Expanding Finance in Rural Areas of the Kyrgyz Republic

1. Expanding Finance in Rural Areas of the Kyrgyz Republic by Michael Marx Credit and Rural Finance, FAO Investment Centre

2. Overview of presentation 1. Background on mission and Kyrgyzstan 2. Agriculture 3. Financial sector 4. Financing of agriculture 5. Perspectives and recommendations

4. 1. Background (1) Our task was to assess: ● the potential of the agricultural sector and ● the ability of the financial sector to serve the agricultural sector, and to recommend how this could be expanded further

5. 1. Background (2) We did this through 3 activities: ● assessment of the agricultural sector ● assessment of the financial sector, ● survey of farm households and food processors We do therefore more concentrate on the potential, rather than lamenting on the constraints (which do exist)

6. 1. Background (3) 3 reasons to invest more in the agricultural sector: ● Higher incidence of poverty in rural areas than in urban ones ● Agriculture contributes 37% to GDP, the highest share in Central Asia (and Eastern Europe), and 11% to total exports; it absorbs 55% of total labor ● Potential to grow further

7. 2. Agricultural sector

8. Some key issues (1) ● 56% of total land area is agricultural area ● 7% is arable land, 87% pastures ● High dependence on irrigation ● Increased pressure on the land (less available land, more farmers) ● Arable land/agricultural worker = 1.2 ha (53% of 1990 level)

9. Some key issues (2) ● Low level of concentration of farming → high level of dispersion, with its implications on risks, dependency, transport costs, market opportunities, etc. ● Concentration on wheat, potatoes and cattle ● Cotton is less important than in other countries

10. Wheat ● Most important crop, ≈ 1m tons ● Slow decline in production, falling profits, after sharp increases in mid 1990s ● Low average yields, as standard practices are not followed, due to lack of capital

11. Other cereals ● Maize, rice and barley are other important cereals ● High demand for Uzgen rice, no marketing problems ● Most of maize and barley is not marketed, but consumed by producer

12. Potatoes ● Second most important crop, 1.2 m tons ● ≈ one quarter home consumed, small quantities exported ● Very little processing (1%) ● High variation of prices influencing production quantity in next season

13. Cotton ● Important for the economy in Osh and Jalalabad oblasts ● Slow growth trends, despite stagnant market prices and slow payment of farmer ● Farmers benefit from a strong commodity chain that covers all aspects from production to marketing

14. Sugar beet and tobacco ● Specific products with good value added ● High dependency on the ability of the supply chains and processors to absorb production

15. Oil seeds ● Soybean, safflower, sunflower and mustard seed steadily expanding ● Reasonable profits, where marketing arrangements exist ● Further expansion for fodder production possible

16. Vegetables, fruits and berries ● Specific market requirements ● High exposure to price fluctuations ● Good potential if stable marketing arrangements can be made

17. Livestock ● Cattle most important, followed by sheep, goats, horses, pigs, yaks ● Processing of wool on the decline ● Egg production increasing ● Many smaller niches

18. Exports and imports Major agricultural exports: ● cotton, sugar, tobacco, hides Major agricultural imports: ● prepared food, chocolates, cigarettes, beer, wheat, vegetable oils

19. Main producers ● Private farmers were the main drivers of marketable surplus production, using 71% of arable land and accounting for 40% of total output ● Household farms with high intensity farming, but smaller share for markets ● Declining importance of the state farms

20. Fertilizers ● Scanty data, dominated by the ‘classical’ agronomy approach to maximize outputs, and therefore not very reliable ● The good results achieved in some sectors were due often to following the standard practices ● Prospects of increasing the use of inorganic fertilizers ● Importers are usually small-scale

21. Agro-processing (1) ● Big gap between potential and actual achievements ● Obsolete machinery, inadequate market orientation, lack of finance, operating in niches with small margins, in many of the older companies; better systems in newer ones

22. Agro-processing (2) ● The commodity chains that existed during the centrally-planned economy functioned very well in the sense that all pieces functioned and contributed to the outputs ● Some elements that disappeared under the market system have not yet been replaced in all commodities (input supply, market arrangements, finance, transport) ● Cost of processing also increased with the fragmentation of the producers

23. Agro-processing (3) ● Key issue: could processors make all the necessary arrangements (contract farming) to secure inputs to farmers and inputs to factories? ● Key constraints: management skills of producer, marketing of products, access to finance, mutual trust and confidence between processor and producer

