Saturday, 20 February 2016

THE CHALLENGES OF FINANCING SMALL FARMERS AND MSMES IN AFRICA: HOW AGRICULTURAL VALUE CHAIN FINANCE CAN BE A RESCUE.

EXECUTIVE SUMMARY
One major discussion across Africa since globalization has been; can small firms and farmers compete in international, national or even local (globalized) markets? Will the poor be marginalized more by globalization? Or can they learn to compete? The challenge therefore has been how to improve the competitiveness of value chains in which large numbers of MSEs participate as well as benefits to MSEs (increased employment and income, decreased risk, improved learning). One way of doing this is by linking large numbers of small firms into value chains with potential for growth while fostering inter-firm relationships & access to resources to enable small firms to compete?

Smallholder farmers are the world’s largest group of working-age poor and the centerpiece of a “pro-poor” agricultural growth agenda. Much of the world’s food supply will continue to depend on their efforts, yet a lack of financial services often stymies their attempts to make productivity-enhancing investments and to smooth their consumption between periods of plenty and scarcity. Capital-constrained farmers minimize risk instead of maximizing returns (for example, by investing in high-quality seed and fertilizer or growing what is most profitable) (Trivelli and Venero 2007).

Agricultural systems worldwide are being transformed in unprecedented ways. Market integration and stringent specification of quality and timing of produce has never been so important.  Farm production and distribution are rapidly evolving from the simple relationships and points of interaction of the past to the highly integrated linkages and closer alignments among business partners we witness today.  Value chains are being promoted as the business development frameworks of choice in the sector. There is much more attention being paid to inter and intra-organizational efficiency in production, processing and logistics. There is increased focus on marketing, product differentiation and product niche development.  Furthermore, the competition is now global: prices are less affected by local conditions, seasonality and markets. All these developments make a solid financing structure even more important than it has always been.  Market competitiveness and market risks are becoming the drivers of financing decisions in the new the agribusiness systems.
While agriculture, agribusiness and finance are evolving rapidly in some parts of the globe, in others like sub-Saharan Africa, there is little change and whole communities merely subsist and become less and less competitive. Many sub-Saharan countries are affected by this scenario. It is important that value chain opportunities be available to all.  But to do so, finance and capacity building will be critical components.
There is also the vast export potential to be considered, especially in Middle Eastern and Asian markets, where food consumption is rising rapidly. However, African agriculture continues to be relatively uncompetitive, especially in relation to developing counterparts in Asia and Latin America. The continent’s over reliance on food imports creates unnecessary trade imbalances, fosters anxiety over food security, and is also a missed opportunity for promoting prosperity.

There is a serious danger that, through its inability to structurally reform agriculture, Africa is forced to make ever greater concessions to powerful foreign interests to guarantee food security. Whilst foreign investment should be encouraged, it should not be negotiated in desperation but from a position of confidence.

Value chain finance holds many positive attributes. These include ease of access, flexibility, and risk mitigation, all of which can lead to the increased competitiveness of the sector. However, there are imminent challenges to institutionalize value chain finance in developing economies, where formal financial institutions are still struggling to develop business models to reach smallholder farmers in remote locations and link these farmers to value chain counterparts. In addition, value chain actors are faced with limited financial resources to cater for the cash flow needs of other actors.
What we have seen in Africa has been a case of always “throwing the baby away with the bath water” by the financial institutions because of lack of understanding of how the agriculture value chain works. This calls for massive capacity building across the continent to enable these financial institutions play their role.



INTRODUCTION
WHAT IS VALUE CHAIN?
A value chain is often defined as sequence of value-adding activities in a supply chain – from production to consumption, through processing and commercialization. Value chains in agriculture can be thought of as a set of processes and flows – from the inputs to production to processing, marketing and the consumer.  Each segment of a chain has one or more backward and forward linkages. A chain is only as strong as its weakest link and hence the stronger the links, the more secure is the flow of products and services within chain.  It is important to note that the benefit of value chain finance goes beyond that of the financial flows within the chain.  It is about finance with agriculture and agribusiness within a chain but also about aligning and structuring finance with the chain or because of it.  Simply being a part of a secure market chain makes one a better credit risk.

