Analyzing and Financing Value Chains: Cutting Edge Developments in Value Chain Analysis

Developing rural financial systems has proven to be very challenging in Africa. Many countries have implemented financial sector reforms designed to create viable financial institutions, increase the supply of financial services for unbanked segments of the population, and stimulate competition to reduce the costs of financial services. Considerable progress has been made in some countries in expanding urban microfinance, but progress has been slower in reaching rural areas and especially farmers. There is a widespread perception that there is less agricultural credit available today in most countries, especially for the poor, compared to the situation prior to the financial reforms. Agricultural marketing companies are becoming more important in supplying credit for small farmers, especially for the export crops of cotton, tea and tobacco. Microfinance institutions (MFIs) are beginning to play a role in rural finance, but there is a concern that farmers cannot pay the high interest rates they typically charge for loans. This situation has prompted some countries in Africa and elsewhere to propose the reintroduction of government-owned financial institutions and other measures designed to enhance the supply of financial services in rural areas.

There is a great deal of enthusiasm today for using the value chain approach as an additional tool to tackle the stubborn agricultural finance problem (USAID/ AMAP, 2005). Integrated economic activities are increasingly the norm in the world economy. Integration involves both the financial and non-financial sectors with the objective of facilitating a smooth flow of commodities and services from producers to consumers within clusters of activities or sub-sectors. Value chain analysis is one way of analyzing how these activities are organized and how they can be improved for the benefit of developing countries. In this paper, the author highlights some key features of value chain analysis, provides some examples of agricultural value chains, and suggests how this analysis can help identify interventions to expand financial services to farmers and rural communities. He gives special emphasis to problems of reaching small farmers.

The author concludes that value chain analysis can be important in focusing attention on where financial interventions may have the highest payoff. It can identify where there may be unmet effective demand and where lending costs and risk may be lowest. The next step is for financial institutions to follow up with the more detailed analysis required to design products, develop lending capacity, and generate diversified loan portfolios.

For example, lending to farmers in the value chain requires asking questions such as “what other economic activities does the farmer and the household engage in? What cash inflows and outflows do they produce? What are the sources of income to repay the loan if the value chain crop fails? How much can be prudently lent and how should the loan be structured given the household’s cash flow?” The issue of portfolio risk requires addressing the questions of “what share of the total loan portfolio should be lent to agriculture? What share should be lent to this value chain? How can the lender’s risk be mitigated to deal with the effects of systemic risks such as drought or disease?”

These questions imply that a combination of value chain and financial systems analysis is needed to solve rural and agricultural financial problems. Value chain analysis provides a commodity by commodity approach to learning about current financial arrangements and potential demands for financial products and services. This is a useful starting point for identifying possible interventions. The results of the analysis logically lead to broader questions about how to create systems and institutions that evaluate the credit worthiness of potential clients, and the types, terms and conditions of financial products required to meet the potential demands.

This paper was presented at the 3rd African Microfinance Conference in Kampala, Uganda in August 2007.

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