects for smallholder farmers to access seasonal input credit through agribusiness companies interested in exploring contract farming opportunities in smallholder irrigation schemes.

On the demand side, the study uses the value chain framework to examine the short-term financing demand of different players along the agribusiness value chains that integrate smallholder farmers. Given the challenges that smallholder farmers and rural agro-traders face in accessing credit, the study explores opportunities for increasing access to credit through contracting arrangements involving national agro-merchant buyers and agro-processors with better access to credit from financial institutions.

2. Methodology) The study uses two complementary processes: one for assessing availability of credit and the other for assessing the credit demand of smallholder agricultural value chain players. The first component explores the short-term supply of credit for financing post harvest smallholder agricultural production activities and marketing. The second component considers demand for credit by the agribusinesses engaged in smallholder agricultural production and commercialization.

The assessment of availability of credit was based on intensive formal interviews of managers at major financial institutions. Through these interviews information on the volume of credit, loan product types, tenor, cost structure, and bank lending policies towards smallholder farmers and frontline rural agro dealers were reviewed. In addition, publications from RBZ, IMF, and other authoritative sources in the public domain were reviewed.1

The second component of the study focused on assessing demand for short-term credit among those players engaged in smallholder agricultural value chains. Research methods also utilized primary survey techniques and the review of secondary information. The primary survey consisted of formal interviews with established large scale agro-processors, smaller scale agro-processors, agro-merchant buyers, and rural agro-traders. The study included information on smallholder farmers and rural agro-traders which was already available from the USAID-funded Restoring Livelihoods – Strengthening Value Chains (REVALUE) program activities in Manicaland. In addition, data on smallholder farmers’ production costs were obtained from USAID/Zimbabwe Crop Budget Summaries from APS Partner Reports. Other information on agricultural production cost came from AGRITEX manuals and agribusiness firms that are already engaged in smallholder contract farming arrangements. For the calculation of credit needs for agricultural inputs, the study considered the optimal investment requirements of the high potential communal farming lands (mostly in Natural regions IIa, IIb, and III) comprising 25% of the total agricultural land that smallholder communal farmers possess (Bratton 1994). Agricultural households farming occupying high potential arable lands of Natural Regions II and III can potentially achieve greater yields of high value produce to profit from agricultural loans.

3. The)AgriTrade)Theory)of)Change))

Zimbabwe’s economy is undergoing a dramatic economic structural transformation following the dislocating effects of the country’s land reform program and macroeconomic instability. The Fast Track Land Reform Program rendered worthless property rights on commercial farmland that agribusinesses traditionally used to secure business loans. With prolonged legal battles for compensation expected for newly resettled land, resettled new farmers may not be able to use their farmland as security for commercial loans for some time. The hyper-inflations of 2007 – 2009 eliminated the value of cash savings, disrupted loan and credit portfolios, and required a complete shift from using the Zimbabwe Dollar (ZWD) as a standard of value to denominating all transactions into foreign currencies. These crises caused financial institutions to lose their traditional agricultural clientele. It also left many banks without the reliable information upon which to assess the creditworthiness of nontraditional borrowers. The new financial environment also sharply reduced the willingness of small to medium sized businesses to deposit their savings into commercial banking and financial institutions from which these institutions could make loans. Whenever domestic savings are insufficient to satisfy market demand domestic lending institutions typically turn to international capital markets. Zimbabwe’s high country risk profile limits the scope domestic banks have to access these global capital markets for financing most domestic investments except for the most profitable investment ventures from some of Zimbabwe’s globally rated

1 The following 14 commercial banks were interviewed for the study: Standard Chartered bank, CBZ, Barclays Bank, Stanbic Bank, NMB, CABS, Premier Bank/Ecobank, Metropolitan Bank, ZB bank, ZABG bank, First Bank, Trust Bank, Royal Bank, MBCA/Ned bank, one microfinance institution, Micro King, and ZAMFI. The primary survey was undertaken with full participation and technical input of the entire Zim-AIED agribusiness credit and marketing team.

low risk agribusiness corporations. In a tight liquidity situation, credit rationing in favor of high return -low risk investment opportunities renders credit markets less accessible than in the past for a majority of smallholder farmers, middlemen agro traders, and agro processors engaged in the commercialization of agricultural produce from the smallholder agricultural sector.

