Whether for profit or social motives - and often both - an increasing number of investors are targeting opportunities in African agriculture. At the same time innovative approaches for deploying aid to support farming businesses linked to smallholders are emerging. This blog provides a snapshot of who is doing what, where and how.

23 October 2011

The need for catalytic finance for African agriculture

The EMRC Agribusiness Forum in Johannesburg last week brought together private companies, investors and development agencies who all share a vision of a profitable African agriculture sector which delivers wide benefits to rural populations. I spoke about the role of public private partnerships (PPPs) in making this happen.

In AgDevCo’s view PPPs in the agriculture sector are most likely to be successful if they are backed up by public private finance – we call it “catalytic finance”. So what is catalytic finance and how can it be most effectively delivered?

It is concessional funding made available by governments, donor agencies and philanthropic organisations that can be invested in early-stage agriculture businesses to reduce the costs and risks of future entry by commercial investors. It is catalytic because each dollar of public capital can expect to leverage at least 5 dollars of commercial capital into agriculture businesses which would not otherwise have been able to tap the private capital markets.

Two types of catalytic finance are: i) "Social Venture Capital" for start-up businesses, expecting a return of 5% - 15%; and ii) "Patient Capital" to invest in agriculture-supporting infrastructure including irrigation, with a coupon of c. 5% over 15-20 years. Here are specific examples:

• A new seeds company in central Mozambique needs $300,000 as “social venture capital” to cover the costs of registering new germ plasm, introduce irrigation and buy seed cleaning and packaging machinery. Local bank debt is unavailable at less than 25% interest or for more than 12 months tenor. Once operational the company can supply improved, locally-adapted and lower costs seeds to over 100,000 smallholder farmers.

• An irrigated soya and barley farm which plans to incorporate large and small farmers on 2,500 hectares needs $5 million of “patient capital” to invest in feeder roads, small dams and electricity connections. The remaining finance requirement of $20 million - for land preparation, farm machineryand buildings and working capital - will come from private debt and equity providers.

The rationale for catalytic finance is the existence of mulitple market failures in early-stage African agriculture which in most situations is still at an infant industry stage of development. The lack of economies of scale and cluster effects, under-developed capital markets, weak infrastructure, and a shortage of trained and experienced management and workforce (“learning by doing”) means that pioneer investors in African agriculture – and indeed subsistence smallholder farmers themselves – face high costs in doing business which competitors in other parts of the world do not. High inputs costs, high transport costs, high personnel and training costs and high infrastructure costs typically far outweigh the benefits of relatively inexpensive land.

Catalytic finance needs to be carefully targeted. The challenge is to identify genuine situations where there is good potential for profitability once the initial market failures/ barriers to entry have been overcome. This calls for management by professional investment teams within a strict set of operating policies and procedures designed to protect the public interest.

What are the benefits of catalytic finance? If properly deployed it can be the key to unlock large volumes of new private investment in African agriculture. Numerous private equity and debt funds are being raised for African agriculture but there remains a severe shortage of “investment ready” opportunities. As argued elsewhere on this blog, the risk is that much of this money does not get deployed, or the price of the few bankable projects gets bid up to unsustainable levels. Catalytic finance helps avoid this situation by supplying a pipeline of investments that are ready to take commercial debt and equity and can offer reasonable financial returns.

Another major benefit of catalytic finance is that it can be used as a tool to influence private investor behaviour. It comes with strings attached which ensure that agriculture businesses operate in a socially responsible way and build meaningful links to smallholder and emergent farmers. Again, professional management of catalytic finance is important to ensure disciplined monitoring of private sector behaviour and the design of robust contractual arrangements which can lock in development benefits for the long-term.

There is very limited catalytic finance available in the international aid system today. For a long time the aid mindset has been: provide grants directly to governments and charities; or invest on commercial terms through the development finance institutions such as the International Finance Corporation. But increasingly it is being recognised that the development of the agriculture sector does not lend itself to this model. There simply are not many opportunities to make commercial returns given the early-stage of most African agriculture. Catalytic finance is a vital bridge to long-term viability.

It is encouraging to see the traditional mindset is beginning to change. The likes of DFID, USAID and the World Bank Group are now talking the language of catalytic finance in the agriculture sector. There is broad support, for example, for the agricultural growth corridors approach. There seems to be a recognition that for private public partnerships to deliver on their potential they need to be backed up by innovative financing mechanisms. AgDevCo will continue making the case for catalytic finance for African agriculture.

Postscript: The EMRC Agribusiness Forum Johannesburg Declaration calls for "increased public investment in agriculture-supporting infrastructure" and for development partners to "increase support for catalytic financing mechanisms and matching grant facilities to promote inclusive business models".