Agricultural Credit: Assessing the Use of Interest Rate Subsidies by Agence Française de Développement

July 2015

Agricultural Credit: Assessing the Use of Interest Rate Subsidies

CONSULTANTS

COORDINATION

Christine WESTERCAMP Miryam NOURI André OERTEL

Aurélie CHEVRILLON and Mathilde GASPERI chevrillona @ afd.fr gasperim @ afd.fr AFD Sustainable Development Department

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29 Agricultural Credit: Assessing the Use of Interest Rate Subsidies / July 2015

Since the beginning of the 20th century, interest rate subsidies have been one of the tools used all around the world for developing agriculture, especially by major agricultural countries such as France, the United States, and Brazil. However, a general consensus against their use now exists among donors, despite the fact that all of these latter still use them more or less directly. In each donor institution, there is debate between the “financial” faction, who oppose such subsidies, and the “agronomist” faction, who cannot effectively organize agricultural development projects that rely solely on rural financial markets, as the latter are insufficiently developed and usually offer exit interest rates that are prohibitively high for financing investments in infrastructure. The issue of interest rate subsidies is moreover stirring up intense discussion within international bodies, in particular the OECD Development Assistance Committee (DAC). This study takes a critical look at the consensus against interest rate subsidies and examines the arguments for and against them.

Agricultural Credit: Assessing the Use of Interest Rate Subsidies A SAVOIR

Christine WESTERCAMP Miryam NOURI André OERTEL

A SAVOIR

Agricultural Credit: Assessing the Use of Interest Rate Subsidies CONSULTANTS

Christine WESTERCAMP Miryam NOURI André OERTEL COORDINATION

Aurélie CHEVRILLON chevrillona @ afd.fr

and Mathilde GASPERI gasperim @ afd.fr AFD Sustainable Development Department

À Savoir The A Savoir collection was created in 2010 by AFD’s Research Department and gathers either literature reviews or existing knowledge on issues that present an operational interest. Publications in this collection contain contributions based on research and feedback from researchers and field operators from AFD or its partners and are designed to be working tools. They target a public of professionals that are either specialists on the topic or the geographical area concerned. All our publications are available at http://librairie.afd.fr/ Already published in the collection (see page 164). All our publications are available at www.afd.fr/A-Savoir

[ Disclaimer ] The analyses and conclusions in this document are formulated under the sole responsibility of the authors. They do not necessarily reflect the viewpoint of AFD or its partner institutions.

Director of Publications:

Anne PAUGAM Editorial Director:

Gaël GIRAUD

Design and production: Ferrari /Corporate – Telephone: 00 33 (0)1 42 96 05 50 – J. Rouy / Coquelicot

Executive Summary

Contents

Introduction 9 1. Historical analysis

1.1. France 1.1.1. Transition from a largely rural economy to a modern economy 1.1.2. Strong growth in interventions that include interest rate subsidies, since their start in 1910 1.1.3. Impacts on the French agricultural and financial sectors 1.1.4. The essential role of interest rate subsidies in the major phase of French agricultural modernization, in conjunction with other support

11 12 14 23 31

1.2. United States 1.2.1. Shift from a largely rural economy to a modern economy 1.2.2. Interventions that include interest rate subsidies, essentially under the sponsorship of the FSA 1.2.3. Impacts on the agricultural sector and the financial sector 1.2.4. Conclusion: the subsidized loan system has acted as a security net, but cost has been high

32 32

1.3. Brazil 1.3.1. Agriculture, a strategic sector for Brazilian growth 1.3.2. Success in adapting interest rate subsidy interventions to the size of farms 1.3.3. Impacts on the agricultural sector and on the Brazilian bank sector 1.3.4. Conclusion: little prospect of the private sector taking over the subsidized loan supply

58 58 60 71

1.4. Summary and comparison of case studies

34 50 57

2. Review of donor policy on subsidized credit interventions

2.1. History, strategy, and forms of donor intervention

2.2. Donor positions on subsidized credit lines

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Sommaire

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3. Analysis of arguments for and against the use of subsidization

101

3.1. Introduction

101

3.2. Presentation of the pros and cons

102

3.3. Arguments for and against subsidization as a tool of intervention

104

3.4. Arguments for and against subsidization within the specific framework of agricultural financing

112

4. Recommendations

121

4.1. Recommendations regarding the intervention context

122

4.2. Recommendations concerning how to implement the subsidization tool 4.2.1. A healthy subsidization system that is regularly evaluated and audited 4.2.2. Targeting: an essential element for effectiveness and cost control 4.2.3. Financial and non-financial loan conditions whose aim is to establish healthy behavior

124 126 132

4.3. Support measures

137

4.4. Conclusions

140

134

Appendix â&#x20AC;&#x201C; List of persons contacted

143

Acronyms and abbreviations

147

References 151

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Executive summary Interest rate subsidies were dropped with the shift in the rural finance paradigm in the 1980s. However, new approaches have not led to satisfactory solutions to address financing needs for agriculture, as rural financial markets remain insufficiently developed, and their exit interest rates are often too high for farmers to finance structuring investments. The present study specifically assesses the effectiveness of providing end beneficiaries with credit at interest rates that are below market rates, as a way to foster the development of agricultural credit supply. The analysis relies on a historical review of practices in three large agricultural countries that have used interest rate subsidies as a central element of their agricultural policies: France, the USA and Brazil. Based on these three case studies, a literature review, and an overview of how donors’ positions on the matter have evolved (World Bank, KfW, IFAD, USAID), this study seeks to determine whether subsidized loans to agriculture have contributed to modernizing small farms, increasing yields, and creating sustainable access to credit. An analysis of pro and con arguments is followed by recommendations, mainly relating to the conditions under which subsidized interest rates can have positive effects on the development of small-scale agriculture and on its sustainable access to financial services. The three case studies highlight different strategies implemented by public authorities. France: The French case study is particularly interesting, for two main reasons. French agriculture developed strongly over the 20 th century, closing technical gaps, and thus making France the second-largest agricultural commodities exporter at the end of the century, despite its relatively small size compared with other agricultural countries. This was achieved thanks to strong state support, with interest rate subsidies as a major component. One of the specificities for France lies in the fact that, until 1990, subsidized loans were exclusively extended through “Crédit Agricole.” This cooperative bank developed over the past century, and it was strongly supported by the state, which controlled its apex. However, interest rate subsidies appeared to be very expensive and difficult to control, in terms of costs borne by the state and controls to ensure proper allocation of subsidies in accordance with state policy. The system was criticized in particular because it led to public funds being allocated to large agricultural enterprises. Despite these limitations, interest rate subsidies were a major policy instrument throughout the modernization phase of French agriculture. Two

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Executive summary

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aspects appeared key to achieving this result: 1) good linkage with complementary measures (training and technical support for farmers, targeted subsidies, sector stabilization funds, public research); and 2) long-lasting credit programs. USA: US agriculture shifted over less than a century from being fragmented and underdeveloped to an extensive activity that is one of the most productive in the world, notably thanks to successive governments’ strong commitment to its support, in particular in terms of fostering the development of agricultural credit supply. The federal government implemented support measures for the development of agricultural finance starting from 1916, relying on two main organizations. The Farm Credit System (FCS) is a network of credit cooperatives, initiated and sponsored by the federal government, but which was, from the start, intended to be owned, managed, and controlled by the farmers. The Farm Service Agency (FSA) is a federal agency that directly extends loans to the agricultural sector, at below market interest rates. Today, FSA specifically focuses on vulnerable farmers, extending subsidized loans to those who do not have access to bank credits, and guaranteeing bank loans for the others. One of the main specificities of FSA’s credit program is close monitoring and capacity-building services provided along with the credit. The goal is to help borrowers step into the commercial credit system, including in terms of acquiring the required management skills. Some regions have been highly dependent on these programs, which took over the role of commercial banks, notably during crises, but the cost of the system has attracted significant attention from Congress. Administrative costs (infrastructure and human resources) represent the major cost component of FSA’s interest rate subsidy programs. Brazil: The provision of subsidized loans has been Brazil’s main instrument to support its agriculture. The Brazilian case shows how the private banking sector was for a long time left out of the financing of agriculture, although the responsibility for this cannot be laid at the door of interest rate subsidies. Indeed, Brazil started supporting the agricultural sector as early as the 1930s, by providing coffee producers with direct subsidies to compensate for price fluctuations. Under interventionist economic policies, the government then introduced a sophisticated credit mechanism with subsidized interest rates as the backbone for its agricultural development policy. Credits to the agricultural sector are mostly channeled through the National Rural Credit System (SNCR), which includes targeted financing schemes that are funded by compulsory contributions from the banking sector sometimes linked to pricesupport mechanisms, and largely subsidized. Within SNCR, the National Program to Strengthen Family Farming (PRONAF) was initially aimed at accompanying the government’s policy to allocate land to rural populations and supporting small-scale

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Executive summary

farms. It now also strives toward poverty-reduction objectives. This expensive program has only been able to achieve its objectives thanks to a dense network of rural unions and agricultural extension services, as well as a guarantee mechanism supported by the government. These case studies and the literature review show that the effects of interest rate subsidies are closely related to the capacities and orientations of the structures extending the subsidized loans to end beneficiaries. These effects also cannot be isolated from those of other support measures implemented simultaneously. The organization of financial and agricultural sectors are often not considered in analyses found in the literature, which frequently include a confusion of terms, for example between interest rate subsidies and interest rate caps, or between subsidized and directed credit. The present study reviews the pros and cons found in the literature in light of the case study findings. On this basis, the study concludes that interest rate subsidies for the agricultural sector always appear to be a relevant tool to support small-scale agriculture as soon as the environment is favorable, or made favorable by complementary support measures, and if the mechanism, targets, and loan conditions are properly designed. Interest rate subsidies require rigorous monitoring and management systems to avoid divergences from their objectives, and costly systems are frequently required for implementation. Part 4 of the study presents operational recommendations for avoiding negative effects in the implementation of subsidized interest rate programs. These recommendations relate to the context, the subsidy mechanism, target beneficiaries, loan conditions, and accompanying measures.

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Introduction In developing countries, the agricultural sector still represents a significant proportion of value added, exports and jobs. One of the constraints in the development of this sector is access to financing. The donors that support this sector have modified their approach to agricultural financing to follow the “change in paradigm” of rural finance from the 1980s: directed credit, which was distributed by projects or development banks more often than not under “soft” conditions, frequently led to poor management of the loans and could hinder the development of rural financial markets. It was given up for an approach based on the financial system as a whole. Yet, this change in approach does not seem to have provided a satisfactory solution to the needs for agricultural financing, as rural financial markets remain insufficiently developed and more often than not offer exit interest rates that are difficult to bear in the case of financing structural investments. The implementation of the new paradigm has thus resulted in a drastic drop in the financial services supply, especially credit, for agriculture. Interest rate subsidies, which are understood as the distribution of loans to final beneficiaries at interest rates lower than market rates, are one of the instruments used widely around the world since the beginning of the 20th century to develop agriculture. Interest rate subsidies are a type of subsidization with distinctive characteristics. Their amount is proportional to the amount borrowed. It is distributed through financial institutions, which choose the beneficiaries based on applications. The mobilization of loan resources generates leverage on the amount of the aid. It is disbursed gradually throughout the duration of the loan. One of the objectives of this study is to provide fuel for thought on the interest rate subsidy tool as applied to the agricultural sector. The study is based on the following elements: first, an analysis of the experience using interest rate subsidies in three selected countries (France, the United States, and Brazil); second, how four selected donors position themselves on the issue (the World Bank, IFAD, KfW, and USAID); and, finally, research works on the subject, which we have used in particular to identify the reasons that allow us to think that, in a given historical context, the subsidizing of exit interest rates in the agricultural sector seems to have contributed to reaching the objectives aimed for.

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Introduction

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We have analyzed, from a historical perspective, experiences in subsidizing interest rates for agricultural credit. This has allowed us to identify the situations and conditions in which this tool was suitable. We then examined, in the light of practice, the pros and cons of the tool, in order to work out concrete recommendations on how it can be used. Our hope is that the results can act as a guide for donors working in this sector.

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1. Historical analysis We have analyzed the use of interest rate subsidies from a historical perspective in order to shed light on: • the purpose of establishing these subsidies; • details on the system used (subsidy channels, eligible beneficiaries/purposes, institutions in charge of distribution, monitoring of proper use, modes of implementation, etc.); • the context in which this instrument was used (in terms of agricultural situation and financial-sector situation); • the support measures established, if applicable (other tools of development support); • insofar as possible, the impact of using the instrument and elements concerning the cost-benefit ratio; • the conditions required for such systems to be effective, and the roles that other public actions or the context may have. The objective is to analyze past experiences in interest rate subsidies, to help developing countries choose whether or not to use this instrument, according to their circumstances and their objectives.

1.1. France The French case study is particularly interesting, for two main reasons. French agriculture developed strongly over the 20th century, closing technical gaps, and thus making France the second-largest agricultural commodities exporter at the end of the century, despite its relatively small size compared with other agricultural countries. This was achieved thanks to strong support from the central government, with interest rate subsidies as a major component.

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1. Historical analysis

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1.1.1. Transition from a largely rural economy to a modern economy During the 20 th century, France shifted from a strongly rural economy, with a very large agricultural labor force, to a modern economy based on the development of industry, and then services. Agriculture has nonetheless maintained a much more significant role in France than in its European neighbors.

Table

Selected macroeconomic indicators for 1900, 1960 and 2010 1900

Population (in millions)

1960

2010

38 47 65

Percentage of rural population

56% 38% 22%

GDP (in constant USD billion, 2000)

NA 350 1 ,485

Share of agricultural sector in GDP

NA 12% 1.8%

Share of agricultural sector in employment 45%

20%

2.9%

Sources: World DataBank, French national education system, Agreste, Gueslin (1984).

Economic crises bring change to the agricultural sector, with a high level of indebtedness and long-term support from the European Union France is made up mainly of arable land, with varied characteristics that enabled the development of a variety of farming and livestock value chains. At the end of the 19 th century, France was still a major agricultural and rural country, but its many small farms lagged behind technically compared to its neighbors in northern Europe. French agriculture was severely struck by the agricultural crisis of 1880-1890 linked to the â&#x20AC;&#x153;globalizationâ&#x20AC;? of trade. After World War II, productivity improved thanks to mechanization, breeding methods, large-scale use of fertilizers and pesticides, and the adoption of new techniques. This led to considerable increase in production with a large concurrent drop in the agricultural population, and to an increase in the average size of farms.

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1. Historical analysis

During the 20 th century, the agricultural economy became a debt economy, based on lending at negative real rates until the middle of the 1980s. Indebtedness accelerated strongly between 1960 and 1980. From the 1960s, Europe’s common agricultural market began supporting agriculture in the six member states of the European Economic Community (EEC), by establishing high and uniform prices as well as the free circulation of products. The Common Agricultural Policy (CAP) then shifted to limiting production and readjusting European agricultural prices on the world market. In 1956, French farmers, with the support of agricultural development players, created agricultural management centers ( centres d’économie rurale – CER). Their foremost objective was to acquire management tools, especially for mutual comparison purposes. The CERs played a significant role in guiding the modernization of farms and in establishing the monitoring of management, which is required for the granting of subsidized loans. Until 1999, the net income per agricultural worker experienced considerable growth, this despite a decline during the decade 1973-1983, linked to successive climatic and economic crises. But from 1999, the combined effect of decreases in European subsidies and in volumes produced led to a period of income decline.

Agricultural credit: a crucial public policy tool for modernizing French agriculture Faced with the absence of suitable financial channels during the economic crisis of agriculture at the end of the 19 th century, systems of cooperative credit emerged. One of them evolved toward what became the model of French agricultural credit: a system that was cooperative at its base, but that received encouragement from— and had its apex controlled by—the central government. Crédit Agricole thus became the main public policy tool for the modernization of agriculture based on dynamic family farms. It remained specialized in agriculture until 1971 and then reached out to new types of clientele, all the while guarding its strong rural base. In addition to Crédit Agricole, parallel credit unions in agricultural circles developed in some regions, giving rise to the Crédit Mutuel bank.

