Guarantee Fund as an enabler for new-age agriculture enterprises
The need for resilient agricultural ecosystems and enhanced farmer livelihoods is more important than ever as the world begins to recover from the disruptive effects of the COVID-19 outbreak. The pandemic has obstructed the growth of new-age innovative enterprises that are envisioned to disrupt the agriculture sector and provide a new direction, especially for smallholder farmers. Parallelly the agriculture industry expansion has drawn interest and participation from a variety of entrepreneurs and investors, agribusiness, and corporates across verticals on this road to recovery. Some of the biggest challenges which continue to exist are lack of digitization translating into information asymmetry, expensive and inefficient energy systems, and food and agricultural waste because of the absence of efficient supply chain networks and solutions impacting the small and marginal farmers (SMFs). Due to its potential for value creation and impact, policymakers, businesses, and private investors are attempting to pave the way for cutting-edge solutions to the age-old issues of dismantled agricultural value chains. Government initiatives to support the industry’s rapid expansion include the promotion of FPOs (Farmer Producer Organizations) and the use of Renewable Energy (RE) in agriculture. Over the past ten years, India has seen significant investments in the AgriTech and Food Loss Solution industries, but overall, both fields still have enormous financing deficits, with only 120 out of 1500 active AgriTech start-ups having exposure to institutional capital (Kalaari Capital, 2022).
Farmers are collectively organized through FPOs, which helps to provide economies of scale to different production stages. In India, more than 10,000 FPOs are currently registered under various legal frameworks. Financing Institutions (FIs) are less interested in investing in FPOs because the bulk of them are new, have few producer members, and have their equity capital. Likewise, Agri-businesses working in the field of RE face several challenges, including lower adoption rates, lack of farmer awareness, and shortage of Funding because of investor aversion. However, the adoption of RE sources is crucial as it can circumvent many of the sector’s teething issues, such as carbon emissions and erratic power supply, resulting in reduced productivity. Due to poor digital infrastructure and inept supply chain systems, the new-age enterprises in the AgriTech and food loss solution industries also suffer significant resistance from FIs and investors. Most of these new-age Agri enterprises struggle to increase their consumer bases and accelerate expansion due to a lack of access to capital, eventually resulting in sub-optimal reach and a lowered impact on SMFs and agriculture as a sector.
Innovative credit risk mitigation
Mechanisms are now put in place to incentivize FIs to mitigate their risks and overcome their reluctance to lend to such agri-business and close the funding gap. Credit guarantees from donors, governments, or multilateral/bilateral agencies are one of the mechanisms for compensation. Other mechanisms include the provisioning of grants and subsidies on investment taxes but since these methods provide a one-time cover to the lender, a credit guarantee is more suited for this scenario to encourage FIs to float capital in the sector.
Credit guarantees aim to enable reluctant FIs to lend to groups that interest governments and donors, such as agriculture, small and marginal farmers, women, microenterprises, and other high-risk borrowers. It is typically believed that one of the biggest barriers to lending in the formal sector is the perceived risk involved. It is anticipated that FIs will extend more credit to clients with restricted access to credit because of a guarantee that lowers the default risk. More borrowers gain from partial guarantees than they would if the same money were used to rediscount targeted loans. In addition, it is anticipated that FIs would realize certain groups or sectors are not particularly risky and will lend to them in the future without the requirement of guarantees. Over the years and across geographies, these guarantees have been useful in providing financial support to microenterprises in various sectors. One such initiative by the Indian government is the Credit Guarantee Fund Scheme for Micro and Small Enterprises, which offers partial guarantees to linked FIs to support MSMEs. With the intention to steer and ensure the growth momentum of new-age agriculture enterprises, USDFC (the Guarantor) and Rabo Foundation, along with IKEA Foundation and UK Charity Shell Foundation in partnership with the UK government (Now referred to as the Foundations) through an Agri-transition Fund (Now referred to as the Fund) provides a partial guarantee aimed at mitigating the risks of new-age enterprises with the intention to disrupt the conventional Agri-finance modality. The Fund will strengthen the FIs to lend to new-age enterprises to enable Agri-transition for Small & Marginal Farmers (SMFs) and covers four key sectors that are FPOs, RE, Food Loss Solutions, and AgTech. These new-age enterprises are businesses with unique and unconventional business models to tackle complex problems existing in the agriculture sector. The disruption in the Agri-finance modality is, therefore, a change in the perception of lenders to extend loans to new-age enterprises working in these four sectors. The Fund seeks to drive the agriculture sector in India towards sustainable practices through the medium of Agri-enterprises which will be supported by the capital of the affiliated FIs. The capabilities and functions of these Agri-enterprises would eventually translate into a more significant and long-lasting impact on SMFs. The Fund also facilitates a Technical Assistance service for both borrower Agri-enterprises and FIs to support them with their operations. Given this program context, the question is whether the Fund created has been successful in changing the perception of lenders and to what extent? Preliminary results of the Fund at the FI level are discussed here.
