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5 Value Chain Finance

[1]

The provision of credit within state-controlled supply chains was widespread in the 1960s and 1970s. This was most extreme in the Communist system where production at various stages and the exchange of outputs and inputs, including credit and finance, along the chain was coordinated and determined by the central command system (Rozelle and Swinnen, 2004). Also in other regions, government marketing organizations and parastatal processing companies often provided credit to their suppliers. The dominant form of state-controlled VCF was that of seasonal credit provisions to small farmers in return for supplies of primary produce (Poulton et al., 1998). In fact, state-controlled VCF was often the only source of credit (and other inputs) for peasant farmers (IFAD, 2003).

This system of state-controlled supply chains and VCF has undergone tremendous changes during a period of reform in the 1980s and 1990s. In the transition world, the liberalization of exchange and prices, and the privatization of farms and enterprises caused major disruptions in the chain and in credit supply for farms (Swinnen and Gow, 1999). During the period of transition, many farms faced serious constraints in accessing finance. Also in many developing countries privatization and market liberalization led to a sharp decline in the supply of credit and inputs to farms as it disrupted the working of various government-controlled agricultural institutions, cooperative unions, and parastatal processing companies (IFAD, 2003). As government marketing boards and cooperatives have ceased to play a major role in the procurement of agricultural produce, so has the provision of credit through state-controlled VCF. In addition, market liberalization led to a decline in government (subsidized) credit to the agricultural sector.

Following privatization and liberalization, new forms of VCF have emerged and are growing (Swinnen, 2007; World Bank, 2005). These are no longer statecontrolled but are introduced by private companies. Private traders, retailers, agribusinesses, and food processing companies increasingly contract with farms and rural households to whom they provide credit and financial services in return for guaranteed and quality supplies.

Farmers face financial constraints and constraints in accessing inputs because of imperfections in rural credit and input markets. Private contract-farming schemes are primarily set up by processors, traders, retailers, and input suppliers as a private institutional response to these constraints.

Table 2, based on surveys, shows that for small cotton farmers in Kazakhstan access to credit is by far the most important reason to enter into contracts with cotton gins. Similarly, for small vegetable farmers in Madagascar and Senegal, access to credit in the form of cash credit, as well as in the form of pre-financed inputs, is a very important motivation to sign contracts with exporters.

Table 2. Motivations of small farmers to supply high-value chains

Source: Minten et al., 2009; Maertens et al., 2007; Swinnen, 2005

For VCF to function, the downstream company offering finance itself needs sufficient funds and cash flow to finance an VCF system. Initiators of VCF programs often include foreign investors (who have access to more financial means because they have “deep pockets” or because they can access financial markets internationally), or companies who have financial resources from activities in other sectors (and who are interested in investing these funds in the food sector, such as financial-industrial groups in Russia), or domestic processors and traders who sell on the international market (and have thus sufficient financial liquidity, such as grain traders in Kazakhstan); or domestic processors who have links with the international finance through VCF themselves (such as cotton gins in Central Asia who receive pre-financing through contracts with international cotton traders) (World Bank, 2005).

  • [1] See Miller and Jones (2010), van Empel (2010), Winn et al. (2009) for excellent recent reports on the importance of value-chain finance and reviews of different cases, models, and applications; and Kloeppinger-Todd, R. and M. Sharma (2010) for a review of innovations in rural and agricultural finance.
 
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