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1. Historical analysis

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1.1.2. Strong growth in interventions that include interest rate subsidies, since their start in 1910 Supporting agricultural modernization and preventing desertification of the countryside: these are the motivating objectives of state intervention in the agricultural sector Summary The creation of Crédit Agricole as a public bank originated from economic analysis of agriculture’s need for long-term and inexpensive resources, and from a political objective of supporting a significant proportion of the population. Agricultural modernization became a governmental priority after World War II, at a time when industrialization was rapidly emptying the countryside of its labor force. This modernization was strengthened by the establishment of the “policy on agricultural structures” in the 1960s. From the middle of the 1980s, France considered that an increasing number of farmers had become competitive enough not to need interest rate subsidies. It therefore targeted its interventions specifically on young farmer start-up and on modernization. The main reason public authorities were attentive to agricultural issues was their political concern to support a large number of smallholder farmers, who were seen as a stabilizing political element. Agricultural policy was therefore based on maintaining a large number of smallholder farmers, as access to small farm ownership was perceived as the means for curbing rural exodus. These various concerns led to state support for Crédit Agricole, whose purpose was to finance small farm ownership. Since its creation, Crédit Agricole’s objective was to finance agriculture under affordable conditions. This led the bank to carry out—in addition to the distribution of state-subsidized loans—a “self-subsidizing” of lending rates for many years. These were granted based on its own funds, using its surplus operating income. The Law of 5 August 1920 established the Office National du Crédit Agricole , a public bank that took on the name Caisse Nationale de Crédit Agricole (CNCA) in 1926, marking a bit more its calling as a financial institution made up of Caisses régionales (regional banks). This law enabled Crédit Agricole to develop its twofold policy to meet France’s dual objective of developing strong agriculture, in both demographic and economic terms. These were:

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1. Historical analysis

• a social and political policy based on the model of a smallholder farmer economy dominated by small-scale commercial production, and • an innovative economic policy, directed toward competitive intensive agriculture. After World War II, France’s agricultural policy shifted from one of production and prices (from 1948 to 1960) to one of structures (from 1960) along with the framework laws on agriculture proposed by Edgard Pisani. France took various measures to implement these policies. First, agriculture was disconnected from the market and protected by state-set prices (a policy that was intensified later by the CAP of the EEC). Then, subsidies were granted to certain types of agricultural investments. Finally, a very favorable system of low-interest loans was developed, for which Crédit Agricole was the privileged tool. It was from the early 1960s that a real agricultural policy was defined, the policy on agricultural structures, which was laid down in the framework laws on orientation of 1960 and 1962. These encouraged farmers to take out subsidized loans, with the purpose of helping to create modern farms that were better equipped and larger in size. At the end of the 20 th century, only young farmer start-up and the rational modernization of family farms remained priorities, because these were means to prevent the desertification of the countryside and to curb farm concentration, which was judged to be excessive. Only loans with these objectives remained subsidized. In 2000, the percentage of medium- and long-term bank loans for agriculture still receiving state aid was less than 20%, although it should be noted that liquidity loans had never been subsidized (Neveu, 2001).

The mechanisms of interest rate subsidies, a monopoly of Crédit Agricole until 1990 Summary Interest rate subsidy mechanisms have changed over time. They were initially based simply on providing state resources at a reduced rate. They evolved into state payment of the difference between market cost and subsidized rate, with special conditions as to the types of loan and the beneficiaries of subsidized credit. Crédit Agricole had a monopoly on the latter until 1990 and had to cover the commercial risk. Subsidized credit is a form of public aid that includes leverage and investment orientation, and they are linked to other intervention systems. The system to audit the subsidies is cumbersome and complex. It is based on a dedicated public structure

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1. Historical analysis

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that delegates on-site auditing based on records to decentralized government services. While this system has existed in its current form since 1961, none of the audits provided for were carried out before 2005. When Crédit Agricole started up, the government began to pump aid initially from Bank of France ( Banque de France ) funds and then funds from the French funding body for public works and housing ( Caisse des Dépôts ) in 1926, by granting lowinterest capital loans to Crédit Agricole. It was up to the latter to use these funds in the form of loans to farmers, agricultural cooperatives, or rural artisans. Crédit Agricole used these resources to grant low-interest loans without government constraints on interest levels or the beneficiaries. From 1942 to 1966, when Crédit Agricole’s own deposit-taking developed, its funds were recycled by the Treasury. This latter used them for subsidizing interest rates, transforming short-term resources compensated at market rates into reduced-rate long-term loans by levying 30% of deposit-taking in order to respond to mismatch risk. The CNCA gained its financial independence in 1966. The government then covered, in the form of interest rate subsidies, some of the interest rate normally due by farmers, so that the agricultural sector could continue to take advantage of reducedrate loans. To do so, the outstanding debt and the average rate of subsidized credit were calculated each year, as were the cost of the resource used to finance them. The subsidized interest the government paid to the CNCA each year was the difference in the rate multiplied by the outstanding debts not yet paid back and increased by the bank’s management facility. The government defined the conditions of access to the various categories of subsidized loans from which it wanted agriculture to benefit. Finally, in 1990, the government put an end to Crédit Agricole’s monopoly over the distribution of interest rate subsidies and opened it up to other major bank networks. To do so, the government set up an annual competition among the banks wishing to distribute subsidized loans, in which each bank offered an interest rate corresponding to the costs of the resources it wished to allocate to subsidized credit. The subsidy corresponded to the difference between this cost, increased by the management margin and the rate of the subsidized loans (Neveu, 2001). It should be mentioned that, up to 1996, Crédit Agricole enjoyed a special transitory regime in the form of a so-called réservataire share: a diminishing share of loans at special conditions. Moreover, Crédit Agricole enjoyed a special form of invoicing that circumvented the certification by the public auditing body ( Cour des Comptes, 2007). Currently, the subsidy corresponds to the difference between the rate of interest paid by the borrower and the rate of interest observed on the market.

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1. Historical analysis

During the entire period, the loan write-off risk was covered by the lending bank. The surpluses at the CNCA, which were linked in particular to subsidized loan activities, were partially allocated to these write-offs and to assistance for farmers in difficulty. This then led Crédit Agricole to introduce selectivity in loan granting , in the 1960s. The government participated in covering the difficult situations and granted subsidies for debt rescheduling to aid value chains in difficulty. This was done via a fund for easing the financial burden on farmers ( Fonds d’allègement des charges financières – FAC), which also made it possible to help farms in difficult financial circumstances partially pay back interests on subsidized or non-subsidized loans. At the same time, a system of government-regulated loans was established, by which the banks selected for distributing subsidized loans undertook to grant farmers loans at attractive but non-subsidized rates. In 1990, the ratio of such government-regulated loans to subsidized loans at Crédit Agricole was 3:1 ( Chambres d’agriculture, 1990). The conditions for subsidized loan eligibility were the same as those for other agricultural support systems, such as assistance for start-up (implemented jointly with the young farmer’s grant), agricultural disaster aid (to supplement compensation by the National Agricultural Disaster Guarantee Fund), or measures to deal with crises (along with systems for repayment of bank interests, for liquidity assistance, and for tax and social contribution relief). The government thus intervened at several levels: setting the regulatory conditions for access to loans and their rates; setting the amount of the various budget envelopes for subsidized loans and dividing them up geographically among the départements ; organizing the selection of the lending banks; checking that the regulatory conditions were respected during each loan request; and, finally, monitoring afterwards that the loans were used properly by the borrowers. The subsidies allocated to the Ministry of Agriculture’s budget were transferred to a public institution, the National Center for the Management of Farm Structures ( Centre national pour l’aménagement des structures des exploitations agricoles – CNASEA), which became part of the Agency for Services and Payment ( Agence de services et de paiement – ASP) in 2009. This institution paid the banks the amount of the interest rate subsidies, in principle after the legality and reality of the credit granted were demonstrated and verified. In reality, the banks received 90% of the subsidies they were supposed to grant during the year, and the balance was paid to them by the CNASEA in March of the following year, after proof of their actual expenses.

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1. Historical analysis

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Examination of applications, and thus of the verification of the conditions for being able to benefit from subsidized loans, was shared between the banks and the Departmental Agriculture and Forestry Directorates ( directions départementales de l’Agriculture et de la Forêt – DDAF). The banks carried out an initial verification of the rights of the borrower and then requested financing authorization from the DDAF. The latter made the decision to grant the subsidy after examination of records. Management of the loan application was then the responsibility of the banks during the entire term of the loan, while ex-post investigations were up to the CNASEA. In practice, however, things were different: in its annual public report of 2007, the French audit office ( Cour des comptes ) revealed that none of the investigations provided for in national and European regulations had been carried out up to 2005. Yet, these investigations were a required condition for payment of the European share of interest rate subsidies to France. This absence of investigation meant France was subject to financial penalties. The French audit office concluded that the persistent shortcomings in the investigations and in the ensuing conflicts were directly linked to the complexity of the system. The decision-making and commitment-monitoring channels remained complex and thereby risky for the central government. Indeed, the CNASEA was the body that paid and managed the national and European Community credits and furthermore was in charge of monitoring commitments by the government, yet it was not responsible for decisions on the granting of subsidized loans, which were the competence of decentralized state services. The information and internal monitoring systems at that time did not fully guarantee the reliability of the information on the accounting commitments of the state. Investigation programs were begun late, under the threat of clearance refusal by the European Community authorities. The certification audits of invoices by credit institutions were conducted very late ( Cour des Comptes , 2009).

Interest rate subsidy programs originally intended for small farms came to support “professional” farms Summary The scope of interest rate subsidy programs greatly changed: intended for the majority of small farms from before World War II up to the 1950s, they were redirected from 1960 toward the creation and modernization of “professional” farms. Their main purposes were land purchase, disaster support, equipment, and support for cooperatives.

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1. Historical analysis

Initially, subsidized credit theoretically targeted smallholder farmers, with ceilings that governed its accessibility. France’s policy reorientation toward modernization in the 1960s was accompanied by a new notion: credit selectivity in order to develop profitable medium-sized farms. At this point, surface-area thresholds were established for access to some subsidized loans. The subsidized credits had various purposes. Conditions of access evolved along with agricultural policy and according to budget constraints. Initially, disaster loans were widely allocated. But the drought of 1976 and the floods of 1977 led to the introduction of selectivity (income and loan ceilings, minimum losses). Real estate loans, which were launched very early (1910), enjoyed favorable conditions up to 1959 (between 1 and 3%, along with extra subsidies according to number of children, for loan lives reaching up to 30 years), but these were subject to the value of the borrower’s resources and of the loan granted. Government decrees in 19631965 reversed the situation by requiring a self-financing effort by the purchaser (between 20 and 40%) and a minimal threshold in surface area for start-up, along with an enhancement of the loan ceiling amount to around 28 ha and relatively low rates (4.5%). These changes provoked lively growth in loan volumes, by allowing medium- and large-scale farmers access to subsidized real estate loans. They thus contributed tto the concentration of farms. In 1969, subsidized loans at 7% appeared, followed in 1971 by non-subsidized loans. France decided to limit the cost of these loans for the state by orienting them toward farmer start-up and by limiting them from 1978 through measures of control, non-reevaluation of ceilings, and raising of rates. Loans for equipment investment were developed above all after World War II, within the framework of planning, and they were promoted during the agricultural modernization phase between 1960 and 1980. They became the main object of loans by Crédit Agricole, with 40% to 65% of its medium- and long-term loans granted for specific purposes. A special loan regime was created as early as 1931 for young farmers, but the main official act goes back to 1946. After revision of the mechanism in 1984 (reevaluation of the amounts, extension of the loan life, and grace period, but limited to farmer start-up), “young farmer” loans were still an important aspect, despite a context of credit control. Other special loans were set up within the framework of the CAP (livestock buildings and special livestock loans), and “special modernization loans” were established in 1972 for financing farm investment programs as part of a development plan (EEC directive, 1972).

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1. Historical analysis

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Ordinary medium-term loans, the last subsidized loans of a general nature, were eliminated in late 1983. Procedures for aiding farmers in difficulty were set up and partially financed by drawing from CNCA surpluses. The procedures included subsidized loans for debt consolidation for farms threatened with bankruptcy, together with grants and low-interest loans. They also required a recovery plan to be set up for such farms, as well as involvement by the director of the Crédit Agricole regional structure in its implementation. Such subsidized consolidation loans were set up to deal with the drought in 2010, within the framework of the special agricultural support plan ( Plan de soutien exceptionnel à l’agriculture – PSEA), this in addition to grants from the specific support plan for farmers in difficulty ( Dispositif d’accompagnement spécifique des agriculteurs en difficulté – Dacs-Agri). There were also loans to cooperatives. Their aim in particular was to help regulate the agricultural market situation via financing of storage. The share of subsidized loans among all loans to cooperatives at Crédit Agricole dropped from 66% to 33% in the 1970s. The cost of interest rate subsidy programs led the government to limit them gradually, from 1970. This was done by specializing them. The government then focused almost exclusively on modernization rather than the handing down of farms. These are factors that explain both the shrinking of the real estate market from 1974 and, at the same time, the decline in Crédit Agricole’s share in financing purchase of land by farmers: from 43% in 1972 to 27% in 1987 (sources: CNCA; Gueslin, 1988). Increased specialization in subsidized loans reduced the number of potential beneficiaries. In 2005, loans for young farmers and for farm modernization represented, in practice, 80% to 90% of loan commitments that benefited from interest subsidies. Such loans were granted for terms of up to 15 years (Cour des Comptes, 2009). In 2007, the system was refocused on only start-up loans for young farmers, which were the only ones still cofinanced by the European Community up to 2015. Start-up loans represented 54% of new subsidized loans and 70% of outstanding debts; Crédit Agricole disbursed nearly 83% of new loans for start-ups ( Cour des Comptes, ibid).

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1. Historical analysis

Interest rate subsidies became a big burden for the state budget during periods of high inflation, due to the heavy cost of monitoring and managing the system Summary During periods of high inflation, interest rate subsidies became a very big burden for the state budget. France therefore gradually reduced subsidized loans via more precise targeting. In addition, the subsidy mechanism led to strong budgetary inertia, due to the length of the loan life and their fixed rates. The cost to the government thus changed according to external factors that made it difficult to control the allocated budget. In addition to the direct cost of the subsidy, the cost of the system’s management and control, as well as remuneration of bank services, also had to be taken into consideration. All these points led the French audit office and the Ministry of Finance to begin questioning, from 2007, the relevance of maintaining this system with its heavy cost and reduced impact. From 1966 to 1978, the amount of the interest rate subsidies increased at an annual rate of 15.9% (7.6% in volume) (Gueslin, 1985). In 1976, an inter-ministerial task force commissioned by the government sought to assess the effectiveness of interest rate subsidies for agriculture. The government at that time was worried about the increased cost of the subsidy, which had tripled from €1.2 billion in 1970 to €3.7 billion in 1976. By 1979 it reached €5.6 billion (Blogowski et al, 1983). The increase was related to two factors: encouragement by the agriculture policy on structures to borrow, and the growing gap between the cost of the resource and the rate of the subsidized loans. In 2004, subsidized loans for agriculture still represented outstanding debts of €7 billion, annual commitments of over €600 million, and an annual budget liability close to €200 million. From 1961 to 2004, the subsidy system led to public expenditures of around €15 billion ( Cour des Comptes, 2007). The budget liability linked to interest rate subsidies then decreased, in particular because of the drop in interest rates. It was markedly weaker than 20 years earlier when, in its 1987 public report, the French audit office had already highlighted its size. Subsidized loans represented, along with the deficiency payment for natural handicaps, the main aid paid out as part of rural development policy. To limit this budget cost, France took a series of measures. It gradually increased the rates of certain subsidized loans (the rate of real estate loans rose from its historical level of 3% to 4.5% in late 1969 to 6% in 1978 and to 9% in 1981, whereas other loans remained stable, at around 5% for certain start-up or modernization loans). From 1970, the government furthermore set an overall annual envelope for interest rate

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A SAVOIR

subsidies, rounded out from 1972 by sub-envelopes depending on operations and rates. In the 1970s, the government reviewed the calculation of interest rate subsidies, by taking into account less expensive resources. In 1983, medium-term subsidized loans were eliminated. In 2007, a “waiting list” for loan applications was set up in order to spread their budget impact over time. Finally, in 2008, the subsidization periods were reduced, and an equivalent subsidy ceiling was introduced. Competition among several bank networks, which were then authorized to distribute loans, made it possible to limit the amount of bank commissions. Furthermore, subsidized loans for agriculture came to be partially financed by the European Union: from Jan. 1, 2000, the EU cofinanced 25% of interest rate subsidies for modernization loans and 50% for start-up loans for farmers. In 2009, the French audit office revealed that the state’s financial balance was threatened by two significant changes. First, the scheduled termination from 2015 of cofinancing of start-up loans by the European Agricultural Fund for Rural Development (EAFRD) already requires France to include in its accounts all the subsidization commitments after that date. Second, the marked upswing in market interest rates from 2006 led to an increase of nearly 40% in the subsidization differential. The cost of the management and auditing of the system came on top of the direct cost of the subsidization. The cost of the partial management of subsidized agricultural loans rose from €1.1 billion to €4.3 billion per year, according to the CNASEA, which was state-subsidized for this management ( Cour des Comptes, 2007). The complexity of the examination, payment, and auditing system was cumbersome for users and led to high management costs. In 2008, for a comparable amount of aid granted, the payment of subsidized loans mobilized the equivalent of 46 full-time jobs at the CNASEA, compared to seven for the payment of the Environmental Cropping Plan ( Plan végétal pour l’environnement ) and the livestock building modernization plan ( Plan de modernisation des bâtiments d’élevage ). In addition to the personnel costs of the administrations and operators concerned, it is important to point out the significant share of the budget envelope devoted to the remuneration of bank services. Set at 0.5% per year in 2003 and reduced by 0.05% each year every year up until 2006, the rate of remuneration of credit institutions seemed to exceed the costs the latter had to pay. This was especially the case of Crédit Agricole, which made profits on a significant scale, thanks to the considerable market share it enjoyed. Another effect of this remuneration rate was to give management costs a preponderant role in the resources devoted to certain subsidized loans.

