Module 8 - Production Credit from Input Suppliers, Processors, and Buyers

Private firms, such as input suppliers and product buyers and processors, supply a sizable portion of farmers’ credit needs. The provision of credit fits naturally with established business relationships, facilitated by good mutual knowledge, while collateral constraints are limited by linking credit with nonfinancial services. This investment note highlights the largely unexploited potential of supporting these arrangements by improving the development of producer associations, brokering contractual linkages between farmers and private businesses, and developing linkages with specialized financial institutions. Support in this area must proceed with caution, however, given limited project experience and thus limited knowledge about good practice. The risks of moral hazard are high, especially where contract enforcement is weak. There are also dangers of distorting input and output markets.

Agricultural commodity systems in developing countries frequently are characterized by financial transactions that serve as an important source of financial services for market participants in the absence of, or in addition to, institutional sources.⁸  Although these financial transactions are largely independent of government and donor support and influence, and although they fall outside the formal financial sector, they are often vital for farmers to obtain inputs and bridge periods of low income prior to harvest. Usually on the basis of securing access to a farmer’s produce, processors or buyers provide inputs on credit (usually in kind), often supplemented with technical advice to ensure quality standards are met, and guaranteeing a market for the produce. The repayment of the credit (and interest, if charged) is deducted when a farmer’s produce is sold.

Because these trading arrangements fall outside formally regulated financial systems, farmers are vulnerable, and the true cost of credit is difficult to ascertain. Smaller-scale and more marginal farmers are particularly at risk, because often they have limited access to market information, low bargaining power, and weak business relationships with credit providers. Successful models have evolved, however, that create clear win-win outcomes for farmers and private credit providers. These models have included smaller-scale farmers, often through producer groups (box 8.15). Governments and donors can increase the outreach of production credit from input suppliers, processors, and buyers by (1) developing producer associations to enable small-scale and marginal farmers to engage with agribusinesses; (2) facilitating market brokerage between farmers and agribusiness; and (3) supporting linkages with financial institutions to improve the efficiency and transparency of credit.