This Note discusses two major constraints to agricultural finance that hinder private investments in food production. The policy gaps that need government intervention are likewise discussed.Philippines, food security, agricultural finance, food production

Llanto, Gilberto M.

English

Research Papers in Economics

Addressing constraints to agricultural
finance to boost food production
Gilberto M. Llanto
Philippine Institute
for Development Studies
Surian sa mga Pag-aaral
Pangkaunlaran ng Pilipinas
Policy Notes
No. 2010-11 (October 2010) ISSN 1656-5266
PIDS Policy Notes are observations/analyses written by PIDS researchers on cer-
tain policy issues. The treatise is holistic in approach and aims to provide useful
inputs for decisionmaking.
This Notes draws from “Innovations in financing food security” written by Gilberto
M. Llanto and Jocelyn R. Badiola, and presented at the ADB-FAO-IFAD Invest-
ment Forum on Food Security in Asia and the Pacific, 7–9 July, Asian Develop-
ment Bank, Mandaluyong City, 2010. The author is Senior Research Fellow at the
Institute. The views expressed are those of the author and do not necessarily
reflect those of PIDS or any of the study’s sponsors.
Hunger stalks the land
In a survey conducted in 2009, the Social
Weather Stations (SWS) found the proportion
of families experiencing involuntary hunger at
least once in the past three months of April–
June 2009 rising to 20.3 percent or an
estimated 3.7 million families, as compared
with the estimated 2.9 million families
(15.5%) in the previous quarter.1 In terms of
severe hunger,2 meanwhile, an estimated 4.3
percent (790,000 families) experienced it in
June 2009 (please see Figure 1 for a
comparison of the state of hunger between
the past Estrada and Arroyo administrations).
Discourse on food security has revolved
around taking actions ranging from securing
adequate arable land for crop cultivation to
subsidizing the cost of inputs to farmers,
repressing interest rates, protecting domestic
producers through tariff policy, to controling
the price of basic staples. Concern about the
plight of the poor and the vulnerable has
motivated governments to design
interventions that seek to provide them
adequate food safety nets. Invariably, the
thinking is that governments should use a
combination of instruments such as taxes,
subsidies, incentives, tax breaks, and other
policies and measures to motivate greater
domestic food production.
Unfortunately, these interventions have been
found wanting. What may perhaps bring us to
______________
1 Second quarter 2009 Social Weather Survey, fielded over
19–22 June 2009.
2 “Severe hunger” refers to the condition of those who
experienced it "often" or "always" in the last three months.PN 2010-11
2
Policy Notes
the desired goal is a market-based approach
that stimulates private investments in food
production.
But to be able to effectively pursue this, an
understanding of various constraints to
agricultural finance and an identification of
policy gaps, that is, areas where governments
could intervene to enhance the workings of
the market are appropriate. Efficient
agricultural credit markets will be
indispensable for raising resources for those
investments.
In this regard, this Policy Notes discusses two
constraints to agricultural finance: (a) high
risk in agriculture and food production, and
(b) high transaction and supervision costs. It
then identifies policy gaps that need
government intervention.
Getting the private sector on board
Given the physical and environmental
constraints on increasing land and water use
for food production and other economic
activities, agricultural productivity will have
to substantially improve to meet the
increasing demand for food. For this to
happen, substantial investments would have
to be made by both the government and the
private sector. There is scope for governments
and the private sector to work together to
generate more investments in the food sector
and thereby, increase the capacity to produce
more food.
In many developing countries, private sector
investments in agriculture are not found in
the production of basic foods, e.g., rice, corn,
or other staple products, which is oftentimes
left to small shareholders cultivating small
plots of land. Private investments of the
Figure 1. Degree of hunger in households, Philippines, July 1998 to June 2009
Source: Social Weather Stations (2009).PN 2010-11
3
Policy Notes
business sector could be found in cash crops,
e.g., sugarcane, rubber, and palm oil destined
for the export markets. The worldwide boom in
the demand for energy fuels, encouraged by
deep concerns about rising prices of
petroleum and climate change, has also
attracted substantial private sector
investments in growing so-called energy
crops.
The strategy of working with the private
sector focuses more on motivating greater
private investments in food production.
Governments should take a different strategy
to stimulate a significant private sector food
security response. This is not to say that there
are no incentives to invest in food