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1. Historical analysis

From 2007, the French audit office questioned the relevance of maintaining this system with its heavy cost and reduced impact. In 2009 it again concluded: “ Subsidized loans, which require keeping up an organization and procedures that are specific, cumbersome, expensive, and difficult to monitor, are probably not without merits both for farmers […] and the government, which spreads the cost of this aid over several fiscal years. However, they are not without disadvantages. Indeed, no real assessment of the effectiveness of subsidized loans has been made. ” The Ministry of Finance seemed to agree with the French audit office, as can be seen in this statement: “ The state can, of course, thanks to the subsidized loan mechanism, spread the cost of the aid over several fiscal years. However, subsidized loans eventually turn out to be more expensive for public finances than is direct aid, not only because of the management costs levied by the banks, but also because the base interest rate provided to credit institutions is markedly superior to the cost at which the state becomes indebted. ” Response by the Minister for the Budget, Public Accounts and the Civil Service, in Cour des Comptes , 2009).

1.1.3. Impacts on the French agricultural and financial sectors While interest rate subsidies had a definite impact on the penetration of bank use in the countryside and on agricultural modernization, the effects differed according to the type of farm Summary It is not possible to ascribe the changes in French agriculture precisely to specific factors, such as credit or subsidization. However, the claim can be made that subsidization, combined with a long-term loan supply, played a decisive role in the spread of bank use in the countryside. Subsidized loans played a major role in agricultural modernization and intensification, as well as in start-up for young farmers, especially between 1965 and 1980. Subsidized loans and the Crédit Agricole system also had an effect on the structure of agriculture, by promoting larger farms to the detriment of smaller ones, largely due to irregularities in the management of subsidized credit. Indeed, some of the subsidization acted to provide windfall profits for farms that did not really need them. Farm indebtedness, which was encouraged by the subsidization, put many farms into difficulty during the changes in the economic situation in the 1970s and 1980s. At the same time, the government scaled back its aid. The impact of real estate loans on farms is especially controversial. In 2007, the French audit office and the Ministry of Finance called into question the effectiveness and efficiency of

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subsidized loan systems, in a context of limited impact due to the overall drop in commercial rates and to the existence of other systems encouraging start-up and investment. The change in environment described in the previous section is the foremost factor of change in agriculture. “In a branch with low profitability, inexpensive credit was [also] an objective requirement for many farms. Another imperative was for agriculture to have access to long-term loans, given the slow speed of reproduction of capital. ” (Gueslin, 1985). The subsidized loan supply thus made it possible to make some of the potential demand solvent, by lowering the profitability threshold of indebtedness. The introduction of inexpensive credit from a real bank with an extended rural network—along with encouragement to become indebted, within the context of the agricultural policy on structures—was a decisive factor in the spread of bank use in the countryside. André Neveu considers that “ the subsidized loan mechanism played a particularly decisive role in the modernization of French agriculture in the 1960s and 1970s. The results are moreover spectacular: production increased at a rapid pace, and France became a net exporter of agricultural products. Above all, work productivity increased considerably, so as to reach the level of the best European or even global agricultural countries” (Neveu, 2001). What had been a labor activity in the past became a veritable heavy industry, with a capital-output ratio [ 1 ] rising from 6 in the beginning of the 1960s to more than 12 in the beginning of the 1980s (Gueslin, 1985).

[1 ] Capital-output ratio: (operating capital + land resources)/value added of the sector. Source: Gueslin, 1988.

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1. Historical analysis

Figure

Share of indebtedness of agriculture in the value added of the sector

160% 140% 120% 100% 80% 60% 40% 20% 0%

38 940 942 944 946 948 950 952 954 956 958 960 962 964 966 968 970 972 974 976 978 980 982 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1

Source: Gueslin, 1988.

The share of agricultural land purchases financed by Crédit Agricole rose from 22% to 42% between 1965 and 1973. André Gueslin considers that real estate loans definitely enabled an increase in the average size of farms. Rate of investment for this share, including land and equipment (gross fixed capital expenditure/the sector’s value added) rose from barely 12% in 1960 to 25% in the beginning of the 1980s (Gueslin, 1985). It should be mentioned that the subsidized credit implementation conditions impacted farm structure. In the initial period, until 1960, the subsidization policy sought to promote small-scale family farming, and credit amount ceilings were set very low to limit the appeal of subsidized credit for large-scale farmers. From the 1960s, France’s agricultural policy evolved toward an objective of profitable medium-sized farms. At that time, minimum surface-area thresholds were established for access to certain subsidized loans, and selectivity in credit access based on beneficiary profile was introduced. However, the thresholds set by the policy were not always applied strictly, and many large-scale farmers took advantage of subsidized loans to develop their farming activity. This practice was regularly condemned by the audit department of French public services and had already been taken up by the “Méline” circular of 7 October 1916.

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Various investigations demonstrated that the credit above all benefited large-scale farms in economic terms (Gueslin, 1985). So while the subsidization did enable the development of farms that would not have been able to develop without interest rate subsidies, it also benefited farms that had no need for it. This non-respect of predefined credit ceilings led to the doubt about the subsidized credit tool, on the grounds that it seemed to have benefited large-scale farmers without managing to specifically target small farms. Crédit Agricole thus contributed to the establishment of a two-tiered agricultural system. On the one hand, there was indebted and economically viable agriculture, which saw a mix of both very large capitalistic farms—which may have taken advantage of Crédit Agricole during the “Trente glorieuses” (the approximately 30 years of strong post-war economic growth) but never really needed it—and profitable medium-sized farms that succeeded in modernization via indebtedness. On the other, there was agriculture that encountered economic difficulties: farms of this type either suffered over-indebtedness (with income that did not allow them to repay their loan) or refused credit. These latter were made up mainly of small farms that had not chosen to modernize and that sometimes explored other models than productivism via a single agricultural activity (Gueslin, 1988). In an inflationary environment, access to inexpensive and easy credit encouraged farmers to become indebted, especially with real estate loans that generated heavy depreciation charges that were not compensated by improvement in profitability. Faced with liquidity shortages, some farmers also had to deal with the dilemma of either indebting themselves to reach a presumed economic profitability threshold, or going out of business. In times of economic crisis, limiting subsidization envelopes led to credit shortages and thus to the establishment of waiting lists by Crédit Agricole’s regional banks. Overall, the proportion of interest payments in farm expenditures rose from barely 5% in 1959 to around 25% in 1982, but an overall view does not reveal the big gaps that existed. Small farms thus increased their short-term non-subsidized borrowing to alleviate their overall difficulties. The situation evolved to a point where difficulties in repayment were encountered. Up until the 1970s, defaulting on repayments was more often than not due to particular family circumstances. But defaulting increased significantly in the 1980s due to the combination of several factors: the big drop in agricultural prices after the first oil crisis, the setting up of milk quotas in 1984, and the rapid decline in inflation. The credit crunch that followed in the late 1970s had big social consequences on the agricultural sector and Crédit Agricole was greatly concerned by these, in view of the farm takeovers and expropriations that occurred.

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1. Historical analysis

Crédit Agricole sounded the alarm from 1978, warning about the potential bankruptcy situation of some farms (“ L’endettement de l’agriculture française ,” May 1978, CNCA annual meeting, quoted by Blogowski et al., 1983). In all, 40,000 farms found themselves in financial difficulty at the end of the 1980s (Neveu, 2007). In 1980, a survey of 756 farms in 30 départements showed that their difficulties came from borrowing in 18% of cases: 7.3% for overuse of credit and 10.6% for poorly adapted finance plans (Gueslin, 1985). From the beginning of the 1980s, smallholder farmers themselves adopted more cautious behavior regarding indebtedness, and particularly so in the case of real estate purchases. The reduction in the volume of state aid led to an increase in average nominal rates paid by the farmers, and—as all this occurred within a context of deflation—they had to bear substantial real interest rates from 1984. In its 2007 report, the French audit office concluded the following: “ While subsidized loans are attractive products for banks, bringing them customers and commissions, they generate procedures that are cumbersome and difficult to monitor. In the end, they are expensive for state finances. Despite the advantages granted to the beneficiaries, repayment of loans puts a strain on the financial situation of farms for several years. [...]. However, the drop in interest rates has strongly reduced the advantages of subsidized loans (which were considerable for farmers at the time when rates exceeded 15%), and no longer represent a condition for young farmer start-up or a decisive incentive for investment, for which there now exist other mechanisms. ” The Ministry of Finance stated a similar opinion when it quoted the report established as part of the mid-term evaluation of the 2000-2006 plan by the audit firm Ernst & Young (quoted in the response by the Minister of Economy, Finance and Industry and by the Deputy Minister of the Budget and State Reform and Government Spokesperson, in Cour des Comptes 2007). This report criticized the effectiveness of the subsidized loan systems, deeming that the weakness of the market rates rendered them “ inoperable. ” The Ministry of Finance stated that this aid did more to improve the financial environment of farms than to act as a “ trigger effect, ” and that as a result it led to risks of a windfall effect. The effectiveness of subsidized loans must moreover be put into perspective, as other types of aid in the form of capital have been established since their creation, with similar goals (livestock barn modernization plan, environmental cropping plan, etc.).

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A concrete impact of subsidization on the financial sector: the creation of a strong agricultural bank Summary The foremost consequence of subsidized loans on the financial sector was that they contributed to creating a strong agricultural bank, thanks to the undeniable commercial advantage they represented for Crédit Agricole. They provided the latter with a captive clientele that turned out to be less risky than that of most other economic sectors. The use of Crédit Agricole as a vector of state aid via the subsidized credit system, together with the limits of the credit technology applied, led to what was tantamount to a right to credit. The result was that, up until the 1970s, loans were provided to farms that could not afford them. To straighten out this situation Crédit Agricole engaged in-depth modification of its financing methods in the 1980s (Neveu, 2007). Along with the elimination of the monopoly on subsidized credit in 1990, several major banks began to become interested in agriculture. Crédit Agricole—and Crédit Mutuel in some regions—nonetheless remained its main banks. Non-subsidized loans took over from subsidized loans to finance agriculture, especially due to the drop in bank rates, which reduced the appeal of subsidized loans. The foremost consequence of subsidized loans on the financial sector was that they contributed to creating a strong agricultural bank, thanks to the undeniable commercial advantage they represented for Crédit Agricole. They provided the latter with a captive clientele that turned out to be less risky than that of most other economic sectors. However, while state aid and the monopoly on subsidized loan distribution played a big role in the development of Crédit Agricole, its activity had already started to change before the end of this monopoly. Indeed, in 1987, the proportion of subsidized loans it distributed fell to less than 25% of its medium- and long-term loans. Crédit Agricole strengthened its position as leader in the agricultural finance world by developing a suitable culture and an ability to grant debt relief. The conventional bank sector remained wary about smallholder agriculture and refused to adapt its loan products. Crédit Agricole was able to adapt its loan strategy to the characteristics of various agricultural zones: in poor agricultural zones it limited its activities to long-term real estate loans, accompanied by medium-term loans intended for the acquisition of a minimum start-up capital, whereas in richer zones short-term credit financed the harvest cycle and medium-term loans gave real support to modern agriculture.

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1. Historical analysis

The use of Crédit Agricole as a vector of state aid via the subsidized credit system, together with the limits of the credit technology applied, led to what was tantamount to a right to credit. The result was that, up until the 1970s, loans were provided to farms that could not afford them. To deal with the strong growth in repayment default following the crisis of 1970-1980, Crédit Agricole developed new procedures and tools: tools for early identification of risk situations, improvement of loan monitoring and especially of late repayments, and establishment of pre-litigation services making it possible to look for solutions before going to court. From the 1980s, it was clearer in asserting (despite initial discrepancies between theory and practice) refusal of right to credit, refusal of indebtedness as the norm, and refusal of multi-phase procedure. In short, it gave up the old political and administrative practices inherited from the past (Gueslin, 1988). The end of the monopoly on subsidized credit in 1990 enabled other banks with networks (mainly the Banque Populaire group, Société Générale, and BNP) to increase their activities in the agricultural sector. Before that, only Crédit Mutuel had a relatively large agricultural clientele in the traditional areas where it had branches. Until 1989, the other major banks were satisfied with financing several large farms that had hardly any access to subsidized loans, in the wine-producing and arboricultural sectors for example. Being able to distribute subsidized loans enabled them to expand their field of intervention. However, progress in this area was slow, difficult, and relatively small. The government did gradually reduce the volume of subsidized loans granted each year. Many farmers moreover remained attached to their local Crédit Agricole branch. Further, Crédit Agricole counter-attacked with a more effective business policy than in the past. The other banks entering the market, with the exception of Crédit Mutuel, initially received only the applications that had been refused by Crédit Agricole. This led to significant losses. The reactivity of the private banks did not turn out to be better than that of Crédit Agricole, and they had less competence in this area because they lacked agricultural advisors familiar with the sector. They thus could not highlight any advantages when entering the market. Fifteen years after the end of the subsidized loan monopoly, Crédit Agricole was still the main bank for agriculture, with market share of nearly 70% (instead of 75% to 80%) and 80% of subsidized loans.

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Figure 2 Market share of subsidized loans to agriculture among banks between 1990 and 2011 BNP-Par

BPCE

CIC

C Mar

NEF

100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0%

1 1 1 90 99 992 993 994 995 996 997 998 999 000 00 002 003 004 005 006 007 008 009 010 01 1 2 1 1 1 1 1 1 1 2 2 1 2 2 2 2 2 2 2 2 2

Source: memorandums and tables provided by the credit and insurance office of the French Ministry of Agriculture.

In 2005, the proportion of subsidized loans in agricultural financing fell to 8% of total professional agricultural loans, partially because of the drop in rates that made them less attractive.

Figure 3

Subsidized and non-subsidized loans made between 2000 and 2005

Non-subsidized loans

Subsidized loans

8,000 7,000

In millions of euros

6,000 5,000 4,000 3,000 2,000 1,000 0 2000

2001

2002

2003

2004

2005

Source: French Ministry of Agriculture memorandum, SG/DAFL/SDFA/N2006-1563 of 26 December 2006.

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1. Historical analysis

Figure 4 Cost of credit and prescribed rates of subsidized loans for agriculture (1991-2005) PPVS Cost of loan PSE

PSM JA disadvantaged zone PSM JA others, disadvantaged zone MTS disadvantaged zone MTS CUMA disadvantaged zone

PSM JA plain zone PSM JA others, plain zone MTS plain zone MTS CUMA plain zone

12% 10% 8% 6% 4% 2% 0%

1 D

2 D

3 D

4 D

5 D

6 D

7 D

8 D

. -9

9 D

0 D

1 D

2 D

3 D

4 D

Source: French Ministry of Agriculture memorandum, SG/DAFL/SDFA/N2006-1563 of 26 December 2006.

