Issues: Tax and other economic instruments need to be used as incentives for catalysing investment in agriculture without creating rent-seeking unproductive entrepreneurship. The general business environment is a critical factor in the investment decisions of domestic and foreign investors.
With the paradigm shift towards a value chain approach to productive capacities, investment policies and the tax structure should target each part of the value chain in agricultural production, agro-processing and agricultural services.
The incentives package designed to be attached to the Investment Promotion Act should be revised to be reflect the new incentives outlined in the 2009 GoSL budget.
The reforms in the general business climate should be further deepened to provide a level playing field, certainty and predictability for domestic and foreign investors.
Sierra Leone should take advantage of the flexibilities in the WTO Agreement on Agriculture to provide protection for infant agriculture industry (See Section 7).
Access to Finance
Despite recent reforms in the private sector development area, there nevertheless remains a missing link. Many studies and surveys point to access to finance and the associated financial environment as major hindrances to the development of the private sector.
The Sierra Leone financial sector is relatively small, but with some recent movement in the number of players, the sector could see substantial growth over the next few years.32 The banking presence outside Freetown, although growing, is still thin. Access to rural and agricultural finance has proven to be a challenge for various reasons including high cost, perceived limited market potential, limited know-how in terms of agricultural finance, limited access to long-term finance, lack of clarity in rural land titling making collateralization of land difficult. The nature and characteristics of agricultural production mean that sustainable and long term funding for its growth and development will be required. Many aspects of agricultural production and agro-processing involve considerable risk. In addition, much of the agricultural production in the country is in the hands of small holders and SMEs, which are considered too small and too risky for the types of loans provided by the banks. For this reason, the approach taken towards financing of agriculture should be long term and comprehensive.
However, commercial banks are risk averse and do not routinely lend to small farmers and SMEs. Indeed high rates on Treasury bills provide no incentive to banks to lend to the private sector, particularly to those investing in agriculture. In effect, there is a ‘crowding out’ of the private sector from available financial services. This contributes to limit the range of financial products available and restrict access to financial services for agricultural enterprises. High lending rates (of close to 30 percent) discourage investment despite excess liquidity in the banking system.
Risks in Agricultural Finance
Most banks are willing to lend only against certain fixed assets that serve as collateral or that provide sufficient guarantees. Banks typically require collateral such as real estate that is easy to sell or liquidate in the event of default. On the other hand, the collateral that most farmers, processors and traders can offer, such as inventories, may be difficult to sell, especially where markets are located abroad or the commodities are not well graded. Even where the borrowers are able to provide collateral, the banks may impose fixed repayment schedules that do not reflect cash flows and cash flow risks in agriculture.
Credit providers are extremely wary of supplying funds to producers, processors and exporters in Sierra Leone because they perceive the risk of default as being high. Yet, the poorer producers, processors and agricultural traders are, the more constrained they are in their ability to obtain credit and finance. This is because they have little land and few capital resources to fall back on in the event of emergency. Ironically, their vulnerability makes them poor credit risks.
As a result of these financial constraints, it is difficult to organise production and processing efficiently. Cash flow is always a problem. The most profitable techniques are unavailable because the machinery cannot be purchased. This results in lack of competitiveness, especially in export markets. Exporters are unable to effectively trade with large buyers and users because they do not have sufficient capital to provide deferred payment terms on their own account as required by such users. Lack of investment in processing and storage also leads to high losses and the inability to meet standards. Without working capital, farmers are forced to sell at harvest time, when prices are low. Thus it is difficult to break the cycle of poverty since lack of capital leads to low income which contributes to lack of capital.
Sources of Agricultural Finance
In the past, a number of financial institutions played a role in rural and agricultural finance, such as the National Development Bank, the National Cooperative Development Bank and the Post Office Savings Bank. The National Development Bank (NDB) owned by government, used to undertake project financing with a credit line from the African Development Bank, but high costs and a large number of non-performing loans resulted in severe liquidity problems. The National Cooperative Development Bank (NCDB), also owned by government, in pre-war years, provided financial services to a large number of cooperative societies across the country. The Postal Savings Bank was established in 1990 and its operations mainly comprised of savings from small depositors, salary accounts for employees of small businesses, and loans to depositors. However, none of these institutions are viable contenders at the moment in the provision of financial services for agriculture.