24. Conclusions (1) ● Small production size, scattered producers, high transport costs, distance to markets, management skills, fragile natural environments suggest to concentrate on higher-value, niche markets, and a well diversified production ● Investments in management, marketing, finance are indispensable to tap the potential

25. Conclusions (2) Market potential: cotton, tobacco, barley, sugar beet, lucerne seeds, seed potatoes, tomatoes, cucumber, cherry tomatoes, berries, fresh beans, medicinal herbs, mushrooms (?), cattle meat, milk, hides, yak, pig, silk, wool, fresh water fish

26. 3. Financial sector (1) ● 19 commercial banks ● 1 Govt.-owned agric. bank (KAFC) ● 106 microfinance institutions ● 306 credit unions ● Pawnshops

27. 3. Financial sector (2)

28. Financial sector (3) ● Migrant remittances ($ 195 m) almost as high as total loans outstanding of commercial banks ($ 205 m) [2005]

29. 3. Financial sector (4)

30. 3. Financial sector (5) ● Loan purposes of commercial banks [2004] still concentrating on trade (49%) and manufacturing (18%) ● 6% for construction ● 3% for agriculture (increasing trend)

31. 3. Financial sector (6) ● EBRD-funded Micro and Small enterprise Finance Facility implemented since 2002 ● Downgrading of commercial banks to suit MSE requirements ● No collateral for loans below USD 1000 ● Quick loan processing (2-15 days)

32. 3. Financial sector (7) ● Rapid expansion with excellent portfolio quality (PAR 30 days + > 1%!), more profitable than corporate lending ● 20 000 loans outstanding worth $ 36 million after 4 years

33. 3. Financial sector (8) Key constraints: ● Low confidence of the public into banks ● Inadequate mobilization of deposits (efforts and products) ● Inadequate legislation on collateral and collateral substitutes ● Insufficient lending experience (risk analysis, term loans, enterprises)

34. 3. Financial sector (9) Key constraints (cont’d.): ● Low capitalization of the banks ● Term structure of liabilities, with predominance of short term funds, only permitting short-term lending (73%) ● Modest overall profitability of banks (2.4% RoE) ● Big spreads between deposit and lending rates (23% for som lending [16% for $])

35. 4. Financing of agriculture (1) ● Moderate level of funding agriculture (≈ $ 48 million ≈ 16% of total loans = 2% of GDP), most of which coming from KAFC ● KAFC portfolio switching from livestock to other agricultural activities ● Growing exposure of commercial banks ● 8% of EBRD SME Finance Facility used for agric. lending after only 15 months

36. 4. Financing of agriculture (2) ● Poor experience in the past with agricultural finance (high debts in 1990s) ● Perceived often as high risk + low return ● Insufficient experience by staff ● Growing interest due to govt. talk and search for borrowers ● Insufficient knowledge where to start/continue ● Absence of more innovative concepts beyond direct lending, such as contract financing orstructured financing in supply chains

37. 5. Perspectives (1) ● Development of collateral substitutes, such as warehouse receipts, pledging of future harvest + secured sales, livestock, personal guarantees ● Increase threshold of zero collateral lending (currently $ 1000) for good clients ● Revision of land laws to permit banks accept farm land as collateral, more security for buyers of agricultural land ● Revision of collateral legislation

38. 5. Perspectives (2) ● Assist banks to identify profitable supply chains and finance supply chain actors; this goes beyond the mere financing of processors to fund contract farmers ● This also requires more investments in building permanent, mutually beneficial relationships between producer/farmer and processor, and eventually the facilitation of equity participation by farmers in the processing sector

39. From classical finance to Commodity/Market Supply Chain Finance Finance Supplier’s Supplier Trans-port Sell Customer Customer’s Procure Produce/Process Supplier Customer ,

40. 5. Perspectives (3) ● Assistance to build the capacity of farmer associations and cooperatives to manage their role in supply chains ● Experimentation by banks to provide structured finance in supply chains (cession of payment claims, domiciliation of payments in bank accounts as collateral for working capital loans)

41. 5. Perspectives (4) ● Experimentation on products linking savings and credit ● Outreach of financial institutions in general to poor and low-income households ● Training of bank staff in medium to large-scale agricultural project analysis ● Adjusting repayment schedules to cash flows ● Assistance in designing new products and cross-selling approaches

42. What clients want ● 35% want lower interest rates ● 18% want longer term credit ● 8% want less bureaucracy and red tape

43. Thank you for your kind attention!