1.1.4. The essential role of interest rate subsidies in the major phase of French agricultural modernization, in conjunction with other support The subsidization of interest rates for end beneficiaries is a policy that has been followed by France from 1928 up to the present. This long-term continuity has been necessary to enable real in-depth change, ranging from the implementation of changes in the modes of production of existing farms to support for young farmer start-up, in conditions that enable modern production. However crucial the subsidization tool has been in certain periods, it has always been implemented in conjunction with other actions. This aspect has been decisive in its impact on the development of agriculture: follow-up and training of farmers, targeted grants, stabilization funds for the sector, research, and training. This period can now be considered as finished, as the importance of subsidized loans has been considerably reduced in the agricultural aid system. The latter is now focused on the organization and support of agricultural markets, established by the European Union (Neveu, 2001).

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1.2. United States In less than a century, the United States has shifted from not very developed agriculture with fragmented plots to agriculture that is extensive and one of the most productive in the world. This has come about especially thanks to strong support by the government for agriculture, and especially through its help in developing a financial offer for the sector.

1.2.1. Shift from a largely rural economy to a modern economy During the 20 th century, the United States shifted from a largely rural economy characterized by a large proportion of the population living from agriculture in rural areas to a modern economy based on the development of industry and then services.

Table 2

Selected macroeconomic indicators for 1900, 1945, and 2010 1900

Population (in millions)

1945 76

2010 140

310

Percentage of rural population

60% 39% 19%

GDP (in constant USD billion, 2010)

~500 2,263 14,729

Share of agricultural sector in GDP N/A 7% 1% Share of agricultural sector in employment 41%

16%

Sources: United States Census Bureau; Fuchs, 2009; Bureau of Economic Analysis; USDA Economic Research Service (USDA/ERS); Bureau of Labor Statistics; The CIA World Factbook.

From an agriculture of fragmented plots to extensive agriculture At the start of the 20 th century, American agriculture was not very developed. It was labor intensive and depended on animal power. It was conducted in rural areas, where the majority of the population lived. The situation was thus comparable with that found in some of the countries where AFD is involved. North American agriculture is characterized by vast arable land and great geographical diversity. These conditions led to extensive agriculture and to the development of a large range of value chains.

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1. Historical analysis

At the beginning of the last century, most of the country was agriculturally based. The structure of agriculture then evolved, concentrating in the most favorable regions. There, agricultural land was exploited on a nearly continual basis. It was this concentration of farms in agriculturally favorable regions that enabled the shift from agriculture of fragmented plots to extensive agriculture. The diversity of production value chains was maintained thanks to the strong concentration of the sector and to specialization on the farms. The productivity of American agriculture began to accelerate from the 1960s.

The financing of the agricultural sector relied largely on federal action At the beginning of the 20th century, the commercial credit supply to the agricultural sector was limited. Rural banks were at a disadvantage because of their small size and their isolation. American farmers thus had trouble obtaining access to formal credit under satisfactory conditions. The problem of access to agricultural real estate loans by farmers drew increasing attention from the US authorities at that time. This led to the implementation, from 1916, to federal intervention to support the financing of the agricultural sector. The FSA (Farm Service Agency) and the FCS (Farm Credit System) continue to be the two main components of federal action on agricultural credit markets. They are part of a set of interventions that structured and supported these markets. The FSA is a federal agency that distributes concessional or subsidized loans to farmers. As for the FCS, it is an independent cooperative organization, sponsored by the federal government and supervised by a dedicated regulatory body, the Farm Credit Administration. The FCS is not a savings institution, but it offers short-, medium-, and long-term loans to retail clients of the agricultural sector credit markets. Their loan conditions are similar to those offered by commercial banks, as the purpose of the FCS is not to offer loans with subsidized interest rates. In this respect, the activities of the FCS do not fall within the framework of those presented in this report. Today, commercial banks take care of about half of the financing of the agricultural sector, and the FCS cooperative system covers 41%. The share of informal financing has decreased considerably, and the FSA limits itself to a minority of needs.

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1.2.2. Interventions that include interest rate subsidies, essentially under the sponsorship of the FSA Of these two main bodies of the federal government’s program for intervention in the financing of the agricultural sector, only the FSA plays the role of “last-resort lender.” Its purpose is to provide direct distribution of concessional or subsidized loans to farmers excluded from commercial and cooperative financing systems.

The interventions, justified by political, economic, and social objectives, have evolved along with the domestic situation Summary The federal government’s interventions in the agricultural sector credit markets are carried out to meet political, economic, and social objectives. The objectives and targets of the subsidization programs change according to circumstances, due to the fact that they are controlled by the political authorities. The choice of the subsidization tool rather than the grant tool is justified on the one hand by the opportunity it creates to provide long-term support for the development of farms, and on the other by the leveraging affect it enables on the loan resources. The federal government’s interventions on the agricultural sector credit markets are made to meet political, economic, and social objectives. On the political level, the objective of food sovereignty is the underlying reasoning for policies to support the agricultural sector. The close link between agriculture and a country’s food independence makes the agricultural sector seem a strategic one, as meeting the food needs of the entire population is a prerequisite for maintaining social harmony in a country. A second political objective is to maintain family farming to a certain degree (Dodson and Koenig, 2001). On the economic level, the federal government’s intervention in the agricultural sector credit markets was—and continues to be—justified mainly by the shortcomings of these markets, which are related to information asymmetries, externalities, economic unbalances, lack of competition, lack of liquidity, and the unfinished nature of markets. The motivation for federal interventions is the observation that there is a gap in financing affecting the volume and characteristics of loans and the cost. The volumes of credit available in rural areas are generally insufficient. The variety and availability of the credit supply are disconnected from farmers’ needs, and the conditions

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1. Historical analysis

associated with available credit do not correspond to the specificity of this need. Agricultural credit provided by private sources is too expensive for some farmers, and the poorest farmers cannot obtain credit at all or obtain insufficient amounts (Brake, 1975). The overall objectives regarding agricultural financing are to reduce regional disparities in terms of interest rates (harmonization), to reduce the average cost of agricultural credit (interest rates), to provide long-and medium-term credit (duration) and to adapt credit availability to the periodic variations in demand (seasonality). The influence of each of these objectives varies according to the context and to government policy, as described in the chronology on the following pages. Furthermore, in relation with food sovereignty, one of the objectives of support for agricultural financing is to reduce food expenditures per person, so as to contribute to economic growth. Indeed, when the share of food expenditures in the household budget decreases, people are able to spend their money on other types of goods, thereby favoring economic growth. On the social level, in certain cases the Office of Management and Budget indicates that federal interventions in agricultural credit markets can be used to influence the allocation of resources to help the disadvantaged segments of the farming population. The original aim was to provide assistance to victims of disasters, and then to the poorest. Today, the main objective is to help ethnic minorities, women, and young people. Contrary to the FCS cooperative system, whose operating mode allows for decisions to take the opinion of the beneficiaries directly into account, the successive federal programs of interest rate subsidies for the agricultural sector have been decided by the government. There are no specific procedures to take into account the opinion of beneficiaries, and influence by farmers on the programs can be made only very indirectly, via Congress. This difference in mode of operation makes the objectives of subsidization programs much less adaptable to the context than those of the cooperative system, and it is also the reason for more frequent amendments over time. The first subsidized credit program, launched in 1918, was called â&#x20AC;&#x153;Emergency crop and seed loans.â&#x20AC;? Its main purpose was to provide emergency relief to farmers hit by natural or climatic disasters, so that they had enough resources to pay for the inputs they required and for the material losses they suffered.

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1. Historical analysis

A SAVOIR

The programâ&#x20AC;&#x2122;s motivations changed from 1932, during the Great Depression, and became more welfare-oriented. It was followed by successive institutions over a brief period: the Rural Rehabilitation Corporation in 1933, the Resettlement Administration in 1935, and the Farm Security Administration in 1938. The subsidization program then sought to support families whose farms were suffering financial troubles. There was a dual objective to this: to keep these families on their farms and to reduce their needs for direct welfare support. It is also during this period that measures for financial supervision to accompany the loans began. The education provided to the beneficiaries thanks to the supervision is an argument that even today is used to justify the program compared to other forms of grants. 1946 saw the creation of the Farmersâ&#x20AC;&#x2122; Home Administration (FmHA), which was replaced in 1994 by the FSA. With the FmHA, the objectives of the subsidization program changed again, as they became closer to those of economic development. The program was refocused to target farmers deprived of access to credit but for whom the possibility of eventual access to commercial credit could be considered. During the 1970s, market interest rates were high, and there was a turnaround once again. Congress decided to use subsidized loans for the agricultural sector as an instrument of massive aid to farmers in financial trouble, in order to help them deal with their weak incomes and difficult financial situations. This aid-type objective continued in the 1980s, faced with the agricultural sector crisis in the early years of that decade. It was only in the beginning of the 1990s that, in view of the enormous public spending associated with this program, the government decided to change its form of intervention in order to reduce the costs. Direct loans were then refocused on the most disadvantaged segments of the farming population. Today, the arguments made to justify the maintenance of the program take up the points evoked in the past. First of all, the objective of social equity, seeking resource redistribution to disadvantaged segments (currently ethnic minorities, women, and young people); next, the benefits of the education provided to the beneficiaries thanks to the close supervision of the loans, which would be less likely with a direct grant program; finally the greater leverage associated with interest rate subsidies, compared to a direct grant program, and consequently the insufficiency of direct grant amounts equivalent to the cost of the subsidization.

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1. Historical analysis

The subsidized credits finance ownership, operating , and emergencies, from federal borrowing and budget resources and from private financial sector resources Summary The federal administration, via the FSA, has distributed three types of subsidized credits since 1946 (ownership, operating , and emergencies), which are either distributed directly or, since 1974, guaranteed (except for emergency loans). The FSA’s resources are managed via the Agricultural Credit Insurance Fund, which is fueled by credit repayment and interests, public treasury borrowing , and funding passed annually by Congress. Resources financing guaranteed loans are provided by the private sector. The FSA replaced the FmHA in 1994, taking over all of its prerogatives. The FmHA, founded in 1946, had itself been preceded by several other institutions, and its scope of intervention has markedly evolved over time. From 1918 up to the Great Depression, the subsidized loan program provided only emergency loans (“Emergency crop and seed loans”) to help farmers deal with disasters. From the 1930s, the government began to establish loans to cover operating expenses in addition to the emergency loans. Then, from 1946 and the creation of the FmHA, the subsidized loan supply was structured into three areas: farm ownership (FO), operating loans (OL), and Emergency Disaster (EM). These loans cover short-, medium-, and long-term needs. The structure is still in effect today. Finally, as part of the government effort to reduce the cost of farmer assistance, a program for guaranteeing loans distributed by other players was launched in 1974. However, the volumes of guaranteed loans did not reach a significant level before 1984. The loans are 90% or 95% guaranteed. Today, the FSA still offers short-, medium-, and long-term loans for ownership, operating costs, and emergencies, according to its structure established in 1946. The FO or OL loans can be provided either directly by the FSA, or by a private body (commercial banks, FCS, etc.) with the FSA guarantee. The FSA loan supply is not exclusively intended for agriculture; it includes the needs of all rural inhabitants. For example, the FSA has proposed real estate loans for rural housing since 1949, as well as loans for rural communities, introduced in 1954. The scope of such loans has gradually extended since then. These loans will not be covered by the present report, as they do not directly concern the agricultural sector.

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1. Historical analysis

A SAVOIR

Funding for the FSA comes from various sources. The Agricultural Credit Insurance Fund (ACIF) is a revolving credit fund created in 1946. It enables the FSA to borrow directly from the US Treasury and thereby benefit from the low cost of federal resources, compared to market resources, to finance its loans. Congress votes on the credits, by program, within the framework of determining the budget of the United States Department of Agriculture (USDA). These credits cover losses and interest rate subsidization. A budget is then allocated by the FSA to its regional offices, i.e. state by state. In the event of a significant gap between demand and the funds allocated to each state, reallocations or centralization of resources are possible during the year. As for the resources to finance guaranteed loans, these are provided by commercial banks and the cooperatives that offer these loans. In the 1980s, some banks denounced the lack of transparency in how the FSA guarantee program is taken into account in the federal budget: as the guaranteed loans do not give rise to an immediate financial flow, these were not inscribed in the budget (Penner, 1983). This situation came to an end with a reform passed in 1990, after which the corresponding amounts were taken into account as soon as the loan guarantees were granted (Dodson and Koenig, 2006).

The credit targets the poorest, with different conditions, and includes systematic support for the beneficiaries Summary The FSA targets the most disadvantaged segments of the farmer population. The level of interest rates of loans granted directly by the FSA is indexed on the cost of the administrationâ&#x20AC;&#x2122;s resources, with the addition of a small margin. Special interest rates benefiting from extra subsidization, intended for target populations, were moreover introduced in the 1970s and extended to guaranteed loans in the 1980s. The loan periods make it possible to cover short-, medium-, and long-term needs. To avoid aberrations, the period for participation in the program has been limited in time since 1992, but these limits are not systematically applied. One of the main specificities of the FSA loan programs is close supervision and training associated with the granting of credits. The objective is to help borrowers acquire the capacities they need, including in management, in order to obtain commercial credit. The main target of the subsidized loan programs are young farmers and socially disadvantaged groups (ethnic minorities and women). Young people are a very privileged target of the subsidized loan program, insofar as a large proportion of grants are reserved for them during the first 11 months of the year, every year (70% of farm

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ÂŠ AFD / Agricultural Credit: Assessing the Use of Interest Rate Subsidies / July 2015

1. Historical analysis

ownership loans and 35% of operating loans) (Dodson and Koenig, ibid). A portion of the loans, which is variable depending on the county, is also reserved for socially disadvantaged groups and women. Obtaining an FSA guarantee is subject to having been refused all loan applications to commercial and cooperative lenders, whereas obtaining a loan directly granted by the FSA requires that these same conditions be met, plus refusal for the FSA guarantee. For directly granted loans, the borrowers must also undertake to pay back their loan to the private or cooperative sector if their financial situation improves during the loan period. The guarantee ceilings are low enough to ensure that targeting is consistent with the program’s objectives. The ceiling for loans directly granted is lower than the ceiling for guaranteed loans. Beneficiary eligibility is assessed locally, case by case, and in some cases can be reviewed annually. Historically, the interest rates of loans offered by the FSA are based on the cost of borrowing for the federal government. The FSA’s “standard” interest rates are still determined that way today. For example, in 1998, the interest rates were based on the average rates of US Treasury bonds plus 1%, for a 5-year term for operating loans and 25 years for ownership loans. The interest rates of loans guaranteed by the FSA are commercially negotiated by the customer with the lending intermediary (commercial bank or FCS). However, they are subject to conditions as part of the agreement with the FSA: they must be similar to the rates of loans for comparable purposes granted without guarantees. In the 1970s, macroeconomic conditions led the government to establish a preferential interest rate for certain farmer populations in difficulty. It benefited from an additional interest rate subsidy. This alternative was first introduced for direct loans, and then extended to guaranteed loans in the 1980s. For example, in the 1990s, the special rate was equivalent to half the average rate for 5-year US Treasury bonds, with a minimal 5% threshold under which the rate could not descend. While the level of these subsidized rates has sometimes been inferior to inflation, in periods where the market interest rates are low, the 5% threshold creates situations in which the special rates may be superior to the standard rates. This is especially the case for operating loans since the 2000s (cf. Figure 5). Some guaranteed loans can also benefit from a so-called assisted special interest rate. This rate is subject to terms that are different from those concerning the special rates

July 2015 / Agricultural Credit: Assessing the Use of Interest Rate Subsidies / © AFD

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1. Historical analysis

A SAVOIR

for direct loans. For example, in the 1990s, the negotiated interest rate dropped four points, without a minimal threshold. The special interest rates concern three specific categories of borrowers. The first is borrowers who cannot or can no longer pay back their debt at the standard rate. The purpose of the special level is to provide temporary assistance, and beneficiary eligibility is reviewed each year: if the financial situation of the borrower improves, the standard rate is applied anew. Next are the borrowers of emergency loans, which have the lowest interest rates. These are set for the entire life of the loan, independently of the borrowerâ&#x20AC;&#x2122;s ability to repay loans at the standard rate. For example, in 1998, the interest rate for emergency loans was 3.75%. This is lower than the minimal threshold under which the special interest rates could not fall (5%). The third category is that of young farmers, who can systematically benefit from special interest rates, even if they have the capacity to pay back a loan at standard interest rates. However, they must be able to supply capital equivalent to 10% of the amount of the investment. The special interest rate applies until the end of the loan period. For example, in 1998, this interest rate was 4% for the purchase of a farm. Figure 5 shows an example of the difference between commercial and FSA rates between 1977 and 1997, for loans covering operating expenses. For the standard FSA rates, this difference is around 2 to 4% (with occasional overlaps). The difference is much greater for the special rates, with a minimum of 4% and spikes occasionally reaching up to 10%.