Key drivers of the Fund
Three Non-Banking Financial Companies (NBFC) or FIs that have expertise in lending to high-risk borrowers and have shown intention to expand their debt portfolio in the agriculture sector are provided with a guarantee by USDFC against loan default. A study conducted by Sambodhi suggests that the Fund has been able to enable access to capital for new-age Agri-enterprises through NBFCs under the Fund. These enterprises are carefully vetted by the NBFCs and are provided access to finance to promote their innovative solutions to contribute towards a sustainable and efficient agriculture value chain. These solutions range from chilling and cooling solutions at the farm level to AgTech-based fodder ecosystems, women-led Farmer Producer Companies (FPCs), and RE solutions such as solar panels. There are four key factors that have worked in favor of the Fund: (1) Identification of FIs that shares the same vision of sustainable agriculture, (2) Increase in the risk appetite of FIs (3) Expansion of portfolio to first-time borrower entrepreneurs (4) Expansion of FI portfolio into unchartered Agri-sectors.
Vision Alignment between the fund and the FIs
The first factor is essential for the guarantee Fund to be functional. NBFC is a clear and the preferred choice for new-age agriculture enterprises despite the higher cost of capital vis-à-vis conventional FIs (PSUs, Private sector banks). The absence of collateral requirements and innovative loan products allowing supplier payments to match loan repayments make NBFC a favored financial institution.
Increased risk appetite of the FIs
Second, FIs, with the Guarantee, showed a willingness to take on different kinds of risks, such as operational, governance, and industrial risks associated with new-age enterprises. Within Operational risks, resilience risks and third-party risks were key themes that emerged. For example, loans were renewed to enterprises with whom FI had past engagements but wouldn’t have in the absence of the Fund. The COVID-19 outbreak had stalled the growth and scale of these business enterprises; a loan at this juncture ensured business continuity and avoided potential business shutdowns. Similarly, loans were lent to organizations with long working capital cycles with third-party risks. Renewable Energy (RE) companies fall into this category. Most RE enterprises were tied with the KUSUM scheme of the government, which resulted in longer than usual payment cycles.
Increased access to credit for first-time borrowers
Third, lending to new-age enterprises has enabled extending loan products to first-time entrepreneurs who demand small ticket-size loans. FPOs and Village Level Entrepreneurs (VLE) owning small processing units at the village level are examples. Such enterprises inherently lack credit history and strong management and governance structures. Risk assessment for such organizations is time-consuming and cost-intensive. Physical visit to FPO office/VLE unit becomes necessary to evaluate the competence of board members, staff, clients, aligned promoting institutions & key market intermediaries, adherence to compliance and regulatory requirements, etc. FIs view participation in the fund as an opportunity for evidence generation by taking on governance risk and high due-diligence costs. “We have lent INR 0.5 million to a women led-FPO for which we have received payment, we intend to renew the loan cycle with an increased loan disbursement”, exclaimed a participant FI of the Fund.
