Every up-and-coming farmer knows that the absence of collateral can be the difference between growing and stagnating. Jobs Fund boss Najwah Allie-Edries argues that guarantee mechanisms can be a valuable tool to mitigate risks, and enable these farmers to access funding at a reasonable rate.
In a post-Covid economy, guarantee mechanisms hold the promise for more efficient and sustainable funding partnerships between government and the private sector to benefit smallholder and emerging farmers. That being said, certain foundational elements need to be in place to promote the success of the guarantee model.
The South African agricultural sector faces several challenges, including recent changes in climatic conditions, a lack of access to the right quality of inputs at the right time, inadequate or deteriorated agricultural infrastructure, a shortage of farming skills and experience, worsening soil conditions and, in addition, a strained economy.
Crucially, access to finance is cited as one of the major constraints for South African emerging farmers in their quest to reach commercialisation.
Financial institutions are often averse to funding these farmers due to the high risks associated with agricultural production (significant variability of production outcomes) and markets (input and output price volatility) and the fact that many emerging farmers do not have the required collateral or track record to meet the minimum funding criteria.
Traditional financiers pursue an asset-based lending approach that requires immovable assets (land) as protection against default. In the emerging farmer development space, this is largely untenable and has negatively impacted the ability of emerging farmers to develop into more sustainable and commercial entities.
Increasingly, there is evidence highlighting that the risk associated with the financing of emerging farmers is not as significant as frequently claimed by financial institutions. There is a drive to develop hybrid financing models that use innovative risk assessment methodologies in the absence of collateral.
What’s the deal?
Guarantee mechanisms have emerged as a valuable tool to mitigate these perceived risks and enable emerging farmers to access the required funding at a reasonable rate.
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The guarantee mechanism assumes debt obligation on behalf of emerging farmers in the event of default, thus reducing performance risk and the absence of collateral, allowing commercial banking entities to expand finance to them at a reasonable rate.
For the past ten years, the Jobs Fund has been testing various innovative job creation models, with more than 30% of its portfolio of projects implementing within the agricultural sector.
Some of the agricultural financial models tested include contract farming, blended loan financing, debt funding, grant funding and the guarantee mechanism to enable emerging farmers to access appropriately structured finance.
One of the projects operating in the grain and forestry sector has successfully demonstrated how the use of a guarantee mechanism (complemented with key business development and technical support interventions) can be deployed to mitigate the perceived risk presented by emerging farmers.
The project partner was approved R50 million in Jobs Fund grant funding to implement a project which would see the establishment of a guarantee mechanism (R30 million) and provide complementary business development and technical support to selected emerging farmers (R20 million).
The initiative further required off-take agreements to be in place for the farmers’ production, which the project partner provided. The risk mitigation offered by the Jobs Fund grant catalysed the investment of R100 million by commercial financiers.
It enabled the production and working capital finance to be extended to more than 90 farmers in Mpumalanga.
Over the past five years of implementation, the programme has issued R125 million in loans, resulting in more than 200 permanent jobs and 1 000 seasonal jobs and trained more than 200 beneficiaries.
To date, R7.6 million has been drawn down from the guarantee mechanism to cover defaults from farmers whose production was affected by adverse climatic conditions (such as flooding, hail damage and drought). Given the development context and the impact of climatic conditions, the level of default over this period is considered acceptable.
Technical partnerships are key
The Jobs Fund’s experience has confirmed the importance of collaboration between public and private sector players in addressing the various social challenges faced by the country. When it comes to guarantee mechanisms, strong technical partnerships are vital for success.
Government provides the funding to capitalise the guarantee portion of the fund, and the implementing private sector partner offers the requisite technical expertise and experience to manage the fund; secure financiers and offer emerging farmers business development support and access to finance.
The implementing partner’s profile in the market is also improved since the grant provides the added security required to de-risk the overall initiative, allowing it to approach commercial banks to source additional funding that it then makes available to emerging farmers.
Recently, this was put to the test when a Jobs Fund partner was required to seek out commercial funding instead of relying purely on development finance. The project’s proof of concept and the partner’s improved profile in the market as a reliable financier allowed them to leverage the required investment with commercial banks. This is the significant benefit of guarantee funds.
Over time, they tend to have a catalytic effect on private investment and promote the establishment of strong linkages between traditional financiers and borrowers that are unable to meet their conventional lending criteria. The guarantee mechanism de-risks the investment and crowds in additional funding for emerging farmers.
From a development finance perspective, the guarantee mechanism offers a more sustainable funding instrument.
If designed correctly and if accompanied with business management and technical skills development, it can bring about systems change by providing financing options that are appropriate for the development stage of the emerging farmer, gradually assisting them to be less reliant on pure grant funding, graduating to lower-priced debt financing on their journey to self-sustainability.
Furthermore, the provision of appropriately priced debt finance and the subsequent repayments ensures that funds are recycled to either provide further support to the existing portfolio of farmers or new and aspiring farmers, thereby resulting in wider impact.
Most notably, there will also be farmers who will outgrow the programme and be able to access commercial funding based on their established track record.
The keys to success
So, what are some of the fundamental elements required for the successful implementation of such programmes?
- Strict farmer selection: The selection of farmers who are motivated to improve their production areas to more than existing farming units. Bias should be towards younger farmers where possible since they are more likely to expand their land sizes.
- Solid and clear guarantee mechanism structure: The drawdown terms must be clearly stipulated, as should the institutional structure. The size of the mechanism should be evaluated periodically to ensure that it still supports the finance amount, considering that the guarantee amount may reduce over time due to drawdowns.
- Farmer development: Crucially, any loan financing must be coupled with farmer development support to ensure that they can manage the loan, that production levels meet the required quality and quantity as stipulated by the market, and that the farming operation is effectively and efficiently managed.
- Balanced, integrated approach: The importance of investing in business development services and mentorship should be a key priority to these guarantee mechanisms.
- Alignment of interests: The guarantee fund’s success necessitates the alignment of interests between parties to ensure cohesive implementation towards a common goal.
The provision of funding to emerging farmers through a guarantee mechanism has an impact beyond the immediate farmers receiving the loans. The successful implementation of the guarantee mechanism can change the risk perceptions of emerging farmers and open up further financing opportunities for the emerging farmer market.
Instead of applying a one-size-fits-all approach to risk assessment for this group, traditional financiers should adopt a more nuanced approach, actively identifying the investment potential of emerging farmers and structuring support that is appropriate to the growth cycle of these farmers.
Government and the private sector should continue to work together to find innovative solutions to support emerging farmers.
Najwah Allie-Edries heads up the programme management office of the South African National Treasury’s R9-billion Jobs Fund. Allie-Edries was also the project officer for a research programme on employment, income distribution and inclusive growth, in partnership with the South African Labour and Development Research Unit at the University of Cape Town, as well as a research programme on pathways to youth assets and employability with the Centre for Social Development in Africa, based at the University of Johannesburg.
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