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ÂŠ AFD / Agricultural Credit: Assessing the Use of Interest Rate Subsidies / July 2015

1. Historical analysis

Figure 5

Trend in commercial bank and FSA interest rates for operating loans between 1977 and 2004

Un-weighted average quarterly interest rate on new loans (percentage points)

FSA special rates

Commercial banks

Standard FSA rate

0 1977

1980

1983

1986

1989

1992

1995

1998

2001

2004

Source: Dodson and Koenig, 2006.

Farm ownership loans have maturities of up to 40 years for direct loans and generally 30 years or less for guaranteed loans. Operating loans vary from 1 to 7 years if they are directly granted by the FSA; under special circumstances they can reach maturities of 15 years. The guarantees for operating loans are available for up to five years (Dodson and Koenig , 2006). The maturities for emergency loans are similar and depend on the need covered (operating cost or investment). The purpose of the limits in period of participation in the program is to encourage beneficiaries to turn to the financial sector to finance their activity. For example, in 2006, obtaining new loans was possible for 10 years after having obtained an initial farm ownership loan and for six years after having obtained an initial operating loan. These limits were suspended many times by Congress because of the difficulties a significant number of farmers experienced in respecting these limits. From the early 1930s, the administrationâ&#x20AC;&#x2122;s subsidized credit program included a component for supervision of the operation of beneficiary farms. This supervision was then extended in 1935 in order to take into account overall household economy in support for financial management.

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1. Historical analysis

A SAVOIR

In practice, the FSA has agencies in most counties, and the local FSA staff help the borrowers to develop long-term financial plans. The staff visit the farms several times per year, in order to give advice on the credit needs and to help in planning. At the end of the year, they work closely with the farmer-borrowers to help them establish their balance sheet and to adjust the plans for the following year according to how their situation evolves. The close supervision is an integral part of the lifecycle of direct loans granted by the FSA. The supervision, which is provided by FSA agents, is thus free of charge, and mandatory in virtue of federal regulations (Government Printing Office, 2012). For the guaranteed loans, the regulation also provides for annual supervision visits, but these are made by the commercial and cooperative banks that distribute these loans. The specific object of supervision in the direct loan program is to train the beneficiaries in financial management and in planning their activities, so that they can then have access to the commercial credit supply. Since 1990, the training aspect of this system has been formalized in the farm bill. The loan beneficiaries are obliged to undergo two training sessions, in financial management and in production management. The beneficiaries of direct loans are now obliged to undergo these training sessions and receive certificates of validation, at their expense, in the two years following the granting of a loan. The cost of training sessions can be included in the amount of the subsidized loan. The training sessions are taught by organizations approved beforehand by the FSA. Out of concern to facilitate access to the system, as well as to limit time spent away from the farm, some training organizations now propose programs online. [ 2 ]

The scope of interest rate subsidy programs has greatly increased since the crisis period of the 1980s Summary The portfolio of FSA loans to the agricultural sector experienced considerable growth at the end of the 1970s and the beginning of the 1980s, along with significant default rates due to troubles in the agricultural sector. This growth came within the framework of overall increase in volumes of agricultural credit. The subsidized credit programs corresponded to a small part of the agricultural sector debt, except during crisis [2] Example of financial management training via the Internet, at a price of USD 100, offered by the service provider Mi Casa Enterprises: http://www.fsa-micasa.com/Section2/lets_begin.html

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1. Historical analysis

periods. The scope of the special interest program varied from year to year, depending on several internal or external factors. The share of volumes granted within the framework of the guarantee program grew from the end of the 1980s and quickly became dominant. During the 1970s, the American agricultural sector developed its export activities and thus its dependence on international demand. As a consequence, a sudden drop in this demand at the beginning of the 1980s led to serious difficulties for this already very indebted sector. Congress thus used the subsidized loan program as an instrument for its social assistance policy, by passing measures that sought to force the FSA to grant loans to farmers who were already beneficiaries, even if they were already defaulting in their payments. In 1984, a court order prohibited the FSA from initiating foreclosures to ensure the guarantees it had made on direct loans with delinquent repayments (Dodson and Koenig, 2006). Following this, the FSA portfolio was difficult to control, with annual grant volumes increasing eightfold between the beginning and the end of the decade.

Figure 6 Trend in outstanding debt in the agricultural sector at the FSA and its rate of annual growth between 1960 and 2010

50%

40%

30%

20%

10%

-5

- 10%

-10

-20% 0 196 2 196 4 196 6 196 8 197 0 197 2 197 4 197 6 197 8 198 0 198 2 198 4 198 6 198 8 199 0 199 2 199 4 199 6 199 8 200 0 200 2 200 4 200 6 200 8 201 0

60%

Growth in outstanding debt

196

Outstanding debt in the agricultural sector at the FSA (in USD billion)

Outstanding agricultural sector debt at the FSA 30

Source: USDA, Farm business balance sheet.

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1. Historical analysis

A SAVOIR

The FSA’s status as “lender of last resort,” without any other activities, gives it a relatively limited market share of agricultural loans. This market share remained at about 5% in the 1960s and 1970s. Since the beginning of the 2000s, it has been less than 4%. But during the crisis period, which began in the late 1970s, it increased to nearly 18%. Under these circumstances, the FSA did indeed take over from the private sector in order to guarantee credit access to farmers already in financial difficulties, and to ensure—thanks to these subsidized rates—that debt service did not weigh too heavily on the business results of farms.

Figure 7

Trend in the share of FSA programs in outstanding debt of the US agricultural sector between 1960 and 2010

Share of the FSA in agricultural sector debt 20% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0%

60 62 64 66 68 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 20 20 20 20 20 20

Note: Most of the ERS references correspond to freely accessible data sheets on the USDA site: http://www.ers.usda.gov/data-products.aspx The data used are those that were available during the preparation of the report, in 2012. Sources: ERS/USDA, Farm business balance sheets, 1960-2010.

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1. Historical analysis

Each year, the FSA is obliged to grant at least 25% of its direct loans based on the special rate. However, there are years when the percentage of special rate beneficiaries can be much higher (e.g. 60% of direct loans and 14% of guarantees in 1997). The proportion of loans at a special rate varies according to several factors. These include the available resources at the FSA, the level of the standard interest rates, the conditions of the program, and the financial health of the beneficiaries. The use of special rates spiked in the middle of the agricultural sector crisis in 1981, when the market interest rates and budgets granted were at their highest level and the government sought to help farmers in financial difficulty via this program. The guarantee program introduced in 1974 had trouble taking off in the first years because of too stringent conditions, especially regarding the maximum interest rate authorized for private partners (capped at 5%). The relaxing of this rule made it possible for volumes to grow from 1986, as illustrated in Figure 8.

Figure 8 Trend in annual volumes of direct loans and guarantees granted (stacked), between 1974 and 2004 Direct programs

Guarantee programs

In constant 2004 USD billion

16 14 12 10 8 6 4 2

04 20

02 20

00 20

96 19

94 19

90 19

88 19

84 19

82 19

78 19

76 19

Source: Dodson and Koenig, 2006.

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1. Historical analysis

A SAVOIR

The USDA indicates, in a publication by the FSA’s economic research service, that the guarantees are generally considered suitable for offsetting the deficiencies of the market, whereas the direct loans are preferable in situations in which the objective is to redistribute resources to disadvantaged groups.

The cost of subsidizing the interest rates results mainly from administrative costs and losses Summary When analyzing the cost of subsidization, we must differentiate between the loans at so-called standard rates of interest (the amount of which is based on the cost of the federal resource with the addition of a low margin) and the special interest rates (which are explicitly subsidized). Administrative costs represent the main budget item of the FSA’s interest rate subsidy programs. These are the infrastructure and human resources costs needed to ensure service and monitoring at the local level, and they are mainly linked to direct loans. Loans granted under special conditions are the main component of the federal grant given. Significant losses are attributed to the direct loan programs and, to a lesser degree, to the guarantee programs. This set of factors leads to a higher rate of subsidies for direct loans than for guaranteed loans, except when the latter benefit from special interest rates. Nevertheless, the share of the cost of interest rate subsidy programs in the total amount of US agricultural sector subsidies remains low, especially in comparison to programs for price support and support for farmer income. The cost of FSA agricultural credit programs is made up of the cost of the federal financial resource, administrative costs, the cost of the interest rate subsidies, and the cost of losses. The loans granted at the standard interest rate, the amount of which is based on the cost of the federal resource in addition to a low margin, could be considered as concessional loans, if the margin added were to enable coverage of all the other costs (see below). On the other hand, the loans granted at special interest rates are explicitly subsidized. Administrative costs represent 60% of the total cost of the FSA’s loan programs. Between 1993 and 2004, a budget of USD 3.2 billion was allocated to the FSA for its operating costs, out of a total budget of USD 5.3 billion, subsidies included (Dodson and Koenig, 2006). These costs are mostly posted to the direct loan program, given that it is the private partners who finance, grant, distribute, and supervise the

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1. Historical analysis

guaranteed loans. The guarantees thus require fewer administrative resources; the administrative cost per dollar loaned as part of the direct distribution program increased as the volumes of direct loans decreased in favor of guarantees. The margin on the standard interest rates does not make it possible to cover all the administrative costs (and the losses); this interest rate is thus implicitly subsidized. The following figure (Figure 9) represents an estimation of the administrative cost of a USD 100 loan, for direct loans and guaranteed loans respectively. This figure thus shows that between 2000 and 2004, the FSA spent USD 0.76 per USD 100 guaranteed, compared to USD 2.52 per USD 100 directly loaned.

Trend of operating expenditure ratios for direct loans and guaranteed loans between 2000 and 2004

Figure 9

Direct loans

Guaranteed loans

Administrative cost in proportion to the outstanding debt of the loan

3.0% 2.5% 2.0%

2.62 %

2.53 %

2.68 %

2.74 % 2.52 %

2.04 %

1.5% 1.0% 0.5%

0.52 %

0.65 %

0.78 %

0.88 %

0.98 % 0.76 %

0.0% 2000

2001

2002

2003

2004

Average

Source: data estimated by the USDA, 2006.

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1. Historical analysis

A SAVOIR

The cost of the interest rate subsidy is the difference between the standard rate and the special rate, for the direct or guaranteed loans. The cost of losses on loans is an important component of the total cost. The crisis of the 1980s led to rapid increase in direct loan losses: from USD 7 million to 113 million per year from 1981 to 1985 (Harman, 1989). These figures marked the start of a period of significant losses: in 2006 the USDA recorded accumulated losses reaching USD 23 billion between 1985 and 2005, representing an average of USD 115 million per year, just for the direct loan program (Dodson and Koenig, ibid.). Because the guarantee portfolio started later, from the middle of the 1980s, the losses are observed with a time lag compared to the direct loan portfolio. But, as in the case of the direct loan portfolio, the guarantee portfolio also led to significant losses: in 1990, the FSA estimated the potential losses for the following years at 23% of the portfolio, or USD 1.2 billion, with effective losses reaching USD 300 million over the previous years (Harman, 1992). All these factors led to a subsidy rate higher for the direct loans than for the guaranteed loans, except when the latter benefited from special interest rates. The federal government calculates the subsidy rate as the relationship between a cost and the amount of a loan. For example, for a 1% interest rate, it will be possible to loan USD 100 for each dollar spent, whereas for a subsidy rate of 5%, it will only be possible to lend USD 20 for each dollar spent. Figure 10 presents the subsidy rates estimated by the government based on data available in the federal budget in 2006. • Because of fewer loan losses, lower interest rate subsidy costs, and fees billed to the lending institutions for the guarantee, the overall subsidy rate of guaranteed loans (3.6%, in light green in the figure) is clearly lower than the subsidy rate of direct loans (11.7%, in black in the figure). One of the differences, in terms of interest rate subsidies, is that only the guaranteed operating loans can offer subsidized interest rates, whereas all the types of direct loans can be associated with special rates, if justified by the borrower’s situation. • On the other hand, guaranteed operating loans benefiting from a special interest rate have a higher subsidy rate than direct loans for comparable purposes. This difference is mainly justified by higher amounts for the guaranteed loans than for the direct loans and, to a lesser degree, by different interest rate subsidy conditions.

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1. Historical analysis

• The subsidy rate for emergency loans (16%, in olive green in the figure) is the highest, as they provide higher subsidized interest rates and are coupled with a higher default rate than for the other programs.

Figure 10 Estimation of the average annual subsidy rates of the various FSA programs between 1992 and 2004 20% 16.00%

15% 12.60%

10%

11.70%

8.40%

3.60%

2.90%

ans

ns ran gua tal To

tal

dir

tee

ect

d lo

loa

ans y lo enc erg

ner

ara

nte

Ow arm –F ns loa

ect Dir

p shi ner Ow arm –F ns loa ed nte Gu

ara

shi p ed sta loans nda – rd Op rat era e tin Gu g– ara n t e wit ed h s lo pec ans ial – O int ere pera st r ting ate – Dir ect loa ns –O per atin g

0.40 %

Source: Dodson and Koenig (2006).

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1. Historical analysis

A SAVOIR

The proportion of the cost of interest rate subsidy programs within the total amount of subsidies to the US agricultural sector remains low, especially compared to programs to support prices and farm income. The Organisation for Economic Co-operation and Development (OECD) estimated that, between 1986 and 2009, the amount of subsidies granted to the US agricultural sector varied between USD 10 billion and 55 billion per year (OECD, 2001), whereas in comparison, between 1992 and 2004, the cost of the FSA direct and guaranteed credit programs hovered between USD 300 million and 450 million per year (Dodson and Koenig, 2006). The relationship between the subsidies granted to the FSA and total subsidies varies: a minimum of 0.8% in 1999 and a maximum of 4% in 1995. In comparison, the program to support prices and farm income managed by the Commodity Credit Corporation (CCC) represented more than half of agricultural subsidies in 1995 and more than one third in 1999 (Dodson and Koenig, 2001).

1.2.3. Impacts on the agricultural sector and the financial sector The agricultural and financial sectors clearly made headway over the period studied, but this progress resulted more from different types of support rather than a particular intervention. Therefore, in view of the large number and diversity of the factors in play, it is not deemed wise to estimate a breakdown of the impact among the various factors.

Regional studies indicate positive impact on agriculture from subsidized loans and supervision and training systems Summary During the century studied, the value added of the US agricultural sector made much headway, but it is difficult to quantify to what degree the FSA contributed to this growth. While the impact of subsidized loan programs is difficult to measure on a national scale, their usefulness is more visible on a regional scale. There has been little study of the impact of close supervision and training associated with the granting of direct loans by the FSA, but the rare studies that deal with this issue are in agreement regarding the positive impact of the training system.

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1. Historical analysis

Figure 11 Comparative trends in the value of production and the value added of the agricultural sector in the United States between 1910 and 2010, and trends in the debt of the agricultural sector and the debt of this sector to the FSA between 1960 and 2010 Value of agricultural sector production Agricultural sector debt, including FSA

Net value added of the agricultural sector Agricultural sector’s debt to the FSA (excluding guarantees)

400 350

USD billion

300 250 200 150 100 50 0

10 14 18 22 26 30 34 38 42 46 50 54 58 62 66 70 74 78 82 86 90 94 98 02 06 10 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 20 20 20

Sources: ERS/USDA (1984 to 2012; 2006).

During the century studied, the value added of the US agricultural sector made much headway, but it is difficult to quantify to what degree the FSA contributed to this growth. The debt of the sector increased along with growth in production and the value added of the agricultural sector, and the FSA clearly contributed to this increase during the financial crisis of the 1980s. However, many other factors helped make this value added rise from USD 5 billion to 130 billion in 100 years. These factors include the modernization of production units during the first part of the century, significant growth in international exports by the agricultural sector from the 1970s, globalization of international agricultural markets from the 1990s, etc. It is difficult to draw conclusions on a national scale on the impact of FSA subsidized loan programs, given that the scope of the program remains limited in relation to the total volume of agricultural sector debt. An exception is the period of financial crisis of the 1980s, for which we can observe a spike to nearly 20% of the agricultural sector’s outstanding debt.