Zimbabwe’s smallholder agricultural value chain players are struggling to overcome a variety of demand side and supply side structural and institutional barriers limiting their access to formal credit markets. In an environment of incomplete information and endemic mistrust by both lending institutions and nontraditional borrowers engaged in smallholder agriculture, these obstacles have translated into high risk premiums and lower effective demand. For small-scale middlemen traders engaged in commercialization of smallholder produce, high cost of credit inclusive of a high risk premium renders commercial loans unattractive. Traders purchasing produce, especially staple maize grain, from smallholder communal areas operate on very thin profit margins that are susceptible to modest changes in transport costs, consolidation transactions costs, and their costs of capital as they face prices pegged against fixed import parity produce prices offered by end users such as National Foods. Thus any small changes in the cost of working capital for middleman traders can render commercial loans unprofitable and the expansion of private buying operations into distant communal farming areas becomes economically infeasible. For the USAID funded Zim-AIED program, making formal credit markets work for smallholder agriculture value chain players is an important key for achieving sustainable rural development and income growth.

There are two major structural challenges that Zim-AIED (and hence AgriTrade) confronts to unlock access to the supply of credit for smallholder agricultural value chain players from commercial lending institutions. The first challenge addresses the limited supply of appropriately structured credit for smallholder agriculture from Zimbabwe’s financial and commercial banking institutions. Traditionally, agricultural lending in Zimbabwe was primarily to large-scale growers with well-established credit histories and secure title to their highly developed and globally tradable commercial farmland (which made this farmland acceptable as collateral to both domestic and international financial institutions). The land reforms carried out in recent years nullified title deeds on most commercial farmland and caused a structural shift from established large-scale commercial growers to less experienced newly resettled farmers with neither an established agricultural borrowing history nor adequate collateral. These structural changes in the agricultural sector have required commercial banks to adopt a fresh business perspective towards financing private sector agribusiness interest in the smallholder agricultural value chains. This paradigm shift requires innovation in the domestic banking and financial institutions to develop new credit products appropriate for smallholder agricultural value chain participants and to look to other forms of collateral and loan guarantees to secure these loans.

The second structural challenge is the endemic problem of incomplete information available for risk-averse credit providers to assess creditworthiness and riskiness of supplying credit to nontraditional borrowers. These potential borrowers have little or no traditional collateral base because their rural farmland, rural business premises, and set of equipments are less readily tradable in thin rural domestic markets and not at all on global markets. Because conventional lending institutions cannot readily sell these assets following a loan default it is difficult for them to assign a collateral value to these rural business asset holdings. Further compounding the challenge of lending to rural agro-traders and farmers is the volume of small sized loans to many rural clients these institutions are forced to solicit, evaluate, and disburse, an administrative cost which increases per loan handling costs and reduces profit realization per dollar loaned out. In Zimbabwe, the commercial banks are accustomed to lending to much fewer large agriculture borrowers and often lack the institutional knowledge and capacity to handle a multitude of smaller borrowers engaged in smallholder agriculture - a sub sector completely unfamiliar to most commercial banks. Together, the factors limiting access to credit for smallholder agricultural value chain players can be summed us as a complex matrix of constraints including: (i) lack of bank capacity to handle small loans from large number of nontraditional borrowers; (ii) absence of traditional forms of collateral or loan guarantees to cover loans; (iii) lack of actuarial data to objectively assess riskiness of lending to these nontraditional borrowers; and above all, (iv) limited interest among conservative mainstream banks to innovate and aggressively broaden the client base beyond the dwindling traditional corporate client base in agribusiness industry.

For AgriTrade, addressing these multifaceted credit market access challenges is critical for unlocking the value of smallholder agricultural value chains.The AgriTrade facility has to spearhead a paradigm shift within the commercial banking sector by helping banks develop a better understanding of a new set of borrowers among the smallholder value chain players and through mentoring borrowers into developing a trusting business relationship with banks. Specifically AgriTrade has to help borrowers to: (i) provide complete business proposals and cash-flow information in the format that lenders understand to facilitate timely assessment of loan application forms; (ii) transform passive capital asset into acceptable collateral asset holdings through buying insurance policies, securing title deeds for any properties owned in urban and peri-urban areas, and presenting their capital asset holdings for bank evaluation; (iii) engage with many agro-traders as potential borrowers and prescreen them against set criteria to recommend a smaller pool of relatively more qualified potential borrowers for banks to undertake their own due diligence; and

(iv) mentor and monitor approved borrowers from credit disbursement, through produce purchase, to loan repayment to establish a credible credit history as a basis for a long-term business relationship with commercial banks.