production—real food prices are expected to
remain high in the future—but the absence of
an enabling framework for private business
and small farmers and shareholders to invest
in large-scale food production, and the
disincentives to food production are strong
reasons for the investment lack. The ‘knee-
jerk’ responses of government in controling
the price of commodities, repressing interest
rates and monopolizing the imports of grain
during lean times are seen to be disincentives
to private investment.
In order for the private sector to step up and
make investments, the market environment
should be improved by providing the
necessary infrastructure, e.g., rural roads,
electricity, and municipal ports (especially for
an archipelagic country such as the
Philippines) and by developing regulations
that support the workings of the market.
Supporting and promoting innovative
financing schemes could be an important part
of that enabling environment for private
sector investments in food production.
Removing constraints to agricultural finance
should figure prominently in the government’s
reform agenda in agriculture and rural
development.
Removing critical constraints
to agricultural finance
In many developing nations, however, access
to agricultural finance is inhibited by two
major constraints:
z High risk. This includes co-variate risks
referring to price fluctuations and extreme
weather events, including pests and diseases
affecting farmers growing the same crop in
the same area. The lack of information on
borrowers’ credit histories, the lack of usable
collateral due to ill-defined property and land
rights, costly land registration procedure, and
social constraints to foreclosure of collateral
make credit risk assessment difficult and
inaccurate.
z High transaction and supervisory costs.
This constraint is also related to the risk,
nature, and characteristics of the agricultural
sector. The dispersal of the rural population
over a vast area in the countryside, and poor
transportation and communication
infrastructure result in high transaction costs
and make loan supervision expensive relative
to lending to clients in the urban areas.PN 2010-11
4
Policy Notes
These constraints have made the access of
rural producers to formal agricultural finance
difficult, forcing said producers to
concentrate on low-risk, low-return activities.
The net result is limited investments in the
agriculture sector and in food production on a
commercial scale.
The challenge therefore to financial
institutions and policymakers is to address
the twin problems in rural financial markets of
high risks and high transaction costs and loan
supervision costs. The innovative financing
schemes discussed in Llanto and Badiola
(2010)3 show particular approaches that seem
capable of surmounting these twin problems.
Much remains to be done, however, on the
part of policymakers such as providing an
enabling environment for innovations to be
sustainable approaches, improving regulatory
frameworks that would strengthen financial
systems, and providing incentives for private
institutions to develop better risk-reducing
instruments and more effective institutions
and credit delivery structures. More efficient
rural financial markets will encourage more
private investments in food production and
agriculture.
What government can do
The government must effectively pursue the
second-generation reforms in the agriculture
and food sector to address agriculture risks
and bring down high transaction costs. Doing
the following will encourage greater private
sector involvement in the sector.
z ensure that regulations, licensing,
procedures, and standards are in place to help
enhance market transactions;
z promote clear rules governing public and
private sector responsibilities in food supply
and distribution activities;
z enforce laws and regulations, particularly
those concerning contracts;
z provide basic food production, market,
transport and processing infrastructure,
facilities, and services;
z promote efficient land and real estate
markets as well as land tenure security; and
z develop and improve risk-reducing
instruments, e.g., index-based rainfall
insurance that has been used in other
countries to address agriculture risks.
In tandem with all of these, the government
should examine and address barriers to long-
term finance in rural financial markets. 
______________
3 G.M. Llanto and J.R. Badiola, Innovations in Financing
Food Security, paper presented at the ADB-FAO-IFAD
Investment Forum on Food Security in Asia and the Pacific,
7–9 July, Asian Development Bank, Mandaluyong City,
2010.
For further information, please contact
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E-mail: gllanto@mail.pids.gov.ph; jliguton@mail.pids.gov.ph
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Addressing Constraints to Agricultural Finance to Boost Food Production

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Addressing Constraints to Agricultural Finance to Boost Food Production

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