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A SAVOIR

However, there are big gaps by agricultural region, state, and county (USDA, 2000, quoted by Dodson and Koenig , 2001). In some regions, or for certain borrower categories, the federal government covers half the agricultural sector credit need (Dodson and Koenig, 2001). For example, the counties the most dependent on FSA programs are located in the Northeast, the Great Plains, and the Mississippi Delta (Maine, Louisiana, Mississippi: nearly 50%; Arkansas, North and South Dakota, Vermont, Georgia: between 20 and 30% (ERS/USDA, 1983 to 2012)). Analysis by region could thus confirm the impact of subsidized credit on the agricultural sector, but few studies have dealt with these regional gaps, and it is difficult to draw conclusions based on available documents. Nonetheless, it is interesting to note from Map 1 below that the increase in productivity of the agricultural sector, as measured by the USDA, was higher than the national average in the states that enjoyed significant financing by the FSA. For example, between 1960 and 2004, average annual growth in productivity was more than 1.90% in Louisiana, Mississippi, and Maine, compared to a national average of 1.76%.

Map

Trend in productivity by state between 1960 and 2004, as an average annual percentage of change

1.9 - 2.6% 1.7 - 1.9% 1.5 - 1.7% 0.6 - 1.4%

Source: ERS/USDA, 1983 to 2012.

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1. Historical analysis

No impact study on the FSA training and supervision system has been carried out on a national scale. However, the results gleaned from several available studies on a state scale are very encouraging. According to an article dealing with an impact study of the training in Pennsylvania (Ballet et al., 2010), the results obtained show that a significant share of producers having received training consider that, at the end of the training, their knowledge, confidence, and attitude in terms of their farmâ&#x20AC;&#x2122;s financial management have improved. They also observe that their practices of farm management have improved and, finally, that their farmâ&#x20AC;&#x2122;s assets, net value, and profitability have increased. A study (Parsons et al., 2000) concerning Delaware, Maryland, New York, and Pennsylvania drew the same conclusions. Furthermore, the Ballet et al. study (2010) points out that the farmers are not always aware of the need of training before having followed the program. The study thus recommends, in view of the significant results observed, that the training program be promoted among other lenders to the agricultural sector, so that the farmer customers of these financial intermediaries can also take advantage of heightened knowledge in financial management for their farm.

The FSA programs have played an important role in supporting and rounding out the US financial sector in order to meet the financial needs of agriculture Summary The share of the private commercial sector (excluding cooperatives) in the financing of agriculture developed parallel to state interventions. The FSA programs in particular played an important role in ensuring that the sector continued to be financed during the financial crisis of the 1980s. Despite the growth of the private sector delivering services to the agricultural sector, the rural markets still lack competition, meaning that there is still a role for federal interventions. The program to distribute subsidized direct loans reaches socially disadvantaged groups better than the program of commercial loan guarantees. As a result, the quality of the direct portfolio is markedly inferior to that of the guarantee portfolio. The loans distributed by the FSA have experienced considerable losses, but the link between losses and subsidization is debatable. The losses are fully covered by the federal government but heavily criticized by some, including within the federal administration.

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1. Historical analysis

A SAVOIR

Between 1960 and 2010, the outstanding debt of the agricultural sector increased more than tenfold, from USD 22 billion to 247 billion. During this period, the share of the private sector (commercial banks and life insurance companies, but excluding cooperatives) grew 40% to nearly 50% of the market, despite the major crisis that brought the share of this sector down to 30% in the early 1980s. As for the share of the cooperative private sector (FCS), it increased from 17% to 40%, with a slight squeeze from the late 1980s to the late 1990s. It is also doing this period that the share of the informal sector dropped from 40% in 1960 to 7% in 2010. The federal interventions make it possible to round out the market supply in crisis periods. This is especially the case of the FSA, whose market share grew from several percentage points to nearly 20% at the end of the 1980s, and then under 10% in the 2000s. It would thus seem that the targeted subsidization of agricultural sector loans acted more as a complement than a substitute to the commercial supply (cf. Figure 12).

Figure 12 Trend of the agricultural sector outstanding debt by type of lender between 1960 and 2010 FCS FSA Informal sector

Commercial banks Life insurance companies

Agricultural sector outstanding debt (in USD billion)

300 250 200 150 100 50

200 0 200 2 200 4 200 6 200 8 201 0

197 2 197 4 197 6 197 8 198 0 198 2 198 4 198 6 198 8 199 0 199 2 199 4 199 6 199 8

197

196

Source: USDA, Farm Business Balance Sheets, 1983 to 2012.

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1. Historical analysis

The private sector developed properly, but the rural markets had trouble becoming competitive. Despite positive trends in the private sector with regard to the agricultural sector’s outstanding debt, the Department of Justice considered, as late as 1993, that 93% of rural financial markets were noncompetitive (cf. Figure 13).

Figure 13 Competitive status of rural financial markets as of 30 June 1993 Competitive

Other noncompetitive Noncompetitive (3-5 banks) Noncompetitive (1-2 banks)

Source: ERS/USDA, 1996.

The USDA checks to see that the directly distributed subsidized credit makes it possible to better finance disadvantaged social groups (women, beginner farmers, and ethnic minorities). Collected data indicates that the direct loan program reaches this target better, with only 23% of direct loans for farm ownership going to nontargeted groups, versus 71% for guaranteed loans, and 50% versus 68% respectively for operating loans (Dodson and Koenig, 2006). The guaranteed loans show better performance than the direct loans, with—as Figure 14 shows—a portfolio-at-risk (PAR) ratio at 30 days that is systematically and significantly higher for direct loans. This is consistent with the fact that direct loans are granted to farmers at risk and to those who cannot find private financing.

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Figure 14 Average PAR ratio at 30 days, at the end of 2004, for guaranteed loans, direct loans, and emergency loans granted in 2000 Guaranteed

Direct

Direct/Emergency

18 16

14.7

12.5

14.5

4,4

13.0

12 10 8 6.2

6 4.4

4.4

3.9

4.6

2 0 All borrowers

All loans

Real estate loans

Operating or emergency loans

Source: USDA, Farm Loan Program Database.

As seen previously, in crisis periods losses are one of the major cost items of the FSA programs. The role of lender of last resort, which was forced on the FSA during the agricultural sector’s financial crisis of the 1980s, had serious consequences in terms of losses recorded at the end of the 1980s and beginning of the 1990s. Over several consecutive years, from 1989 to 1993, the loss rate of direct loans compared to outstanding debt exceeded 10% and reached up to 13.5% in 1990. However, it should be noted that in the years preceding this crisis (at the end of the 1970s) the PAR at 15 days was positioned at less than 3% of outstanding debt (around 12% of the number of loans) and the losses at less than 0.5% of outstanding debt. This demonstrates the FSA’s real capacity to recover loan losses. The problem of losses seems linked more to policies passed by Congress during the 1970s and 1980s (when the FSA was used as an instrument of welfare aid) than to the subsidization of interest rates. The General Accounting Office (GAO) nevertheless condemned the extent of FSA losses in a report submitted to Congress in April 1992, and several studies question the relevance of continuing the direct loan program due to its cost.

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1.2.4. Conclusion: the subsidized loan system has acted as a security net, but cost has been high The subsidization programs act as a last-resort solution targeting the least well-off farmers or those suffering a financial crisis. However, they also maintain their objective of helping farms reach sufficient profitability after several years, so that they can turn to the private sector for financing. This solution is thus systematically accompanied by close supervision, which enables the beneficiaries to develop their management skills. After nearly a century of existence, the interest rate subsidy programs represent, in terms of volumes loaned, a small share of federal action to support the financing of the agricultural sector (except during crisis periods), and growing attention is being paid to whether the associated costs are justified. While the system does reach the target public, the required infrastructure is increasingly expensive for the government, due to the decrease in volumes loaned. In view of the small share of the agricultural sector credit market served by the FSA, it is difficult to draw conclusions regarding the extent of the subsidized loan program’s contribution to the growth of the US agricultural sector at the national level. However, the information available at the regional level shows the influence of these programs in less advantaged regions. Increase in the share of subsidized loans in the agricultural sector’s debt during crisis periods shows the “countercyclical” nature of these interventions. Here we can see the state role in supporting activity at those times when the private sector withdraws due to increased risk.

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1.3. Brazil The distribution of loans with subsidized interest rates was and remains an important instrument of Brazil’s agricultural support policy. The case of Brazil is interesting because it shows how the private banking sector was largely excluded from agricultural financing for many years, but without this situation being due to interest rate subsidy policy.

1.3.1. Agriculture, a strategic sector for Brazilian growth The 20 th century saw the transformation of Brazil from a country with an economy based on cash crops for export to the 6 th largest global economic power. This shift took place after a long period of government intervention in the economy, accompanied by major macroeconomic unbalances. The origins of Brazilian agriculture go back to the colonial period, when cash crops were grown on large plantations. This export-oriented agriculture spread throughout Brazil in several waves of expansion, and it provided the country with an entrepreneurial class. In 1950, the country was still largely rural. Today, despite being heavily urbanized and industrialized, it is one of the biggest exporters of agricultural products in the world. Together, the agricultural and agri-food sectors in Brazil make up 97% of the country’s trade surplus.

Table

3 Selection of indicators, 1900-2010 1900

Population (in millions) Percentage of rural population

1950

2010

17.4 51.9 190.7 68.9% (1940)

63.8%

16.52% (2007)

GDP (in constant USD billion, 2000)

5.0

42.6

549.6 (2000)

Share of agricultural sector in GDP

38.2% (1920)

25.1 %

5.3%

No data available

59.7%

17.5% (2007)

Share of agricultural sector in employment

Sources: Instituto Brasileiro de Geografia e Estatistica (IBGE): Censos Demograficos, 1956-2013; IBGE: Series historicas e estatisticas (http://seriesestati-sticasibge.gov.br); Howe, 1992.

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Brazilian agriculture supplies the large national agri-food sector and provides a high level of income in foreign currency. Its potential for growth is strong and depends above all on improvement of transport infrastructures. Although Brazilian agriculture currently employs a relatively low percentage of the working population, it has taken on a significant dimension in state strategy to fight against poverty.

The persistence of a dual and non-egalitarian agricultural model The development of agriculture by successive waves was the main vector leading to the occupation of the huge Brazilian landmass. Along with growing urbanization, agricultural land surface began to decrease from 1980. Likewise, as the agricultural sector became mechanized, the number of people employed in it also decreased. Agricultural production became very diversified from the 2000s, even if the major â&#x20AC;&#x153;historicalâ&#x20AC;? crops like sugarcane, soy, and coffee continued to dominate production in terms of value. The structure of the Brazilian agricultural sector is characterized by the juxtaposition of very big and very small farms. The number of these latter has greatly increased since the 1990s, thanks to acceleration of agrarian reform and the implementation of large-scale programs to support family agriculture. Today, the vast majority of Brazilian farmers own their land. However, large and very large farms remain the dominant forms of farms in terms of surface area cultivated. Rural credit programs are one of the main instruments of Brazilian agricultural policy. These are mainly organized by the Ministry of Agrarian Development (MDA), which was specifically created to take care of sustainable rural development policies, via land reforms and family agriculture. In this way, it responds to the hopes of social and political movements campaigning for fairer sharing of land. The National Institute of Colonization and Agrarian Reform (Incra), a body linked to the MDA, is responsible for the implementation of the National Agrarian Reform Plan (PNRA). As for the National Program for the Strengthening of Family Agriculture (PRONAF), it was created in 1995 and is one of the pillars of Brazilian agricultural policy. Its purpose is to provide technical and above all financial support to family farms. It offers a large range of subsidized loans to eligible farmers. Loans with subsidized conditions are also accessible to larger farms, especially those granted by the Brazilian National Economic and Social Development Bank (BNDES) and the loans granted as part of the minimum price policy (loans guaranteed by products stocked in accredited warehouses). [ 3 ] [3] From 2003, as part of the minimum price policy, these credit mechanisms have been gradually replaced by other instruments that incorporate market mechanisms, such as disposal bonuses paid to agents who purchase the surplus production and option contracts to which producers can subscribe.

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A SAVOIR

Public banks have a near exclusivity on agricultural financing Brazil opted very early for a mixed banking system, by entrusting the role of economic development to the development banks that each state of the Federation wanted to form. Today as well, the now-reformed public bank sector continues to play an important role. While access by individuals to financial services still remains at a low level, the increase in the number of savings cooperatives and microfinance credit institutions is helping to expand this access. Until recently, the level of financial intermediation by the Brazilian bank sector was low and characterized by high real interest rates. Agricultural financing in Brazil was for a long time almost exclusively carried out by public banks, which carried out their activities within the framework of a set of interest rate subsidization and price-support mechanisms. The opening up of the Brazilian market to international value chains changed the structure of commercial agricultural financing. While commercial agriculture has had access to commercial loans, only the National Rural Credit System (SNCR) finances family agriculture.

1.3.2. Success in adapting interest rate subsidy interventions to the size of farms Interventions with economic and social objectives Summary State interventions in the agricultural sector credit took on two forms: first, they were part of the state interventionist policy for the economy, and then part of its social policy. The policy to support its agricultural sector reflects Brazilâ&#x20AC;&#x2122;s dual structure of big and small farms (Nassar and Ures, 2009). For these two categories, the main instrument has been and remains financing via subsidized loans. Brazil set up policies very early to support economic sectors it considered strategic. The first policy was for the industrial sector, in order to replace imports with national production. The government also considered that export-oriented agriculture should be supported, as it supplied foreign currencies that could finance industrial development. Later, when faced with social and political pressure from movements representing the poorest strata of society, the government set up specific programs to promote family agriculture, to accompany its land distribution policy.

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The Ministry of Agriculture, Livestock, and Food Supply (MAPA) was put in charge of large-scale commercial agriculture, whereas the policy targeting small farms was placed under the authority of the MDA. But, in both cases, the main instrument was and remains financing with subsidized rates.

The Brazilian subsidization programs are based on an intricate financing system Summary The Brazilian government began to intervene in the agricultural sector from the early 1930s, in the form of compensation paid to coffee producers to make up for price fluctuations. Following that, Brazil’s core agricultural policy was based on an intricate system of financing via subsidized interest rates. Most of the agricultural sector loans are channeled through the SNCR, which includes targeted finance mechanisms (sometimes linked to price-support mechanisms for agricultural products), most of which are heavily subsidized. The interest rate subsidy mechanism in the rural sector is based on exit interest rates set by the public authorities and on a compensation mechanism for the credit institutions distributing these loans. Financing for the agricultural sector programs is funded chiefly by levies on the bank sector and by federal budget resources. Distribution of subsidized rural loans is open to all categories of financial institutions. However, these loans are offered mainly by public banks, as they are not profitable enough to interest a significant number of private banks, even though involvement by the latter is growing. PRONAF, the SNCR’s main subsidized credit mechanism intended for family farming, is a program whose initial objective was to guide the policy of land allocation to rural populations and the promotion of family farming. Today, another one of its objectives is the fight against poverty. In the beginning of the 1930s, the government determined measures for intervention to help the agricultural sector. These were compensations paid to coffee producers in general situation of strong price fluctuations. The main aspects of Brazil’s recent agricultural policy are: (i) the granting of loans with subsidized interest rates, (ii) the promotion of agricultural exports, and (iii) occasional interventions in domestic markets. Additional help to the sector includes tax measures, funding of very active public research, and an agricultural extension system. Most of the loans to the agricultural sector are channeled through the SNCR. This government-managed system includes targeted finance mechanisms and finance instruments linked to price-support mechanisms for agricultural products.

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As for the targeted finance mechanisms implemented through the SNCR, PRONAF grants about 30% of the loans, with very strongly subsidized interest rates. The Government Commodity Loan Program (EGF) facilitates access by farmers and agricultural cooperatives to bank loans for the marketing of agricultural products delivered to accredited warehouses, by refinancing these loans with heavy subsidization of interest rates (8.75% per year in 2000, compared to a basic bank rate of 15.70% per year). Finally, the BNDES offers various forms of long-term financing to producers and processors, more often than not with subsidized interest rates including 3% compensation for the bank. Various financial instruments linked to agricultural product price support can be mentioned: • The Federal Program for Processed Product Loans operates like the EGF but targets processors who undertake to pay producers a minimum price set by the government for their agricultural commodities (rate of 8.75% per year in 2000). • The Rural Promissory Note (NPR) is a short-term system in which farmers undertake to deliver their production at a price set in advance. This system is open only to specific crops, e.g. rice, cotton, wheat, and corn (rate of 8.75% per year in 2000). • The Government Commodity Acquisition Program (AGF) program offers loans to farmers who sell their products to the federal administration at a minimum set price (eligible only for certain products, most usually rice, corn, and wheat). • The Subsidy Auction Program (PEP) provides price support for certain agricultural commodities through a mechanism enabling the administration to pay wholesalers and processors the difference between the prevalent market price (determined by public auctions) and the set minimum price of a given product. • Finally, for option contracts, through the specialized National Food Supply Agency (CONAB), the government offers to purchase the harvests of certain products at a price set at the beginning of the season from holders of these option contracts, who purchased them beforehand through an auction system.