AgriTrade has to recognize that commercial banking and lending institutions in Zimbabwe presently face chronic liquidity challenges arising from (primarily) Zimbabwe’s high country risk status and the low volume of domestic savings available for capital creation. While exogenous to the private commercial banks lending strategies, the high cost of liquidity means that domestic bank deposits are competitively allocated to such sectors as mining and retail businesses offering lower risk and higher returns as well as greater security at the expense of the credit needs of the smallholder agriculture value chain; a trend that works against increasing farmer income by developing the smallholder agriculture market. By injecting “patient money” for commercial banks to explore lending to smallholder agriculture, AgriTrade is facilitating a paradigm shift in the banking sector towards lending to private sector borrowers engaged in smallholder agricultural commodity value chains.

This study recognizes that it is, as yet, unclear how much of the comparatively higher interest rates and higher collateral demands that mainstream commercial banks want to recover from smallholder value chain players is an “ignorance tax” to compensate for the bank’s lack of experience with smallholder agriculture, how much potential borrower distrust of commercial banking (especially by the most credit-worthy agro-businesses) has caused commercial lending to not expand into this sector, and how much other factors are causing diminished credit and lower smallholder farmer incomes. To explore these issues, AgriTrade has created a partnership with several banks to bring credible prescreened nontraditional clientele from the smallholder agricultural value chain to the banks as borrowers, to develop innovated loan products and collateral mixes, and to work with both banks and borrowers to develop longer term banking relationships. Information developed from experience with issuing loans to these borrowers and about the business of smallholder agro-business will enable the banks to engage in lower-risk “learning by doing” market research so that in the future they will be able to assign specific risk profiles to specific borrowers engaged in specific agro-market activities. Similarly, experience dealing with commercial banks as partners facilitating the financing of trade, will allow agro-businesses to increase their trust for the commercial financial sector. With trust built on experience, banks and borrowers together can learn to minimize the risks to each and profitably reward creditworthiness.

4. )Bank)Estimated)Demand)and)Supply)of)Agricultural)Credit)) Zimbabwe’s credit market is characterized by structural problems that keep credit costs high. A high country risk profile continues to restrict external capital inflows from regional and international markets to private commercial banks and financial institutions. The lack of clear land titling laws has kept property from trading on international markets, lower the effectiveness of fixed property to collateralize loans. With IMF suspension of lending to Zimbabwe, the government also has limited capacity to borrow from international sources forcing it to rely primarily on domestic borrowing. Government deficit spending financed from domestic borrowing crowds out lending to the private sector competing for a limited supply of domestic credit. The high country risk profile also means that the aggregate domestic supply of credit depends primarily on domestic deposits into the commercial banking sector as foreign capital becomes increasingly expensive. Compounding this problem is the limited trust of the domestic banking system following years of hyperinflation, during which the working population and businesses lost billions of savings held in the formal banking system. As a result, there is limited interest from public in using the formal banking system for accumulating savings. The credit supply is further restricted for the agriculture sector specifically by many financial institution’s perception of the risks of agricultural lending and greater opportunity cost given higher expected returns from the non-agricultural sectors of the economy.

4.1. Aggregate Domestic Supply of Credit

To examine the supply of short term credit for the smallholder agriculture sector, it is important to understand the specifics and history of the overall financial markets in Zimbabwe. As inflows of capital from regional and global capital markets became more expensive due to Zimbabwe’s very high country specific risk profile, domestic market interest rates became considerably higher than those prevailing in regional trading partners. This “price rationing” of available credit strongly impacted the agricultural sector as the highly competitive demand from other productive sectors of the economy such as mining and the distribution industry outbid the agriculture sector for credit. Given the competition from these sectors, even if the demand-side structural changes noted previously are addressed and commercial lending institutions manage to recognize a lower risk profile for the smallholder agricultural value chain, it is conceivable that international donor and other non-market supplies of credit would be required to supplement market supplies to ensure an optimal credit supply for smallholder agricultural development.

