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September 29, 2020
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Analysis
How Governments Incentivize Private Sector Involvement in Agricultural Finance
Pulse 20
Published on
September 29, 2020
How can governments create, incentivize, and regulate space for the private sector in agricultural finance? It’s not one-size-fits-all: Various countries have approached this challenge in different ways. By looking at different cases, we can uncover trends that might point governments in the right direction.
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The long-term growth and development of agricultural markets depends on access to capital. But, as economies grow, governments alone cannot provide the full range of capital needed to maintain the development of the agricultural sector. For example, in the United States—one of the largest agricultural economies in the world—the agricultural sector was valued at more than $1 trillion in 2017. With farm debt alone worth around $450 billion, the US government relies on the private sector to deploy the majority of this capital.
How can governments create, incentivize, and regulate space for the private sector in agricultural finance? It’s not one-size-fits-all: Various countries have approached this challenge in different ways. By looking at different cases, we can uncover trends that might point governments in the right direction. In 2014, ISF Advisors published its first briefing note on The Role of Government in Developing Agricultural Finance, which characterized four stages of agricultural development based on case studies of three developed countries: Germany, South Korea, and the United States.
An important finding of this analysis was that, in the transition from government-led to bank-led agricultural finance, governments must shift from being a direct funder and provider to being a regulator and facilitator of incentives for private sector involvement. The research also raised important questions, including:
- How do countries typically make the transition to more bank- and market-led agricultural finance systems?
- What types of government actions support these transitions, and at what levels of government are actions typically taken?
- What can we learn about how governments can pursue specific actions?
To better answer these questions, ISF Advisors expanded the initial data set by conducting research on three additional countries—Mexico, Turkey, and Uganda—as well as specific initiatives in other countries around the world. The resulting insights are summarized below, as well as in a new briefing note called Role of Government in Rural and Agri-Finance: Transitioning to private sector involvement. An integrated view of the experiences of these countries is presented below.
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Six key insights
By studying the experiences of several different countries across these two briefing notes, we have uncovered six overarching insights about the transition from government- to private sector-led agricultural finance:
- Macro changes lead everything: In all the countries studied, major changes in the structure of agricultural finance were preceded by changes at the macro level that shifted the positioning or nature of the agriculture and/or finance sectors. Some macro-level shifts were in response to a crisis—for example, when Mexico’s neoliberal government emerged following a major recession. Others were in response to new opportunities, as when Turkey joined the European Union.
- The importance of meso-level enablers: All long-term structural change requires the development of meso-level infrastructure, policy, and systems (for example, roads, utilities, or consumer protection bodies). These enablers can take a long time to emerge; but when they do, they enhance the operating environment for both financial service providers and the rural customers they serve.
- The power of integrated government action: Development of the agricultural finance market typically sits between various government bodies. This often includes the ministries of agriculture, finance, and planning—but may also involve government management of telecommunications or infrastructure. To be most effective, the planning and execution of government priorities should be done in an integrated manner.
- The early emergence of niche lending markets: Niche products—such as coffee, flowers, or tea—typically have an export market that brings in valuable foreign exchange. These lending markets attract more attention from policymakers, value chain actors, and a set of large anchor producers and processors that can manage finance.
- Not just what is done, but how and how well: Many state banks and parastatal institutions have failed over the years due to mismanagement and governance issues. Given this trend, it’s important to not only focus on choosing the right initiatives, but on successfully implementing them.
- There is no “best” agricultural finance system: Moving to a market-based system, for example, is not a de facto “successful” agricultural finance system evolution. Given the unique role agriculture plays in each economy, the optimal relationship between the government and private sector financial service providers is one that appropriately serves each country’s national development priorities.
Drawing on these insights, and the case studies from which they emerged, we have outlined a holistic model for understanding government action in the transition to private sector-led agricultural finance.