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1. Historical analysis

The system is rounded out by dedicated financial instruments, such as the Rural Product Certificate (CPR), which is based on future delivery by a producer and is a marketable and cashable security that can act as a guarantee for a loan, the Rural Promissory Note, as well as insurance products like those of the Federal Guarantee Program of Agricultural Activities (PROAGRO) [ 4 ] and the private offers encouraged by the Rural Insurance Stabilization Fund, which protects insurers in the event of exceptional disasters. The mechanism for subsidizing loans to the rural sector is based on exit interest rates set by the public authorities and on a compensation mechanism for the credit institutions that distribute these loans. The exit interest rates applied to subsidized loans are 6.75% per year and from 1% and 5.5% per year in the case of many PRONAF offers. These rates are set and decided by the authorities. For some of the loans granted as part of the SNCR, [ 5 ] the credit institutions authorized to distribute them receive a monthly compensation (an “equalization”) equal to the difference between the imposed exit rate and their costs in paying interest on domestic savings, plus a contribution to cover their administrative fees. The cost of their risk is not covered. The system’s supporters consider that this mechanism avoids over-distortion in the market, as it does not have an effect on the cost of resources and compensates the banks. However, we will see later that the margins of subsidized loans are very low compared to those generated by loans made in the open market. The resources for loans to the agricultural sector come above all from banks’ obligation to devote 25% of transferable deposits to this financing (temporarily increased to 30%; higher rates apply to public banks and cooperative banks). The banks can choose to distribute the rural loans themselves or to make the resources available to credit institutions authorized to distribute the loans. The majority of private banks prefer this latter solution and do not apply for central bank authorization to distribute these subsidized loans, which are not very profitable and subject to excessively complex regulations.

[4] The Family Farming Insurance Program, which was added to it in 2004, makes it possible to guarantee 100% of loans obtained through PRONAF and Part of the Estimated Net Income of the Farm. In 2006/2007, 613,722 took advantage of this insurance. [5] This equalization system applies only to loans financed from the Rural Savings Account resources, the workers Support Fund (FAT), and to federal programs managed by the BNDES; it does not apply to loans financed by levies on banks (25% of transferable deposits).

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A SAVOIR

In 2007, only 403 credit institutions, banks, and cooperatives [ 6 ] contributed to the rural credit system by granting loans with subsidized interest rates to farmers. However, involvement by private banks in the SNCR system increased in 2010. Even though still small, the share of credit cooperatives in the distribution of rural loans is growing. The other SNCR resources are the Rural Savings Account and public resources from numerous funds.

Table 4 Origin and use of National Rural Credit System resources in Brazil, from 2002 to 2010 Origin of resources

Compulsory resources

2002

2006

2008

2009

2010

(levied from banks)

53% 46% 47% 49% 47%

Rural Savings Account

13% 19% 26% 26% 30%

BNDES

17% 8% 1% 1% 1%

Other public resources

12% 7% 6% 7% 6%

Free (voluntary) resources

5 % 9% 9% 7% 8%

Totals

100% 89% 89% 90% 93%

Use of resources

2002

Federal public banks Statesâ&#x20AC;&#x2122; public banks Private banks Credit cooperatives

Totals

2006

2008

2009

2010

55% 51% 46% 51% 50% 2% 2% 3% 4% 2% 36% 41% 42% 36% 39% 7% 6% 9% 9% 9%

100% 100% 100% 100% 100%

Source: statistics of the Central Bank of Brazil, Annuario estatistico de credito rural, 2010 .

[6] In comparison, in 2008 there were 2400 financial institutions in the Brazilian financial system: 139 multiservice banks, 19 commercial banks, 4 development banks, 1 savings bank, 18 investment banks, 55 personal finance companies, 106 securities brokerage firms, 46 currency brokerage firms, 136 securities distribution firms, 36 leasing firms, 17 real estate savings and loan firms, 6 mortgage firms, 12 development agencies, 1460 credit cooperatives, and 45 microfinance institutions.

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Agricultural financing through the private system increased gradually in the 2000s. According to a WTO report (WTO, 2004), the SNCR covered only 32.6% of financing needs of the sector for the 2001-2002 season, the rest coming from private companies and financial institutions. On the other hand, small family farms remain strongly dependent on the SNCR credit supply. PRONAF is the SNCRâ&#x20AC;&#x2122;s cornerstone credit mechanism for family farming. It was launched in 1995, to accompany the agrarian reform policy of allocating land to poor farmers. PRONAF consists chiefly of a system of rural credit accompanied by a technical assistance program. The program also provides funds for rural infrastructure (road construction, etc.). It targets small family farmers (owners, tenants, and sharecroppers) as well as small-scale production associations and cooperatives. The loans are used to finance working capital and investments; all the loans are granted with strongly subsidized interest rates. Rebates are granted to beneficiaries under certain conditions, for repayments of principle made on time. PRONAF loans require a financing plan approved by a technical agent from the agricultural extension or labor union networks; this plan is submitted to an agency of a credit institution authorized by the Central Bank to participate in the SNCR. The loans are distributed by public banks, some private banks, and savings and credit cooperatives. Microfinance institutions are also now participating in it. Conditions for access to the loans depend on the types of agricultural holdings, as shown in Table 5.

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Table

Conditions for PRONAF loan eligibility in 2001 Category A

Category B

Category C

Characteristics of the farm [ 7 ]

Beneficiary Family Same as B, of agrarian labor with some reform off-farm income < BRL 1,500

Category D Same as C, and up to 2 employees

Gross annual income

No limit

Credit limit

BRL 3,000 – < BRL 500 9,000; 35% tied to farm operations

Interest rate

1.15% 1% 4% 4%

Payment

10 years, 3-year grace period

BRL 1,500 – 8,000

BRL 8,000 – 27,000

BRL 500 – 2,000

< BRL 5,000

4 years, 1-year 2 years grace period

2 years

Source: Minister of Rural Development, quoted in: OECD (2001).

In 1998, PRONAF was extended to the poorest rural populations. This offer was then enlarged to benefit rural populations with even lower incomes, via a tax on formal agricultural holdings. Since 2003, PRONAF has in fact been an instrument of poverty reduction within the government’s “zero hunger program.” In 2008-2009, the program was once again extended to include other activities such as fishing and aquaculture, and then renewable energies and eco-friendly investments.

The subsidization programs experienced great success in the 2000s, especially for family agriculture Summary The subsidized loans granted by the bank system to agriculture increased strongly over the 2000s. They represented the majority of bank financing to the sector. However, they reached high levels compared to production values for only a certain number of products. The subsidized PRONAF loans for family farming developed [7] In order to be authorized to receive PRONAF loans, a producer must obtain a certificate of competence issued by the Municipal Council for Rural Development.

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1. Historical analysis

very rapidly, reaching 1.6 million beneficiaries in five years. The scope of eligible holdings was gradually enlarged. Between 1996 and 2000, total bank financing granted to farmers and cooperatives as part of the SNCR program rose from 6.3 billion Brazilian reals (BRL) to approximately BRL 13.8 billion. This amount can be compared with the bank sector’s BRL 25.5 billion in outstanding debts to agriculture, in October 2000. About 65% of SNCR loans were granted to finance working capital needs, 17% to finance investments, and 18% to finance marketing (OECD, 2001). PRONAF, [ 8 ] which groups together the credit programs specifically for promoting small-scale family farming , thus represents a rather small part of the total SNCR program.

Figure 15 Brazil – Development of subsidized loans to agriculture, 1999-2008 (in USD billion) PRONAF

Investment

Marketing

Working capital

40 35 30 25 20 15 10 5 0 1999

2000

2001

2002

2003

2004

2005

2006

2007(e)

2008(e)

Note: (e) = estimations Source: OECD (2011d).

[ 8] PRONAF itself includes several types of loans, for financing investments and for financing needs in working capital.

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A SAVOIR

Overall, short-term loans to the agricultural sector did not exceed 30% of the gross value of agricultural production. However, this figure was higher for cotton, coffee, wheat (more than 50%), and rice. Commercial financing rounds out these subsidized loans.

Figure 16 Brazil â&#x20AC;&#x201C; Subsidized loans for financing working capital in the agricultural sector, in relation to the value of agricultural production (average 2005-2007) Working capital credit

Loans for marketing

60% 50% 40% 30% 20% 10% 0% Total

Corn

Coffee

Rice

Cotton

Soybean Sugarcane

Dry beans

Manioc

Source: OECD (2011d).

Financing activity started up very quickly and reached approximately 1.6 million small farms in five years (1995 to 2000) and 2 million in 2006 (Roux, 2009). The scope of eligible holdings progressively enlarged.

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Table 6

Brazil – PRONAF loan disbursements, 1995 to 2000

Year

Contracts

Value in BRL million

1995

32,000 93

1996

333,000 650

1997

497,000 1,637

1998

710,000 1,815

1999

823,000 1,955

2000

1,600,000 4,240

Source: Ministry of Rural Development, quoted in OECD (2001).

Table

Brazil – PRONAF loan disbursements, 1995 to 2000, by type of loans Crop loans Number

Working capital loans Value (R$ 1,000)

Number

Value (R$ 1,000)

1999 672,426 1,246,159 131,610 586,223 2000

757,536 1,392,128 212,191 796,506

2001

723,754 1,444,733 186,712 708,617

2002

677,730 1,419,748 275,517 965,102

2003

860,730 2,364,895 277,382 1,442,003

Source: PRONAF, quoted in Abramovay and Piketty (2005).

The state bears the cost of the expensive interest rate subsidy programs Summary Overall, Brazil’s level of support to its agricultural sector has been small compared to other OECD countries. PRONAF, which targets small-scale family farming, is a costly program that has been able to achieve its objectives only thanks to an extensive network of rural labor unions and agricultural extension services, as well as a state-supported guarantee system.

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A SAVOIR

An OECD report in 2009 estimated that the level of state support to the agricultural sector, for all categories combined, represented approximately 5% of the gross value of sales from farms since 2000. This figure is small compared to the 26% average in the OECD countries. However, the government has frequently increased its support during crisis periods, such as in 2005-2006, when there was deterioration in climatic conditions and market prices. PRONAF, which targets small-scale family farming, is a costly program. Summary data on the cost of PRONAF to the Treasury are not available. From the beginning, there was controversy regarding the viability of the smallest farms. It has been pointed out that the loans granted to the smallest farms are practically equivalent to donations (because of the rebates granted for repayments on time), and that donations would have been easier and less costly to administer than loans. It has also been estimated that, in 1999 and 2000, two-thirds of the resources for PRONAF were used to cover the distribution costs of banks (Abramovay and Piketty, 2005). According to Abramovay and Piketty (ibid.), the distribution of loans to family farms has only been possible thanks to an extensive network of rural labor unions and agricultural extension services. The creation of a mutual guarantee fund so that distribution of subsidized loans could be offered by the bank sector is a point that had been recommended. But the government had to set up its own loan insurance systems, the biggest one being the Family Farming Insurance program ( Seguro da Agricultura Familiar â&#x20AC;&#x201C; SEAF) launched in 2004. This program guarantees 100% of loans obtained from PRONAF, as well as some of the estimated net incomes of the farm. As the premium income from this program does not cover the expenses, the state must pay for the deficit. Finally, the state had to pay for reorganizing a significant proportion of loans. In the middle of the 1990s, faced with an increase in the proportion of loans not reimbursed according to schedule, the Brazilian government adopted a program for rescheduling agricultural debt, with extensions of 20 to 24 years in repayment periods according to the type of borrower. In the beginning of the 2000s, new rescheduling measures extended the low-interest loan repayment periods for smallholder farmers and beneficiaries of the agrarian reform, and those who paid back their loans on time had part of their debt canceled or were granted reductions. The OECD estimated that, at the end of 2005, the total amount of non-reimbursed restructured debt amounted to BRL 17.3 billion (USD 9.6 billion at the average exchange rate of September 2008). This figure was nearly the value of subsidized loans disbursed for agriculture in the same year (WTO, 2009).

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Overall, we can thus consider that support for small-scale family farming received significant support, which was provided from the state budget and largely implemented in the form of subsidized loans.

1.3.3. Impacts on the agricultural sector and on the Brazilian bank sector Contrasting effects on the agricultural world Summary There are very contrasting opinions regarding the impact of loans with subsidized interest rates. For the loans reserved to family farming, the impact cannot be measured only in economic terms. Aversion to indebtedness is the major reason mentioned by farmers for not applying for bank loans. The complexity of procedures is also a significant obstacle. Medium-sized farms are the ones most often excluded from bank loans due to their past history. The portion of farmers with access to credit is quite small, but the vast majority of those who do have access obtain it from banks, whatever the size of their farm. With regard to PRONAF, while there is controversy over the impact of its loans to the poorest, it has clearly contributed to promoting the use of banks among the latter. Various authors have tried to evaluate the impact of loan subsidization, from various outlooks. Castro and Texeira (2005) attempted to quantify the economic impact of loan subsidization on the countryâ&#x20AC;&#x2122;s economy, but the results can be questioned because not all costs were taken into account. They measured the direct and indirect effects of these subsidies using income multipliers based on an input-output table for two types of farms (small family farms and large farms). They hypothesized a linear relationship between farm purchases and the value of their production, and they came to the conclusion that, for each monetary unit spent by the state to subsidize interest rates, Brazilâ&#x20AC;&#x2122;s gross domestic product (GDP) increased 1.75 currency units in the case of small family farms and 3.57 currency units in the case of large farms. However, the method they used does not take into account (i) the opportunity costs of the public resources used in the system to compensate participating banks, (ii) the costs of insuring loans, and (iii) the considerable cost of arrears. Some authors, including Valdes (2006) consider that it is the opening up of the Brazilian market to foreign investors during the second half of the 1990s that enabled the strong development of agriculture, by being able to link it up with international value chains, and that within the latter significant flows of credit to Brazilian producers

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A SAVOIR

were able to circulate and supplement the rather weak supply from banks. Indeed, we can observe that agricultural production and exports of agricultural and agri-food products truly took off in the early 2000s; this suggests that global demand was one of the causes, and that other solutions to limited financing had to be found.

Figure 17 Brazil â&#x20AC;&#x201C; Exports of agricultural and agri-food products, 1997 to 2005 Total agricultural products Unprocessed and semi-processed products

Processed products

40 35

Net exports (in USD billion)

30 25 20 15 10 5 0 1997

1998

1999

2000

2001

2002

2003

2004

2005

Source: Valdes, 2006.

We have seen that the subsidized loans targeting family farming are an instrument that is part of a broader policy accompanying agrarian reform, with an important political dimension. The loans distributed within the framework of PRONAF, the program to support small farms, covered the needs of households that were allocated land as well as those of many other small farms (more than 1 million farms were created through the agrarian form, between 1995 and 2006, and there were 2 million beneficiaries of PRONAF loans in 2006). To assess their impact accurately, it is important to know whether these smallholder farmers became effectively settled on their land, but this depends upon many other factors and leads us to the question of whether they had continued access to credit.

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Some skeptical authors point out that the participating banks naturally gave priority to farmers who were best integrated into the markets and who often had relationships with major agri-industrial companies, and that this meant that farmers in the southern states of Brazil were favored (Abramovay and Piketty, 2005). Finally, a WTO study in 2004 notes that, despite the free-market conditions in which they were allocated, the PRONAF funds were often under-utilized (only close to half of the PRONAF credit allocations were disbursed in 2000-2001). It would seem that this is due to the administrative complexity of the program and the fact that some family farmers were reluctant to become indebted, as they were not necessarily capable of working out technical projects. According to figures provided by the Brazilian authorities, between 1995 and 2003, only 37% of the amount and 21% of number of loans distributed were made for financing investments, indicating that PRONAF may not have contributed much to modernizing family farming. Results of surveys in the agricultural sector in 2006 show that fear of indebtedness and of “red tape” are the two greatest obstacles to financing farms through bank loans, whatever the size of the farm.