Only when aggregate domestic market supply of credit increases significantly to satisfy highly competitive demand from mining and distribution industry, and hence the extent of the current price rationing of available credit eases, will private credit providers profitably have the residual supply of credit to meet smallholder agricultural value chain demands. While some of this growth will come from increased domestic savings, it is through improved access to international credit markets that domestically available credit is likely to be realized; an improvement seen as largely exogenous to the system.

Domestic savings growth is likely to be small to moderate, since while in 2010, Zimbabwe’s economy grew by 8%, the aggregate savings potential of the working class remained limited by very low per capita income which is still below $500 (Ministry of Finance Budget Statement, 2010) with bulk of those employed in the civil service earning below the poverty datum line.

The Reserve Bank of Zimbabwe reported that commercial bank deposits grew by 33%, from $1.4billion in 2009 to $2.1billion at the end of 2010. Further analysis of the structure of the bank deposits show that 90% of the savings were volatile short-term time deposits from companies and individuals (Ministry of Finance Budget Statement 2010), which banks cannot readily turn into long-term loans needed for economic recovery. From their deposit funds, commercial banks provided $1.485 billion in loans by the end of December, 2010. In the absence of significant capital inflows from SADC regional and international money markets due to high country risk, domestic deposits become the primary source of credit available for financing Zimbabwe’s $5.8 billion dollar economy. The RBZ criticized some commercial banks for conservatively limiting lending rate below 65% of depositors’ funds in the face of severe liquidity problems in the money market. The average lending rate of 68% of bank deposits is lower than apparent thinking at RBZ, which set a minimum loans-to-deposit ratio of 70%. Some banks are lending less than 40% of their bank deposits, despite pressure from monetary authorities at RBZ to increase their lending portfolio to accepted international standard of 70% of total bank deposits. Given that 90% of deposits are volatile short term deposits compared to 40% in stable economies, international standard may not be prudent. In 2009/10, the Reserve Bank of Zimbabwe was worried about stability of the domestic financial sector, in the face of commercial banks failing to meet their reserve requirements while overstretching their lending capacities. (RBZ Midterm Monetary Statement, 2010). Despite improved domestic supply of short-term credit, local prime lending rates remain high at 12% to 18% compared to 8% prime rate in RSA markets.

Domestic interest rates of 15% to 30% are very high by regional standards but consistent with higher risk premium attached to Zimbabwe. High cost of credit can potentially erode competitiveness of domestically produced food and agricultural produce in the domestic markets in the face of competition from imports.

Domestic exports are also rendered less attractive in SADC regional markets and in the global export markets. Commercial banks resort to high loan charges because they must recover full operating expenses from the limited volumes of deposits that they are managing. There are 25 deposit-taking commercial banks managing $2.1 billion gross domestic deposits. The top five commercial banks (CBZ, Stanbic, Stanchart, BancABC, Barclays), account for 60% of total deposits. The combined deposits of the bottom four (ZABG, Agribank, TN, Metropolitan) account for less than 20%f of the average deposits of the top four. For all these small and very large banks to remain viable under managed competition, the banking sector tacitly agreed on higher service fees and higher margins between savings and lending interest rates to ensure continued viability of smaller banks. Ironically the same policy has resulted in very low effective interest rates on savings accounts, thereby further discouraging the majority of the working class and agricultural populations from using bank accounts for accumulating their savings.

4.2. Bank Estimated Demand and Supply of Short-term Credit to Agriculture The agricultural sector, which now accounts for 18% of Zimbabwe’s $5.6 billion GDP, was able to leverage $326 million in credit during 2010 as presented in Annex I. These figures imply that $2 billion worth of agricultural output was generated from $326 million credit facility. About 70% of the $326 million credit facilities financed 100,000 hectare tobacco crop under contract and 300,000 hectare cotton production and marketing operations. The remaining $100 million provided agribusiness lines of credit for production and commercialization of the rest of the agricultural produce. There were also other non-market supplies of finance into the agricultural sector which included $55 million free input scheme from donors and $30 million subsidized input finance scheme from government. Although the free input scheme strategically was designed to target 550,000 vulnerable smallholder communal farmers, poor implementation resulted in leakages which resulted in over 1 million families benefitting from the government sanctioned free input scheme, including those that could potentially afford to borrow from banks offering well structured input credit schemes. Had part of these resources been channeled through private banking and lending institutions a larger part of these $85 million input credit schemes would have been recovered and managed sustainably as a revolving, albeit partially subsidized, credit facility for the poor but capable smallholder agricultural households.