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Holistic model for government action
Often, agricultural finance is portrayed primarily at the micro level in interactions between financial service providers and their clients. But this is an oversimplification. Agricultural finance markets are also reliant on infrastructure, regulation, investment, and policies at both the meso and macro levels. Thus, to build a more holistic understanding of how governments can accelerate the development of agricultural finance in their countries, we have to look at available actions on all three levels:
- At the macro level, where government action focuses on setting a conducive overall policy and development agenda (e.g., national development strategies and trade agreements);
- At the meso level, where government action focuses on indirectly enabling private sector financing activity (e.g., through creating infrastructure such as digital IDs, national payment switches, and credit registries); and
- At the micro level, where government action focuses on directly influencing private sector financing (e.g., by reducing the risk to serve agricultural customers through credit guarantees or public insurance schemes).
In order to illustrate what government actions might look like on these three levels, we can look at one of the case studies examined in this briefing note.
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Agricultural Finance Historical Case Study: Turkey
Soon after the establishment of the Turkish Republic in 1923, the government undertook a state-led development policy, through which it administered agricultural prices and tariff protections, subsidized credits, and infrastructure projects. On the financial side, the government modernized the structure of its Agricultural Credit Cooperative (ACC) and transformed state-led Ziraat Bank into the principal financial agency for farmers. In 1980, triggered by economic problems and a military coup, the government implemented market liberalization reforms that significantly reduced social protections in all sectors, including agriculture. These reforms improved market capitalization and increased the role of private banks in the macroeconomy. However, Ziraat Bank and ACC maintained a monopoly on the agricultural finance market by supplying subsidized credits to farmers.
The transition to more private sector-led agricultural finance was advanced primarily in the 2000s, when Turkey joined the European Union and the economy opened up further. Government action was initiated on all three levels:
- Macro: Turkey committed to a program of reform with support from the International Monetary Fund. The country’s entry into the European Union also required it to come into alignment on many agricultural, environmental, and financial policies.
- Meso: New laws regulating the financial sector and restructuring financial institutions were created, enabling a more competitive market for private banks. The government also introduced an agricultural registry system to collect information on capital needs and land structure of farmers. A new law on licensed warehousing was passed, which gave banks the ability to use warehouse receipts as collateral in farmer credit applications.
- Micro: The IMF-sponsored Strong Economy Program replaced government-administered prices with direct income support for farmers. Government subsidy enabled increased take-up of agricultural insurance, while credit guarantees were used to stimulate lending to small- and medium-sized enterprises.
As a result of these actions, after decades of state monopoly on agricultural lending, private banks entered the agricultural finance market in Turkey. By 2018, private lenders had increased their market share to 31%. These banks also introduced new products, such as credit for inputs and lending via SMS. Agricultural insurance take-up increased dramatically—from 0.5% in 2005 to 16% in 2018—allowing banks to extend lower interest rates to insured farmers. And more than 200,000 farmers are now registered with the credit registry as Turkey continues to improve its institutions and governance in line with the EU Common Agricultural Policy.
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The path forward
While this research is not comprehensive enough in scope or depth to provide definitive guidance to any individual government, the lessons drawn from it inform a number of recommendations:
- Donors have an important role to play in promoting private sector involvement, but government engagement and integration with the policy environment is critical to sustainable participation. Donors must specifically diagnose the macro, meso, and micro enabling environment before introducing new products or initiatives—and must work to complement short-term subsidies with government action that incentivizes private sector involvement beyond the life of a donor program.
- Governments need more, and more reliable, evidence to guide integrated policymaking and implementation. Global agricultural research institutions have a wealth of knowledge, experience, and networks to support governments in the area of agricultural finance. However, we believe this must be complemented with more private sector expertise and perspectives, including from banks, investors, agribusinesses, and industry bodies.
- Governments need new ways of managing the agricultural finance agenda across the macro, meso, and micro levels, as well as ministries to enable sustained private sector participation. This agenda should be intentionally elevated above individual ministries to the level of national development plans that define how agencies work together and in close collaboration with the private sector. A strong mandate from the most senior leadership should enable governments to work with relevant donors and providers, and with the latest research and evidence, to develop and implement these plans.
The role of the government in helping to facilitate private sector involvement in agricultural finance markets across the world is an extremely complex and multifaceted issue. In light of the COVID-19 pandemic—with potential accompanying shifts of entire sectors of the economy—it is more important than ever to advance research on this issue and provide governments with clear pathways for facilitating the transition to private sector finance.
