Financing Kilimo Kwanza: Commodities Markets or Agriculture Bank

In his search for the agriculture development in Tanzania, President Kikwete (JK) has been trying all the tricks in the bag. He first called for the change in the law in order to introduce lease financing so farmers can purchase equipment, especially tractors. Then he went through many initiatives in his monthly speeches to the nation, including introducing seed research center. Recently he unveiled “Kilimo Kwanza” program – an expected holistic way of introducing green revolution in the country. The program is supposed to give access to farmers on research, sustainable market, credit – from the soon to be created Agriculture Development Bank, and many other promised goodies in the bag.

His heart is in a right place, and God bless him, but the path that he is taking is historically well ploughed with dismal result and an anemic economic growth.

The main deficiency here is that as hard as this administration tries it has not fully abandon its state sponsored economic development model in favor of a full private sector driven one. Kilimo Kwanza – or the New Impetus for Agriculture— as per the Daily News, is a model which begins with a thought that the state knows what the farmer’s problems are and therefore it is going to make the solutions readily available to them in the form of services given. This idea is a common mistake in the development arena. Like Mkukuta and Mkurabati before it, the Kilimo Kwanza bag of goodies from the government will only make a small dent.

The Kilimo Kwanza program has many aspects: research for better yielding seeds, providing market access to farmers, using old Nyumbu factory to produce tillers etc. In this piece I will focus only on agriculture financing part of the program. In facilitating credit to farmers there are two ways to go about it, first a dedicated agriculture bank and second a market based capital distribution – commodities market.

Government sponsored credit system led by an agriculture development bank by nature can not efficiently utilize information about the utility of the program. The information that the bank gathers from its clients will not be disbursed to the population at large. When a bank provides a loan to the farmer, the information that it collect will immediately be filed away in the drawer for safe keeping; and it becomes private information instead of it directly becoming public information.

Furthermore, in order for banks to add value to their portfolio and hence survive, they have to lend responsibly. For that to happen, they require collateral – that eternal elusive specie to any farmer in a poor country. And if banks lend without collateral, maybe due to the political pressure of lending to the farmers, the fate of that bank is clear.

For argument sake, let’s assume the long promised title deeds will come true and farmers are going to be able to use them as collateral, banks will still have to figure out how they will get paid back. No bank in the world lends with an intention of confiscating collateral at the end of the credit process. In order for the bank to be paid back, farmers will have to sell their products and therefore gain income first. So the quandary here is that farmers need capital during planting season but they can only pay back after the harvest. Unless there is a way for a bank to be able to estimate how much will the farmer’s income approximately be, there is no way to know how much can it safely lend to that farmer.

Therefore, based on the above mentioned reasons and many others, one can pre-tell the demise of the agriculture bank before it is established. It is not because I can see the future but because agriculture banks in poor countries are hardly successful.

And that is where the power of capital market and its information comes in.

The alternative to the government owned agriculture bank is commodities market. Commodities market is a type of a market which buyers and sellers of agriculture and mining products gets to trade their goods. However, this market due to the nature of agriculture business is a unique market. The market is structured in such a way that solves the farmer’s cash flow timing problem. The market allows farmers to issue a paper – technically in the form of IOU contract — during planting season that let them payback after a specific period of time that will coincide with their cash flow intake. This process most of the time gives farmers the much needed working capital to buy seeds, pay helpers and sustain themselves while the food silos are empty. There is no need of collateral in the commodities market as the market act as an independent third party between the buyer and the seller.

In addition if the farmer does own the land, this market mechanism can be stractured in a way so that the farmer can use the land to raise funds– assuming he does get the title deed—for a capital expenditure like buying a tractor, a harvester, or building an irrigation canal.

This arrangement will give the farmer both types of financing: short term working capital to bridge the cash flow and therefore sustain the production cycle while at the same time allowing access to a long term capital expenditure which will boost the quantity and the quality of his product.

A well function commodities market biggest addition to the society is not just movement of capital from the savers to the users; but also the ability it has to accumulate information from its participants and at the same time making that information readily available to any interested party. Markets normally have many buyers and sellers who come from different backgrounds with different knowledge bases and interests. When these market participants pull their motives of buying and selling the same (or similar) products they technically act on the information that they have accumulated. The act of collective buying or selling at particular price level reveals what market participants think of the value of the good that they are buying or selling at that point in time.

So for example, bwana Mkulima Maridadi who is trying to plant cassava walks into the bank branch and applies for a loan, the branch manager can access the market for the information. The market will allow the manger to quickly ascertain what the current expected value of the cassava that will be harvested three months from today. That way the banker can decide to give Mkulima Maridadi a loan that is not only suitable but at a fraction of the value that he would have estimated that the farmer will rip after harvesting thus increasing the likelihood of profitable repayment.

In addition, Bwana Mkulima could have walked in any bank and not necessarily the government agriculture’s bank to ask for that loan. Because now any bank can quantify, monitor, limit and therefore understand the risk of lending to the agriculture sector. Therefore, what the market would have done technically is to move the agriculture sector away from the opaque informal sector to maybe a translucent area if not a complete transparent formal economic zone. In so doing, the market will disperse the risk of a whole agriculture sector – which in Tanzania is 40% of the GDP, a considerable one—to different banks and not to concentrate it in one institution. The disbursed credit risk will increase the sustainability of financing of the agriculture sector.

Though I am advocating commodities market in place of the agriculture bank, I am not doing it blindly. Markets normally are as good as participant’s knowledge. Therefore, they are susceptible to the highs and lows driven by the risk appetites of its participants. Those who will be borrowing from this market will have to do so responsibly or risk losing everything. Therefore, an education program of how the market works and how to best utilize the funds from the market will have to be in place. Furthermore, in the long run markets normally have more highs than lows and since the rational commodities market participant factors the expected future inflation in today’s prices, the cost of food tends to increase over time. However, if the funds are indeed used wisely, higher food prices do come in tandem with the higher production and quality of food. But since food is a vital resource, commodity markets normally, to certain extent, disfranchise the poor especially the urban poor by making food relatively more expensive.

This last point brings me to the tangent, a line that I don’t want to cross now because it will deviate to a much wider topic: the relationship between food production and hunger or I should say famine. That will be a subject for a next write-up. But just to leave you with a sense of that debate, research has shown that there is no fixed relationship of any sort between the amount of food available and the breakout of a famine.

However, there is a very high correlation between a country’s economic growth and a vibrant financial market of a sector which represent a considerable part of the country’s GDP. Henceforth, JK’s Kilimo Kwanza program should use its limited capital pool to start a commodities market instead of an agriculture bank. Once there is an efficient market, then let all banks, saccoss, and other financial institutions do what they do best: give responsible loans to those who can add the most value to the economy.