Almost all commercial banks in Zimbabwe offer a range of credit and overdraft facilities to the agricultural and agribusiness sector. Most of the banks were offering 30- to 120-day credit facilities. A few commercial banks are now offering, albeit only to their reputable low risk agricultural clients, customized credit and overdraft facilities repayable in 6 to 12 months. Annex I, presents a summary of supply of credit to agriculture by selected banks according to which:

- Agricultural lending from financial institutions is not explicitly targeting credit to smallholder agriculture;

- With the exception of micro lending activities of Micro-King and CBZ, there is limited supply of credit to rural agro-traders due to lack of collateral assets. The small loans from MK and CBZ microfinance (with average loans below $5,000) may not be ideal for agro-trade financing;

- Credit facilities with loan tenures of up to ninety days are generally appropriate for agro-trade financing, but are not always right for financing agricultural production and marketing operations associated with contract farming which require six to twelve month funding facilities;

- The low risk, high profile agricultural and agro-processing companies are potentially overbanked as major commercial banks compete to supply them with credit at favorable terms. These borrowers are crowding out the other players in the value chain. Big agribusiness corporations with favorable ratings have adequate access to credit include:

o Milling companies millers - National Foods of Innscor Group, Victoria Foods and Agrifood stock feeds members of CFI group, Premier Milling, Blue Ribbons;

o Tobacco processing companies - Northern Tobacco, Tribac, Zimbabwe Leaf Tobacco (ZLT), BAT, Tien Ze and other representatives of the Chinese Tobacco Company;

o Agro merchant contract farming companies – Northern Farming, Agriseeds, Progene, Prestine Seeds, Capsicum o Fertilizer companies - ZFC and Zimphos of Chemplex group, Windmill, Omnia;

o Local agro-processors - Cottco, Surface Investments, Delta, Pro-food;

o Seed houses with SADC regional presence - SeedCo, Pannar, Agriseeds and;

o Multinational agribusiness firms - OLAM, Cargill, Pioneer seeds.

Almost all commercial banks interviewed report facing liquidity constraints affecting the size of their agricultural loan book. AGRIBANK which received $30 million in state funds for agricultural lending to commercial and A2 farmers reports challenges in attracting commercial and A2 farmers with requisite collateral cover or bank guarantees as the same group is highly sought after by other commercial banks.

The Reserve Bank of Zimbabwe’s 2010 monetary statement highlighted the risks associated with over-lending to some clients using credit from different banks to service maturing loans at another bank.

Private commercial banks estimate that they have a $223 million shortfall in their current agricultural loan book based on approved project proposals from existing clients. While it should be noted that this figure cannot be independently verified, especially given the possibility that some of these clients could have secured loans from other financial institutions or even foreign capital markets, the commercial banking sector believes strongly that they have potential to grow their agricultural loan book considerably;

especially if provided with affordable access to capital specifically targeted for agriculture from government or development financing agencies aware of the dynamics of the market and willing to help assume some of the risk. Under existing conditions, however, commercial banks estimate that they have been forced to ration $326 million among competing agricultural projects of clients whose potential demand for credit is between $437 million2 and $549 million.

4.3. Factors Affecting Supply of Credit to Smallholder Agriculture Important factors affecting supply of credit to smallholder agricultural value chain players include:

(a) Low liquidity: Severe liquidity crisis has characterized Zimbabwe’s financial markets since the dollarization policy of 2009 which reduced to zero all savings in local currency. Since then low domestic savings fueled by low per capita income and negative nominal interest rates on savings continue to restrict liquidity in the domestic market. Major external driving force to the liquidity crisis is limited external capital inflows into the domestic credit markets due to Zimbabwe’s very high country risk profile spurred by continued defaulting on the $7.9 billion debt to IMF and by governance challenges.

2 Even if 50% of the value of that shortfall is discounted for double counting of possible submission of the same projects to multiple banks for funding, the shortfall in bank credit supply remains substantial at $111 million.

(b) High Opportunity cost. Agriculture competes for a limited supply of credit with highly lucrative low risk investments from established companies in the mining, manufacturing, and distribution sectors of the economy. For bankers, the business of smallholder farming is poorly understood on the credit market. In today’s lender’s market, credit providers are reluctant to increase credit to the agricultural sector, especially smallholder value chains, unless offered market lending rates that include high risk premiums and greater collateral security cover as cushions against perceived higher risks.