Subsidised lines of credit were provided through agricultural projects and the NDB, often with the support of donors under various integrated rural development projects. However, default rates were high and the credit schemes were unsustainable without donor support. This, coupled with the failure of the NDB has had a huge negative effect on the development of the financial sector in rural areas. Also, a credit guarantee scheme, used to operate through a Credit Guarantee Fund, which was designed to encourage the commercial banks to direct part of their portfolio of loanable funds to small borrowers, especially in the agricultural sector. The objective was to enhance the supply of credit to priority sectors while providing the participating financial institutions some guarantee against future losses. The Fund would guarantee 80 per cent of commercial bank loans to agricultural and agri-business projects. About 61 percent of the approved loans went to agricultural projects.
At the same time, an Export Credit Guarantee Scheme (ECGS) was established, with the objective of encouraging financial institutions to provide credit to individuals or groups in the export business, particularly exporters of non-traditional products such as pineapples, horticultural products, gari and batik. The ECGS guaranteed participating commercial banks 66 2/3 per cent of any amount in default by the exporter because of insolvency or protracted default. Although the ECGS was fairly innovative, the commercial banking community never really gave it wholesome support citing the high costs of lending small amounts to numerous and widely dispersed enterprises. Valuable lessons should be learnt from these experiences. The issue of default needs to be tackled through financial education programmes for farmers and SMEs, as well as arbitration procedures for the quick recovery of debts in the absence of a strong and effective justice system. In addition, it is important that the main interlocutors in the finance system: the commercial banks, become partners in any future credit guarantee schemes.
A number of microfinance institutions (MFIs) currently service the rural and low income markets, providing small loans and credit to traders and farmers. Similarly, self-help groups called “Osusus” are formed to provide credit among people with similar incomes and social status. This grouping is more prevalent among the women of Sierra Leone. Some Village Savings and Loans (VSL) schemes operated by CARE International and other NGOs have also proved useful in remote areas. In this way, microfinance institutions have been most successful in reaching rural areas, with 48% of their outreach outside of Freetown. However, supply only covers a fraction of demand,33 and the demand for credit is higher than for savings. Moreover, microfinance is insufficient to meet SME needs especially for long term loans.
The limited interventions to farmers have been achieved only through linkages with private sector initiatives. As such, in the short term, expansion in rural areas will need to be closely linked with private and public rural development initiatives. It will be necessary for financial institutions to be informed of investments and projects in order to assess how financial services may be offered. Only in this manner, can financial services support rural economic development.
The GoSL has established a number of Community Banks in rural areas to provide improved access to finance for rural communities, including micro-finance.34 However, these banks are weak and need substantial restructuring if they are to continue to play a role in deepening financial services across the country. Some commercial banks, such as Union Trust Bank, have started forming associations with the Community banks in order to further leverage their presence in rural areas. This is a welcome development since it can address the anomalous situation where Community banks and MFIs do not have enough funding to grow, whilst several commercial banks have excess liquidity due to their investments in treasury bills. That said, Standard Chartered Bank through a specialised off-shore team of agricultural lending experts, is appraising loan proposals for two large agricultural investment projects. It offers loans ranging from $2 million to $10 million.
The National Social Security and Insurance Trust (NASSIT), the national pension fund, along with general insurance companies could be important potential sources of medium and long-term capital for agricultural development. So far, NASSIT has restricted its asset portfolio to investments in government securities and real estate, although there are indications that the institution is prepared to review the agricultural situation with a view to investment.
Current Initiatives Implicating Agricultural Finance
The current draft of the Ministry of Agriculture’s agricultural development strategy calls for a long-term financing vehicle dedicated to agricultural credit. The agricultural sector within Sierra Leone is working on a plan to convince commercial banks to serve agricultural businesses. A proposal has already been made in this respect by a number of stakeholders for the establishment of a dedicated agricultural finance bank.35
In this respect, the Private Sector Development Strategy Programme (PSDSP) of the Ministry of Trade and Industry proposes to motivate banks to lend to Micro, Small & Medium Enterprises (MSMEs) by establishing a pilot partial credit guarantee scheme that will reduce the risk the banks face in advancing loans to MSMEs. The programme is to be known as Salone BEST - Salone Business Expansion Scheme Trust.36 Management of the scheme will be implemented by a designated organisation that will receive technical assistance from the programme. The reduction in the risk from a loan default provided by the partial guarantee should result in lending at significantly reduced cost, i.e. a lower interest rate. Salone BEST guarantee will not exceed 40% of the value of each loan ensuring that the banks remain committed to the scheme.
Salone BEST will provide a partial guarantee against loans made to MSMEs of between Le3,000,000 (US$ 1,000) and Le30,000,000 (US$ 10,000) from the Participating Lending Institutions (PLI) for a wide range of business needs, including buying assets and
providing funding for working capital. Ideally, Salone BEST is designed to guarantee two types of loans:
Small loans for working capital purposes up to a duration of 12 months.