MAJOR CHALLENGES OF SMES IN AFRICA

Small and Medium Enterprises (SMEs) are often confronted with problems that is uncommon to the larger companies and multi-national corporations.  These problems include the following:
·         Access to finance had been singled out as one of the major challenge impeding the survival and growth of start-up SMEs in Africa. Significantly low figures of start-up SMEs who apply for financing succeed in getting financing. Quite a significant number of entrepreneurs are of the opinion that, although there seems to be sufficient funds available it remains difficult to access these funds, especially for start-up SMEs.
·         The ability of SMEs to grow depends highly on their potential to invest in restructuring and innovation. All these investments require capital and therefore access to finance. Against this background, the consistently repeated conception of SMEs about their problems regarding access to finance is a priority area of concern, which if not properly addressed, can endanger the survival and growth of the SMEs sector.
·         Lack of adequate credit for SMEs traceable to the reluctance of banks to extend credit to them owing among others to poor documentation of project proposals as well as inadequate collateral by SME operators. Weak demand for products arising from low and dwindling consumer purchasing power and lack of patronage of locally produced goods by those in authority.
·         Incidence of multiplicity of regulatory agencies and taxes which has always resulted in high cost of doing business and poor management practices, and low entrepreneurial skill arising from inadequate educational and technical background of many SME promoters.
·         Developmental policies weigh in favour of large firms and sometimes foreign –owned firms leaving SMEs in a distressed and vulnerable position.
·         The problem of access to information may be attributed to the inadequacy of SME support institutions. This point to the need for a supportive policy to encourage the establishment of documentation centers and information networks to provide information to SMEs at an affordable price.
·         Regulatory compliance which ordinarily reduces the cost of doing business for the private sector and incurs costs- time and money, adverse effects on small firms.
·         Corruption, lack of transparency, very high bureaucratic costs but most damagingly, a seeming lack of government interest in & support for the roles of SMEs in national economic development and competitiveness.
·         The most worrying of all among these challenges is funding. Most new small business enterprises are not attractive prospects for banks as they want to minimize their risk profile.
·          Poor or Missing Infrastructure: African agriculture generally suffers from major competitiveness constraints due to poor or missing infrastructure. This includes road and rail transport, storage facilities, irrigation schemes, and access to power and telecommunications. It is not just producers which are affected of course, but also agribusiness. The extra cost, waste and delay incurred by constant power interruptions and transport delays fundamentally diminish domestic competitiveness.
·          Clearly, an agricultural strategy should identify these gaps, but public finances are often stretched to make the required investments. In addition, the public sector sometimes lacks the technical and project management skills required to effectively deliver projects. In this case, governments should be looking at approaches to the mobilization of private sector finance (and expertise) for infrastructure development, particularly through a PPP approach. This is as true for agriculture as it is for any other sector. It is notable, as has been mentioned earlier, that the transformation in agriculture in markets in East Asia (particularly China) has been led by an emphasis on public spending in rural areas.
·         Banks perceive agricultural risks to be high and profits to be low, and lack technical expertise in agriculture and specific crops. Therefore, a fundamental bottleneck is the inability of financial institutions to adequately conceptualize, underwrite, mitigate, and manage agricultural risks. At the same time, agricultural SMEs lack basic business and financial management skills, and poor financial literacy rates and a limited understanding of traditional banking requirements pose a challenge to accessing formal finance.

EVOLUTION OF FINANCING ALONG THE VALUE CHAIN?”
For centuries traders have provided finance to farmers for harvest, inputs or other needs such as emergencies. Many of the traders in turn receive finance from millers and processors who in turn may be financed from wholesalers or exporters who are farther “up” the chain from production to marketing. We all understand how trade finance typically works.  But we also want to note that there are many entry points and many factors involved.

The term “value chain” therefore describes the full range of activities that are required to bring a product or service from conception, through the different phases of production (involving a combination of physical transformation and the input of various producer services), delivery to final consumers, and final disposal after use[1].

While approaches and applications vary, most value chain approaches have several common characteristics, including: a market system perspective; a focus on end markets; an emphasis on value chain governance; a recognition of the importance of relationships; a focus on changing firms’ behavior and transforming value chain relationships; targeting leverage points; and, empowering the private sector.  In the international development field, projects utilizing the value chain approach generally tend to shift the balance of power within value chains through the formation of associations; branding; alternative financing; support for market systems; market or supply diversification; and, changing the basis of competition (generally from price-based to quality-based).