(c) High transactions cost. Transaction costs are high for loans to the less understood smallholder agricultural value chains. Some corporate divisions of the commercial banks establish minimum loan sizes of $1 million to eliminate smaller business operators from applying. Others fix high loan application fees to deter smaller agro-traders and emerging farmers from applying

(d) Statutory Reserve Regulatory Requirements. Reserve Bank of Zimbabwe (RBZ) presently requires $12.5 million minimum capitalization reserve requirement for all registered commercial banks. This requirement forces banks to hold a specified amount of their capital in prescribed ‘safe capital assets’ as opposed to risky investment loan portfolio. This effectively reduces the amount of capital available for lending to the productive sectors of the economy especially agriculture. When lending capacity is constrained, the capitalization requirement effectively reduces the amount of capital available for lending. Given agriculture’s share of the loan book is under $10 million for a number of the small banks, minimum prescribed capitalization requirements disproportionately affects lending to agriculture and especially smallholder agriculture. Failure of seven unnamed smaller commercial banks to meet RBZ minimum capitalization requirements has had reputational and monetary cost to commercial banks especially smaller indigenous banks. These smaller banks will continue to face difficulties in attracting depositors further reducing their capacity to supply credit and remain viable institutions.

4.4. Factors Affecting Demand for Credit for Smallholder Agriculture The demand for credit among the Smallholder agricultural value chain players – including farmers, rural agro traders, national agro merchant buyers and agro processors – is adversely affected by the following key factors:

(a) High interest rates. Smallholder agricultural value chain players attract high interest rates because lending to smallholder agriculture involves higher risks and higher costs. Lenders have limited understanding of these risks and the strategies for minimizing these risks. Higher interest rates render unprofitable agribusiness ventures that are otherwise marginally profitable at regionally competitive interest rates and direct the investments of agro-business players into crops with higher profit margins. Evidence of this is seen as the high cost of credit has reduced commercial farmers’ interest in staple maize production, leaving it to smallholder farmers with access to subsidized inputs are able to supply significant quantities of this crop.

(b) Stringent collateral requirements. Historically, most commercial banks offered loans only to clients who could provide collateral security in the form of readily exchangeable titled land and title deed property in urban areas where the real estate market is fluid and active. For most rural based smallholder farmers and agro-traders these conditions render credit terms unattainable.

Compounding this issue is that some lenders will only lend up to 40% of the value of the collateral, as appraised by the lender (or collateral equal to 2.5 times the amount of the loan).

(c) Market distortions. Distortions in agricultural markets associated with free input programs and food aid reduce the appeal of agricultural credit for farmers. Farmers prefer to receive free inputs and free funds (grants) rather than work with banks to qualify and repay principal with interest.

Similarly food aid schemes that deliver free food in the market dilute incentive of traders that would otherwise borrow money to acquire stocks for sale when there is a risk that food aid would wipe away expected spatial and seasonal price margins.

4.5. Types of Credit for Facilitating Smallholder Agricultural Development Although the focus of the study was on short term supply and demand for credit for commercialization of smallholder agriculture, there are at least three types of credit products for which players in the smallholder agricultural value chain have expressed a demand and for which there is limited supply from the commercial banks and financial markets. The bulk of credit supplied to agriculture was short term loans starting initially from 30 days to three months; loans suitable for buying and selling agricultural produce but not for storing processing and export trading. Increasingly more banks are offering 90 to 180 day credit facilities for highly collateralized farmers and agribusinesses. Other banks are insisting on overdraft facilities which are expensive form of credit especially for contract farming.

Production Input financing remains confined to large scale commercial farmers and large agro-merchants engaged in contract farming with commercial farmers (SEEDCO, PANNAR) or smallholder cotton producers (COTTCO, CARGIL, OLLAM) or tobacco (TRIBAC, Northern Tobacco Tien Zien). For smallholder input credit there are a few companies piloting contract farming with funding from FAO, USAID, or Union Project, Northern Farming among others. But most of these companies lack collateral to secure adequate supplementary funding from commercial banks which is limiting their scope of operations if not their financial viability. The majority of these companies are not yet willing to put up their own limited collateral resources to secure input credit for smallholder farmers unless the farmers buy credit insurance or are covered by some form of Credit Guarantee Facility. Direct credit provision for smallholder farmers has been very limited with the collapse of AGRIBANK government credit guarantee facility. Financing credit provision for expanding contract farming in smallholder irrigation and dryland farming areas remains a challenge for which AgriTrade and ZIM-AIED would have to develop innovative sustainable credit products. Asset financing is another area under-funded for farmers, traders, and processors. The size and tenor of the facility required varies by size of the client from as little as $1000 to more than $1 million dollars for such companies like groundnut merchant companies seeking to establish a consolidated groundnut shelling and processing and packaging plants