Increased FI exposure to new sectors
Fourth, an opportunity presented by the support of the Fund is building FI’s capacity to expand to unchartered business sectors. While this varies across FIs depending on the long-term impact alignment of the FI with that of the Fund guidelines. For example, one of the FI participants having technical expertise in RE enterprises has now begun exploring business models where RE is used in agriculture. Similarly, participant FIs are increasing exposure to food-loss solution enterprises that help mitigate food production losses at the farm gate. With the support of the Fund, FIs are gaining exposure to different types of technological solutions. This allows lending institutions to gain insights into company growth prospects, sensitivity to macroeconomic variables, the company’s bargaining power with suppliers and customers, and industry complexity with a better understanding of opportunities and threats. Thus, the Fund has enabled lending institutions to take on more industrial risk in addition to inherent risks associated with the agriculture sector. The opportunities and resultant behavior change of the FIs discussed above are anticipated changes incorporated into the design of the Fund.
Limitations and Future Challenges
Every intervention has certain limitations and challenges that program designers and implementors must be mindful of. While limitations help in understanding under what context the program is likely to work, identifying and addressing challenges timely, on the other hand, can lead to a higher probability of achieving desired results. In the Indian context, there are two key limitations that have been discussed below:
Benefit of lower credit risk is not passed on to borrowers
Theoretically, when a lender has a loan guaranteed, the interest rate charged to the borrower should be lower than would be the case without a guarantee because the risk of loss is lower (Asian Development Bank, 2016). However, this does not hold true in the Indian context. None of the participant FI offered low-interest rates or increased credit limits to any of the borrower enterprises under the fund. Insignificant changes in the cost of raising capital for FIs, despite the support of the fund, make FIs resistant to passing on the benefit of lower credit risk to borrower enterprises.
Fund does not ensure adoption by end users
The Fund aims to plug one key issue which is bridging access to finance gaps at the enterprise level. This, however does not solve other external issues inherent in the agriculture ecosystem. For example, there is access to finance gap at the end-user level. This hinders the adoption of innovative solutions offered by new-age Agri-enterprises. Therefore, to create an impact at the SMF level, there is a need for the fund to be operationalised in conjunction with other intervention programs that plug externalities of this kind.
Further, the FIs call out three challenges regarding the fund
Loan demand varies with size and maturity of the enterprise
This challenge arises because of the vast gap in turnover of new-age enterprises. A well-intentioned guideline to ensure credit access to underserved enterprises by having an upper limit of INR 20 million per borrower hinders reach to more established RE enterprises. Mature RE enterprises are more capital intensive, with an average turnover of INR 1000 million than an FPO, whose average is INR 10 million. Similarly, AgTech businesses are too capital-intensive. Therefore, the cap on capital under guarantee may be considered for revision and can be different for the four sectors (FPO, RE, AgTech, and Food Loss solutions).
Select loan products covered under the fund
The second challenge is that of strict guidelines leading to the exclusion of borrowers. For example, the exclusion of key loan products has resulted in low traction from AgTech enterprises. The required tenor of the loans is shorter than what is being offered under the fund’s facility. AgTech enterprises demand for a revolving facility that falls outside the Fund’s scope. Agtechs work as aggregators between the market and farmers. The demand for capital is more frequent with a shorter tenor and is seasonality dependent. Therefore, the design of the program has the potential to exclude AgTech enterprises.
Technology failure risk as a barrier to loan disbursements
The third challenge is to extend loans for novel technology solution-based companies with varying levels ranging from ‘low tech’ innovations which involve replicating well-established technologies, to ‘Super high tech’ innovations which are technologies that are novel and do not yet exist in the market. Despite the Fund’s backing, FI are reluctant as technological feasibility may not be established, especially for super-high-tech innovations. The absence of a buy-back facility by the Original Equipment Manufacturers (OEM) acts as a key barrier for the FIs to lend. There is a potential for TA to strengthen underwriting for novel tech product-based enterprises.
