Subsidy back in fashion?

For a long time the consensus has been that investment by development finance institutions (DFIs) should be on 'commercial terms'. Low-cost loans risk propping up weak businesses and crowding-out private investment. There is a case for using public money to increase the supply of credit in developing countries, the argument goes, but not for reducing its cost.

When applied to African agriculture this argument is weak. Firstly, many agribusinesses operate in environments where there are market failures – such as underfunded research institutions, poor infrastructure and inexperienced farm management and labour – which makes it difficult to compete with farmers in other parts of the world. In these situations there is a sound economic rationale for public subsidy to help business get established and achieve the economies of scale which allow them to become competitive.

Secondly, the cost of commercial finance in rural Africa – often more than 25% interest for local currency loans – is prohibitive especially for primary agriculture which is generally a low margin business. For smallholder farmers the cost of credit is higher still – often 40-50% or more – which reflects the high transaction costs of making small loans to large numbers of disbursed clients. Insisting the DFIs lend on the same terms as commercial banks will not stimulate more investment in agriculture. Credit lines simply go undrawn.

Thirdly, there is no shortage of commercial capital looking for opportunities in the African agriculture sector. More than $2 billion of dedicated private equity has been raised since 2010. If there were investment opportunities that could give a reliable 25% + return then the private sector would already have taken them up. There is little benefit in increasing further the supply of credit when the problem is not a lack of capital but a lack of “investment-ready” opportunities (i.e. businesses with a solid business plan, quality management on the ground and some sort of track record).

Interestingly, the ideological opposition to subsidies seems to be on the wane. As Europe struggles to escape austerity more attention has been given to the role of the state in stimulating growth and encouraging entrepreneurship. Industrial policy is back in fashion.

A recent report by Demos titled The Entrepreneurial State points out that in many cases states have been the catalyst to develop and invest in new technologies. Many of the most innovative young companies in the USA were funded not by private venture capital but by public grants such as through the Small Business Innovation Research programme ($30 billion disbursed since the 1970s). The algorithm behind Google was funded by a public sector National Science Foundation grant.

AgDevCo’s view is that African agriculture will not develop with commercial finance alone. There are simply too many hurdles for start-up businesses. There is a strong economic rationale for subsidising agribusiness in its early-years, as long as there is an exit strategy. The DFIs should be doing more to catalyse private investment by increasing the supply and reducing the cost of credit for early stage agriculture businesses.

Why good project development matters in the land grabbing debate

It doesn’t make for exciting headlines, but good project development may be the best way of ensuring that private investment in African agriculture benefits local communities.

Project development is the set of activities required to take a project from the concept stage to the point at which investment has been secured and implementation can begin. Using the language of finance, project development is about making an investment opportunity “bankable”.

Project development is important because it reduces the upfront risks of greenfield agriculture projects. If done properly it demonstrates to potential investors that a project can deliver a stable financial return (e.g. by proving that good crop yields can be achieved and there is a reliable market).

Good project development should also involve structuring deals such that benefits are equitably shared between investors, the local community and the host country government. Failure to get this right will undermine a project's long-term sustainability. Managing environmental impact is also key.

There are no short-cuts. Project development is expensive – often 10% of the total project cost – and can take 2-3 years or more. It needs to be undertaken by a team with the right mix of agronomic, financial, legal and engineering skills. The unexpected often happens and project developers need to be prepared for a long haul.

Where investors have been accused of “land grabbing” it is often because of bad project development usually involving a failure to properly consult and gain the consent of the local community, who in some cases are sidelined when governments or local authorities allocate land directly to investors.

But in many situations projects do not even get out of the starting blocks. The project development process is seen as too risky and expensive given the complex technical, social and environmental challenges involved. The result is that many potentially viable projects never get beyond the concept stage and Africa’s agricultural potential remains unfulfilled.

AgDevCo believes there is a strong case for public subsidy of project development in the African agriculture sector. Firstly, this would allow more “bankable” projects to be developed in situations where private capital was unwilling to take the first step. Secondly, because public subsidy would come with strings attached, it could be used as a tool to ensure projects were designed to maximise smallholder farmer and community benefits.

The way to address "land grabbing" is not to put a moratorium on all foreign investment into African agriculture, as some campaigning groups have called for. Instead a way must be found of ensuring that project development is done properly and benefits are shared with local communities.

AgDevCo is a project development company operating in the African agriculture sector funded by donor agencies and philanthropic organisations. Acting as principal it invests its capital to develop greenfield and early-stage agriculture businesses. Success for AgDevCo involves attracting private capital into projects (at financial close) that are profitable and guarantee long-term sustainable benefits for smallholder farmers and local communities.