5. Input)Credit)Supply)and)Demand)Situation)on)Major)Crops) The assessment of effective demand for credit for inputs has been calculated at the production level. Here the primary producer on the value chain is either an individual smallholder farmer acting as independent producer or an agribusiness firm engaging a number of smallholder farmers into contract farming arrangement. Table 1 presents the results of the input credit supply and demand situation for major crops grown by smallholder farmers in the 2010/11 agricultural season.

Table 1. Private Input credit supply and demand situation for the 2010/11 season Estimated

Supply of Credit ($millions)

Estimated Demand of Credit

($millions)

Credit Demand

Gap ($million)

Maize 0 76 76 Cotton 36 39 3 Tobacco (All size players) 120 120 0 Other cash crop (except cotton and tobacco) 0 33.3 33.3 Major contract farming companies in the smallholder sector (except cotton and tobacco)

0 3.4 3.4

Total 156 271.7 115.7

The summary does not include $85 million supply of free input programs targeting 550,000 vulnerable households financed by donors and government. If well targeted to benefit actual vulnerable poor smallholder communal farmers, this safety net funding would not have much impact on commercial demand for inputs as generally, the most vulnerable would generally not be included in top performing farmers able to afford credit. Thus these subsidies would not be included in the above overview of credit supply and demand. However there is evidence of leakages reported through Agricultural Coordination Working Group hosted by FAO and acknowledged by Government as the free input schemes ended up benefitting more than 1 million smallholder communal farmers as well as some newly resettled commercial farmers. These well-to-do beneficiaries would have otherwise purchased inputs from the market and some would have the potential to borrow from the credit market. This experience highlights the importance for donors and government to work with social services in targeting legitimate needy vulnerable rural agricultural families with appropriate safety nets in the form of farm input and/or food aid to minimize market distortions.

For increasing access to inputs for poor but capable smallholder farmers, donors and government would be better advised to channel their funds for input support through a revolving input credit facility managed professionally by commercial banks to maximize credit creation through sound management and roll over of the credit facility. For example, USAID invested $20 million into a credit guarantee facility with Standard Chartered Bank through which $49 million worth of credit was created for corporate agribusiness in one calendar year. Similarly the $30 million Government of Zimbabwe targeted for emerging commercial farmers could have potentially generated $60 million worth of credit supply to qualified emerging commercializing smallholder farmers had it been managed as a Credit Guarantee Fund through CBZ or any other credible commercial bank.

5.1. Input Credit for Financing Smallholder Maize Production

In 2010/11 a total 1.8 million to 2 million hectares of maize were planted nationwide with smallholder farmers accounting for 1.4 million hectares. At the cost of $160 per hectare, smallholder farmers would have required a maximum of $224 million in seasonal input loans – though effective demand for credit is considerably less as shown below. The input support schemes of government and donors targeted 500,000 hectares or 40% of the planted maize area (Ministry of Finance, 2011 Budget Statement). Even with this source of free inputs, smallholder farmers were left to self-finance the balance of 900,000hectares at a cost of $162 million as they have no access to credit. However, even if commercial banks were to waive collateral conditions, poor maize productivity and profitability performance would still disqualify the crop enterprise from commercial credit provision.

Among the 1.4 million smallholder farmers, the high performing households farming 25% of the total communal and old resettlement areas is located in high potential agro-ecological region II (8%) and III (17%) where potential for achieving higher than 2mt of maize exist (Bratton 1994). The top quintile historically account for the bulk of maize production and over 70% of marketed surpluses sold to GMB during the period of self sufficiency (Carl Eicher et al 1989, Jayne and Rukuni 1993) and even more pronounced in 2010/11 season from preliminary data coming from GMB and National Early Warning Unit (NEWU) of the Ministry of Agriculture, Mechanization and…