Larger loans for investment in fixed capital for a period of up to 3 years.
Box 1: How will SALONE BEST work?
An MSME applies for a loan directly to the PLI. The PLI assesses the loan applying its standard lending criteria.
The PLI assesses the quality and adequacy of collateral, and determines whether it requires the partial guarantee of Salone BEST.
The PLI completes the necessary loan application procedures and presents a summary of recommended applicants to the Scheme Manager Salone BEST for a “No Objection” to proceed. The response of the Scheme Manager will be given by the end of the working day following the day the request for “No Objection” is received otherwise the PLI may proceed with finalising the loan application.
Salone BEST Scheme Manager issues a guarantee in favour of the PLI for the loan(s) concerned.
Source: Salone BEST Concept Note, 12 January 2009
The Salone BEST Concept Note identifies the key gap in the availability of finance is between small, NGO funded microfinance and loans provided by the commercial banks, and declares that it is this gap that Salone BEST is intending to close.37 The Concept Note further asserts that in order to ensure that Salone BEST is not misapplied as an umbrella for difficult loans;
The participating bank will be required to rigorously apply its standard loan evaluation criteria;
The borrower need not know that the loan is being partially underwritten under the scheme and;
The participating bank will request from the Scheme Manager a “no-objection” to proceed with all loans awarded under Salone BEST.38
The Salone BEST programme has not yet begun operations due to delays with the establishment of its institutional structure.39 While the programme is a welcome addition to a more robust and effective financial services sector, the loans it will guarantee are small and the programme depends on the active participation of the commercial banks.40
The Ministry of Agriculture manages a $6.3 million IFAD-funded project with the objective of expanding rural finance, through the establishment of new Community Banks. In addition, both the MTI and the MAFFS are collaborating on a US$30 million World Bank-funded rural and private sector development programme that is intended to:
Consolidate domestic supply chains for specific crops and products
Improve rural market infrastructure to address critical infrastructure needs for select products
Provide technical assistance and knowledge management in order to improve access to market information and identification of opportunities
This programme has had some initial teething problems and is to be redesigned to ensure successful implementation.
Presently, reform of the entire financial sector in Sierra Leone is being addressed through a comprehensive Financial Sector Development Plan (FSDP) coordinated by the Bank of Sierra Leone.41 The FSDP seeks to address the needs of long term funding for agricultural finance through, inter alia, the establishment of a private finance company.42 Sierra Leone’s development partners should be requested to pool their resources through a basket fund to support the establishment and operation of such a finance vehicle that would provide long term finance for a variety of sectors including agriculture. In the short term, the IFAD- funds could be used in this vein.
The MAFFS, the MTI, the Ministry of Finance, and the Bank of Sierra Leone should all work closely together on the solutions to long term finance for agricultural development in order to avoid duplication and to ensure that resources are used optimally.
Special consideration for crop insurance
Risk in agricultural lending is greater than other types of business lending because of the potential for systemic risk either due to crop failure or a sudden change in prices on the international market for export crops. While risk is not the most immediate constraint in terms of agricultural lending (as cost and long-term funding have been cited by all financial institutions), it will eventually become a concern as the other constraints are addressed through innovations, mobile technology and the new financing vehicle.
Weather-based crop insurance and price insurance could eventually be important tools to encourage agricultural lending through mitigating systemic risk. Such insurance would need to be re-insured either regionally or internationally. While the demand for this is not immediate, it will take time to gather the necessary information to appropriately assess risk of crop failure due to weather, such as trends in rainfall and other indicators. With the onset of climate change, this kind of insurance will become a crucial part of the puzzle for agricultural finance. If Sierra Leone is to be able to offer such insurance within the next decade, it will be important to start to gather information from the outset of the agricultural development plan.
Experts estimate that crop insurance is likely to be a long term need, and particularly important in the future to protect farmers from vulnerabilities, and promote lending.43 Crop insurance can be indexed to price or weather. Price indexed insurance is typically offered for export crops, such as coffee which could be affected by drops in the international prices. Weather indexed insurance covers loss due to poor weather conditions. More preparation would be needed to monitor and assess rainfall and weather patterns throughout the country so as to inform the risk level and pricing. All this presupposes a level of planning and product development prior to launching for sale on the market.
In addition to providing cash and equity for agricultural investments, given that SMEs have little access to long term finance for the purchase of equipment, there is also a need for companies to lease out machinery and equipment to farmers and other business people. This provides economies of scale and reduces the need to buy costly machines. The Other Financial Services Act 2001, as amended 2007, provides for leasing activities. Such provisions could guide the establishment of private companies in this business area to provide access to capital equipment for farmers and SMEs.