Conclusion
To conclude, the viability of any social enterprise relies on its ability to create impact or results. Results are either realized immediately, in the interim, or long term. Each set of results acts as a precondition to the next, depending on the size of the investment or the level of effort put into implementing it. This logic works equally for enterprises, FIs, and the Fund itself. In any case, the impact needs to be conceptualized at the beginning of an investment or an initiative and tracked throughout its life cycle. However, it takes more than causal logic and investment to move the needle mostly because causal logic can only hold strong within a controlled environment, and investments have an end date. The question one needs to be asking, therefore, is- “where does the buck stop”? What is the most share of influence an Agri-transition Fund can bring with the current level of effort? For instance, the FIs have seen an increase in their risk appetite when it comes to lending to high-risk borrowers because a Fund exists, but can a two-year term loan routed to an enterprise enable an increase in the income of the farmers, and to what extent? The enterprise’s immediate need for finance is being fulfilled, and the level of impact may be high, but how prudent is it to rely on this evidence to assume that the expected change in the farmer’s income will follow or that sustainable agriculture will be achieved, especially when the program doesn’t directly interact with the farmers.
In the Guarantee Fund’s value chain of impact, a change in the lending perception of FIs to expand their operations to sectors otherwise not considered for Funding stands out as an immediate result. At the enterprise level, there is a need to look beyond access to finance and consider their social ability to pursue impact with adequate social capital, such as their relationship with the market players, farmers, digital technology, affiliations and associations, and competitive advantages over other similar enterprises (Taylor, 2022). Technical Assistance (TA) support plays an important role in enabling enterprises to strengthen technical know-how through interaction with market players that help in better decision-making. TAs are motivated by the belief that with their use, enterprises can overcome operational barriers to catalyze a longer-term systemic change (Davies, 2020). The underlying objective is to support FIs in risk mitigation and make borrower enterprises financially sound by providing tailored support than restricting to purely a loan transaction. The Fund, in context, does make this effort and has launched a TA component for all FIs and borrower enterprises to avail. Their utilization and results are yet to be assessed and will be explored in the near future. Beyond TA, there is also a need to generate concrete evidence at the enterprise and farmers’ level to ascertain whether the impact that the Fund aims to achieve can be achieved as planned and ascertain why can’t the intended impact be achieved if they aren’t. Beyond the realms of the Fund, there is also a need to understand the regulatory mechanisms within which Guarantee Funds in India exist and how the evidence from the current Guarantee Fund makes an intentional effort to move the wheel of larger policy discourse. Guarantee Funds do not work in isolation; it does not mitigate the risk of the same level for all. The need of the hour is to generate as much nuanced evidence to optimize its results at all levels. The need is to find enough evidence so that guarantees can be intentional and customised to specific challenges to pave the way for a holistic Agri-value chain recovery.
References
Asian Development Bank. (2016). Credit Guarantees: Challenging Their Role in Improving Access to Finance in the Pacific Region. Phillipines: Asian Development Bank.
Davies, G. (2020). Making the Most Effective Use of Grants and Technical Assistance to Support Financial Institutions. CDC.
Kalaari Capital. (2022). AgriTech: India Sunrise Sector.
Taylor, K. &. (2022). Sink, Swim, or Drift: How Social Enterprises Use Supply Chain Social Capital to Balance Tensions Between Impact and Viability. Journal of Supply Chain Management. Journal of Supply Chain Management.
Kezia Yonzon – Assistant Vice President, Sambodhi
Aishwarya Sivaramakrishnan – Research Manager, Sambodhi
Shubham Pathak – Deputy Research Manager, Sambodhi
Bram Spann – Program Manager Asia, Rabo Foundation
