The Agriculture potential: agri-value chain financing

SUITS THE C-SUITE By Christian G. Lauron and Ruben D. Simon, Jr.

Business World (07/24/2017 – p.S1/2)

In the last decade, the phrase “inclusive growth” has emerged as an axiom among government policy makers in the Philippines, a trend that is seeing significant support from the business community.

The agriculture sector remains one of the most important sectors that the inclusive growth platform intends to significantly impact in the short and long term. In the three broad employment categories, the agriculture sector employed 27% of the total work force — however, available statistical data do not include seasonal farm workers. Second, farmers in rural areas posted a 40% poverty incidence. It is no surprise to see that most farming households are included in government efforts to aid the economically-vulnerable sector through the conditional cash transfer program, which has been in place for the past two administrations and has even been expanded since its implementation.

There is a broad gamut of issues surrounding the agricultural sector and the abovementioned social issues are just a small part of them, for which a “whole-of-country approach” is required. But before this becomes a battle of ideologies or another massive planning exercise that eventually drifts, we should consider taking targeted and pragmatic approaches guided by overall operating principles.

As part of the private sector, it helps to re-calibrate the way we think about agriculture and how our respective organizations can pitch in. This is where the concept of the agri-value chain comes in, which sees the agriculture sector as an entire interconnected and interdependent system that allows business and government to see where they can optimize business potential.

We will focus on the support subsector that has seen a dynamic landscape change with the issuance of Circular 908 — the Agricultural Value Chain Financing Framework — by the Bangko Sentral ng Pilipinas (BSP). In our experience working with the financial sector, from universal/commercial banks to rural and thrift banks, we are noticing a steady interest in lending to and investing in the agricultural sector. This observation comes against the overall backdrop of high interest rates and collateral cover required for the sector, largely due to information asymmetry and lack of absorptive capacity. Even if there are risk-mitigating measures such as the government-managed crop insurance program under the Philippine Crop Insurance Corp. and the Agricultural Guarantee Fund Pool, the lending penetration rate by the whole banking sector remains relatively low. The April 2017 BSP data for loans outstanding for production and household consumption, agriculture and fisheries only accounted for 3.05% as compared to real estate activities at 18.60%. This, despite the fact that there is an existing Agri-Agra Reform Credit Act of 2009 (Republic Act 10000), which mandates a credit quota of at least 25% of a financial institution’s (FI’s) total loanable funds for credit to agriculture and fisheries in general; of which, at least 10% shall be made available for agrarian reform beneficiaries.

Circular 908 paves the way for the deployment of capital to enterprises along a value chain that links producers and enterprises to the broader market. It sets out the formulation of policies and procedures covering the identification of value chains, comprehensive value chain analyses, and the design of appropriate financial products and services, which will parallel an institution’s direct efforts to form strategic alliances and develop indirect efforts with respect to provisions for technical and marketing support. This could significantly decrease credit risk since the FI incorporates the analysis of the interconnectivity of various enterprises that are associated with a certain commodity. For example, when an FI lends to a cacao farmer, it might view the farmer as an independent credit client, which raises his risk profile considering the longer time it takes for a cacao plant to bear fruit (thus extending the income expectancy period) and associated risks involved such as pests and typhoons.

But when the institution starts to view the farmer as a part of a chain involving an institutional buyer (which engages in contract farming), then the risk profile goes down since the FI can take into consideration marketing agreements between these two participants of the chain. In addition, the technical support provided by the institutional buyer to the farmer can decrease the likelihood of crop failure. FIs can even finance the production capacity expansion and technology upgrades of the institutional buyers, which in some cases are cooperatives owned by the farmers themselves. These upgrades — when coupled with efficiency, brand management and innovation, could help the buyers move up further in the value chain. This producer-driven undertaking is just one of the possible agriculture value chain business models. Various arrangements can also be explored, depending on the main driver of the chain, its objectives, as well as the commodities involved.

While charting and analyzing agriculture value chains, FIs may wish to prioritize those commodities where information asymmetry has been reduced to acceptable levels and where it has made qualified assessments of absorptive capacity and trade potential. This would involve mapping the commodities along the following strategic quadrants — cash cows (e.g., coffee, banana, high-value crops), growth (e.g., cacao, abaca), rehabilitation (e.g., coconut, rubber), and exit. This strategic assessment would allow FIs to evaluate and accordingly synchronize their financing efforts with the government’s ongoing countryside development efforts, which are now undertaken following a regional economic corridor mindset. In this development reframing, FIs need to see agricultural trends and developments beyond cities, provinces, and national borders.

Bank personnel who are involved in frontline activities have to be trained and reoriented to see and analyze agricultural lending clients as part of a broader system rather than independent packets of clients. They should also be prepared to establish linkages among participants of the chain in their areas of operations and spheres of influences, thereby contributing to their book building.

Seeing agricultural lending as a system broadens the horizon in deploying capital for this sector’s development. Aside from commodity-specific lending, FIs can explore developing lending or leasing products for agricultural machineries (from importers, local fabricators, up to the end-users), as well as infrastructure in support of countryside development.

Increasing the country’s level of farm mechanization (which is currently at 1.23 horsepower/hectare [hp/ha] as compared to Japan’s 18.87 hp/ha) can potentially bring down production costs, especially if the elements of production and logistics (e.g., cold storage centers) are properly organized with the help of network modeling and coordinated investment. As for infrastructure, under one of the ‘modes of compliance’ of RA 10000, it provides for “lending for the construction and upgrading of infrastructure, including, but not limited to, farm-to-market roads, as well as the provision of post-harvest facilities and other public infrastructure that will benefit the agriculture, fisheries and agrarian reform sector.”

Realizing the long-term goal of inclusive growth will require the participation of both the government and the private sector. The strongest manifestation of such growth is in a thoroughly transformed countryside. It would be helpful to note that banking follows trade flows, and the “velocity” of trade flows is a function of development and mobility. Development progresses with the presence and use of shared roadmaps, credit and investment enablers, a corridor approach to economic development, and reframing investments in public goods as investments in peoples’ eventual capacity to govern themselves. Mobility on the other hand is a function of integrated supply chains, infrastructure and connectivity.

While the government continues to deploy resources to uplift the unbanked sector, the banking community might wish to seriously consider increasing its risk capital and funding to the frontier sector that is agriculture, which is now exhibiting signs of feasibility and bankability.

This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the author and do not necessarily represent the views of SGV & Co.

Christian G. Lauron is a Partner and Ruben D. Simon, Jr. is a Manager of SGV & Co.