Table 8

Brazil – Reasons mentioned by farmers for not having applied for credit in 2006, by farm size Inadequate guarantees

Less than 10 ha

“Red tape”

Debt default on previous loans

Fear of incurring debts

10%

19%

7% 63%

10 ha to less than 100 ha

28%

12% 52%

100 ha to less than 1000 ha

36%

10% 47%

1,000 ha and over

46%

9% 39%

Sources: IBGE, Censo Agropecuârio, 2006.

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It is not surprising that very small farms of less than 10 ha encounter the most difficulty obtaining a loan, due to inadequate guarantees. However, it is interesting to note that it is the medium-sized farms (between 10 to less than 1000 ha) that experience rejection of their credit applications most frequently, due to their banking history. This shows, indirectly, that these farms benefited from loans the most easily in the past. Looking at land ownership status, we can see that access to credit for the category of farmers “settled without definitive land deeds” is most often refused because of unsatisfactory banking history, probably due to their having moved around more. Unsurprisingly, it is farmers who own their land who have the least problem providing guarantees to lenders. These points underline the importance of land ownership in the issue of agricultural credit.

Table 9

Brazil – Reasons mentioned by farmers for not having applied for credit in 2006, by land ownership status Inadequate guarantees

Owners

“Red tape”

Debt default on previous loans

24%

Fear of incurring debts

9% 59%

Settled without definitive land deeds

12%

32% 22% 34%

Tenant

11%

24%

5% 60%

Sharecropper

12%

20%

5% 63%

Occupant

14%

19%

7% 60%

Source: IBGE: Censo Agropecuârio 2006.

According to a study by Kessel in 2001, only one-fourth of farms had access to credit. Furthermore, despite the establishment in 2001 of a system to finance small-scale family farms, the first 10% of agricultural loans by private banks represented 80% of the volume of their credit to this sector. Likewise, at the Bank of Brazil, 73% of the volume of credit intended for agriculture went to 6% of the biggest customers. However, the results of the 2006 survey on agriculture show that banks (including public banks) are the foremost lenders to farms—including the smallest farms—that have access to credit.

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Table 10 Financing for farms with access to credit, by size of farm and type of lender, in 2006 Banks

Credit cooperatives

Less than

Other financial institutions

Sellers of inputs and other equipment

Companies in the value chain

NGOs

Parents and friends

Others

10 ha

90.1%

4.8%

1.0%

0.7%

1.9%

0.1% 0.8% 0.6%

10 ha to less than 100 ha

86.6%

8.2%

0.6%

1.4%

2.1% 0.1% 0.5% 0.5%

100 ha to less than 1000 ha

85.5%

8.2%

0.7%

3.3%

0.9%

1000 and over

80.4%

5.7%

1.2%

8.1%

2.8% 0.2% 0.8% 0.9%

0.1% 0.7% 0.7%

Source: IBGE: Censo AgropecuĂ˘rio, 2006.

As soon as PRONAF was launched, there was controversy about the viability of the smallest farms and their capacity to deal with indebtedness. The government nevertheless considered that the program would enable these farms to become part of the financial system. The above figures show that this was the case, even if financing came in most cases from public banks.

The subsidization programs above all had an impact on the public banking sector Summary Brazilâ&#x20AC;&#x2122;s agricultural financing policy, which was based on the compulsory granting of loans with subsidized interest rates and on public banks, did not encourage private banks to enter this market. The bank sector suffered significant loss of income from the government claims on the large amount of domestic savings to finance the agricultural sector via interest rate subsidies. With regard to the financing of family farming, the massive restructuring of loans granted to these farms, which again occurred in 2006 and 2007, discouraged commercial banks from investing in this market segment.

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It has been shown that public banks were and still remain the main providers of bank credit to the agricultural sector, even though non-bank private players have played a very important role since the liberalization of the economy in the 1990s. A 2011 survey sponsored by the Central Bank of Brazil (Lundberg, 2011) considers that the profit margins on loans with subsidized rates (not only for agriculture but also for housing and other government programs) are much lower than those made on loans in the open market, and that the result is a significant drop in average profit margins in the bank credit market.

Figure 18 Brazil â&#x20AC;&#x201C; Comparison of estimated bank profit margins for open-market credit and subsidized credit Open-market credit

Subsidized credit

Total

35 30

% per year

25 20 15 10 5 0 June 2000

December 2001

June 2003

December 2004

June 2006

December 2007

June 2009

December 2010

Source: Lundberg, 2011.

It is nonetheless important to recall that the bank margins in Brazil are especially high compared to those observed in similar economies. This is mainly due to banksâ&#x20AC;&#x2122; perception of the risk in the private sector and the degree of macroeconomic uncertainty. The hold that public structures have on the financing of family agriculture, along with the very strongly subsidized loans and partial write-offs of debts after crises, has created a situation that prevents easy entrance into this market for the private financial sector.

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1. xxxxxxx xxxxx xxxxxxx

1.3.4. Conclusion: little prospect of the private sector taking over the subsidized loan supply In its 2001 economic survey of Brazil, the OECD criticized the policy of loan subsidization, all the while stating that banks’ “ continued reluctance to lend would appear to stem fundamentally from weakness in the system of agricultural credit, rather than oversubsidization. ” This comment seems appropriate, at least with regard to very small family farms established on land confiscated following agrarian reform. It must be admitted that, in a fragile and unstable political and macroeconomic context, the state probably had no other choice than to set up financing programs with subsidized interest rates in order to continue its policy of land allocation to a significant fringe of society. Indeed, the objectives it was pursuing were above all political and social. In the case of big farms, which still dominate the Brazilian agricultural landscape in terms of surface area, the justification for the interest rate subsidy policy seems less grounded. This category has in fact highly benefited from the stabilization of the macroeconomic situation and the opening of the Brazilian market to foreign investors. The offer of subsidized interest rates to large farms must therefore be viewed as a form of subsidy to a sector of the economy that for many years had been an important provider of foreign currency, thereby supporting Brazil’s interventionist industrialization policy. The rural credit system represents a considerable government claim of national savings, and today the “price” to pay for the benefits Brazil has been able to gain from its policy of subsidized interest rates for agriculture is the state’s obligation to continue to provide such financing. Indeed, the bank sector alone cannot easily ensure such financing for small-scale family farming, whose accumulated debt arrears have had to be partially absorbed by the state. Even if it is clearly the banks that finance the majority of farms in Brazil, only a quite small portion of these farms receive loans. A legacy of Brazil’s interventionist economic policy is that public banks financed most agricultural credit for many years. Today, they continue to do so for small-scale family farming , using resources and a regulatory framework allowing the granting of loans with subsidized interest rates. Yet, the existence of a subsidized interest rate policy does not seem to have been the main cause for the lack of interest among private banks to work with the agricultural sector. On the contrary, the need to subsidize interest rates seems to be more the result of a state policy that was it self responsible for the reduced role that private banks played in financing agriculture. For very many years, macroeconomic unbalances

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(responsible for strong recurrent inflation and for crowding out the private sector via public debt) as well as the establishment of development banks as part of interventionist economic policies (for industrialization and import substitution), drove private bank institutions to take advantage of profit they could realize from inflation and to adopt other short-term strategies.

1.4. Summary and comparison of case studies Comparative analysis of the three case studies teaches us about the policies that have been implemented. It enables us to draw conclusions concerning their impacts and can provide valuable information to developing countries with economic and political situations similar to those experienced by the countries studied. Economic similarities can be found among the three countries. The share of the agricultural sector in the countryâ&#x20AC;&#x2122;s GDP as well as in employment drastically decreased in each country between the middle of the 20th century and the 2000s. The share of the agricultural sector in France and the United States decreased approximately sevenfold compared to the previous period. The share in Brazil decreased approximately fourfold.

Table 11 Trend in the share of the agricultural sector in GDP and employment, in France, the United States, and Brazil, between the middle of the 20th century and the 2000s France

Share of the agricultural sector in GDP

12%

USA 7%

Brazil 25%

Middle of the 20th century

1.8% 1.0% 5.3% 2000s

Share of the agricultural sector in employment

20% 16% 60% Middle of the 20th century

2.9% 2.0% 18% 2000s

Source: the authors.

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On the other hand, there were relatively specific situations in terms of composition of the agricultural sector: in France, the landscape was marked by small family farms, and the United States by agriculture with fragmented plots that became extensive during the 20 th century. The agricultural sectors in these two countries saw the size of their farms greatly increase throughout the 20 th century. In Brazil, there are simultaneously small family farms and huge commercial farms. All three cases share the experience of strong state intervention in the financial sector. France saw state support for emerging credit cooperatives and made Crédit Agricole the principal tool of its public policy to modernize agriculture. In Brazil, the agricultural support system relies mainly on public banks; the cooperative system is also encouraged, because it contributes, alongside microfinance, to improving access to financial services. The federal interventions in the United States illustrate strong state involvement in supporting the development of financing for the agricultural sector. The government sponsors the credit cooperative network FCS, and the public agency FSA directly distributes loans to non-bankable farms and provides guarantees enabling others access to bank credit. The three countries under study view agriculture as a government priority politically, economically, and socially, but each has their own specific objectives. France at first had the political objectives of providing support for its large rural population and of curbing rural exodus. It then turned to support for transforming the structure of family farms in order to encourage modernization. The United States and Brazil put priority on supporting disadvantaged segments of society or the poorest families, all the while encouraging the bank sector to meet the needs of bankable farms. This was done through regulatory requirements in Brazil and by a system of guarantees in the United States. The foremost agricultural objective of the United States was to guarantee the country’s food sovereignty and meet the food needs of its entire population. France and Brazil above all seek to maintain their ranking among the major exporters of agricultural products. All three countries have given agriculture a prominent role and have been attentive to its impact on their country’s economy. Brazil has relied on foreign currency earned through agricultural export to finance the country’s industrial development. By aiming to reduce per-person food expenses, the United States ultimately seeks to free up income for other expenditures and thereby increase economic growth.

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In the three economies under question, establishment of government systems to subsidize interest rates has taken on various forms, sometimes with specific loans (France and the United States offer emergency loans, disaster loans, and investment loans), increasingly precise targeting, and interest rate adjustments depending on the market situation (in all three countries, the level of interest rates of the loans granted is indexed on the cost of the resource and calculation of a margin). France and the United States have associated the subsidization of interest rates with a system of training and monitoring. This has been a key factor in the success of the development of farms provided with credit. Thanks to this training, the borrowers have improved the financial and accounting management of their farms. In Brazil, the rural credit system is associated with broader interventions in the rural world, in particular with regard to road infrastructures. The subsidization system has nonetheless turned out to be very expensive and difficult to control, both in terms of the volume of costs for government budgets (interests, management costs, and arrears costs) and of verifying that the subsidies are allocated properly, in accordance with government policy. In France, this system has especially been criticized because public funds have been partially used to benefit large-scale farms. In the United States, the cost of the system is the focus of much attention: the administrative costs (infrastructures and human resources) represent the main budget item of the expenditures of the FSAâ&#x20AC;&#x2122;s interest rate subsidy program. In Brazil, PRONAF has turned out to be very costly, despite a financing system based on levies on bank sector resources. Involvement by the private bank sector has been a goal in each country: Brazil has experienced more interventionism; France had a de facto monopoly situation until 1990, when agricultural credit was opened up to all banks; and the United States set up a loan guarantee system from the 1970s. In the United States and France, the bank sector was encouraged to become involved in agricultural credit in a context of competition; this was decisive in mobilizing sufficient resources and in improving the management of agricultural loans. In all three countries, the subsidization policy has been continued over the long term, and this stability is a decisive factor behind its impact. In France, long-term continuity was necessary to enable real in-depth change, ranging from the implementation of new modes of production on existing farms to support for the start-up of young farmers in conditions guaranteeing modern production.

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These case studies do not really provide us with proof of a negative or positive impact on the development of the agricultural sector by interest rate subsidization, as the effects of this latter are closely related to the capacities and objectives of the bodies that distribute subsidized credit. Furthermore, these effects are inseparable from the effects of other measures for support to agriculture and agricultural financing carried out over the same period. Finally, the analyses found in literature on the topic often do not or hardly take into account the degree to which the financial sector—as well as of the agricultural sector—are structured. Nevertheless, the subsidization of interest rates, among other measures, has contributed to the modernization and intensification of agriculture in France, the United States, and Brazil. The subsidization of exit interest rates to benefit the agricultural sector has been an important factor in the development of the agricultural finance market, which has often been hindered by cost structures for both supply and demand, making it difficult to provide a credit supply both affordable for small-scale farmers and profitable enough for the lenders. The subsidization of interest rates has definitely played a role in the spread of bank use in the countryside, in all three economies studied; however, this has sometimes led to insufficiently controlled indebtedness for some farms. The programs set up have sometimes promoted large-scale farms to the detriment of small family farms, either because this met an objective of transforming subsistence agriculture into commercial agriculture, or due to lack of control of the effective utilization of subsidized rates, which have sometimes been partially absorbed by the most influential holdings. The impact on the bank sector is very visible, but in different ways depending on the countries studied. France has been marked by the creation of Crédit Agricole, the centerpiece tool of subsidization, which “reconciled” the bank sector with small-scale agriculture, and which started as an administrative cooperative system enjoying a monopoly on subsidies but went on to become one of the major universal French banks. In the United States, government intervention via the FSA was able to provide continuity in agricultural credit during crisis periods and respond directly to the needs of non-profitable farms. This way, it enabled the private commercial sector to develop at the same time. In Brazil, on the other hand, the regulatory constraints of the agricultural credit program made the system too unprofitable for private commercial banks, with the result that the distribution of subsidized loans became a near exclusivity of public banks.

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A SAVOIR

The case studies of France, the United States, and Brazil do not allow us to conclude that the strong agricultural development observed in these three countries was partially due to subsidization programs. However, these studies can be useful for developing countries wanting to use the subsidization tool, as they indicate which points worked well and suggest how to develop an effective system. Among others, we can mention the points below. • Subsidization of interest rates must not be an isolated measure. It must be part of a coherent public system providing long-term support to agriculture and implemented along with other actions in order to have decisive impact on agricultural development: monitoring and training of farmers, targeted subsidies, sectoral stabilization funds, and research and education. • Through the long-term monitoring that credit involves, a subsidization program is a good support instrument for a monitoring and on-site training system for farmers. This enables increase in the effectiveness of the subsidized credit as the farm develops. • This supervision also helps avoid serious situations. At certain times in the past, the ease of allocating credit has led the systems to grant loans to farms that were not equipped for this burden, sometimes putting small and already fragile farms into long-term debt. • For this reason in particular, regular assessments of interest rate subsidization systems are essential, in order to adapt and adjust the system as soon as necessary. This makes it possible to avoid generating unwanted situations as well as to ensure better effectiveness of the subsidization program. • Impact from a subsidized loan system on agricultural development seems to require implementation over the long term. • In each case studied, the subsidization programs have been a heavy cost for government budgets, if we consider the costs of interest subsidization, the program of monitoring and training farmers, the loan losses, and the system to audit how the subsidy was used. • To prevent the subsidization process from crowding out the private financial sector from agricultural credit, it must be designed so as to complement the private-sector supply and support its development.

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â&#x20AC;˘ When a country chooses to subsidize interest rates, an audit system is needed to check that the loans and aid granted are used properly and in accordance with the targets that have been defined. To avoid the risk of non-application of this audit system, the supervision and audit processes and methodologies must not be complex or expensive.

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2. Review of donor policy on subsidized credit interventions A study of the strategic and operational reference documents of the World Bank, IFAD, KfW, and USAID, as well as several targeted interviews, were carried out to analyze the trends in donor intervention policy regarding subsidized credit.

2.1. History, strategy, and forms of donor intervention International donors organize their actions to develop the rural financial sector according to three levels: macro (governmental policy, legal and regulatory framework, supervision), meso (infrastructures for the financial sector and real sectors), and micro (support for financial institutions). Each donor has a history, objectives, and strategic intervention policies that affect the form and content of its interventions.

There has been internal debate at the World Bank on subsidized credit lines and on whether intervention should follow strictly free-market rules Summary The World Bank supports agricultural development as part of a more overall policy of poverty reduction and food security. Targeted and subsidized agricultural credits were an important component of its agricultural support, and these became a subject of controversy from the 1970s. Like many international donors, the World Bank shifted in the 1990s from the former to the new paradigm of development financing. But this shift was the topic of much discussion. The lack of strategic documents focusing on specifically agricultural finance illustrates its limited influence on the World Bankâ&#x20AC;&#x2122;s development policy. The World Bank may offer, under very stringent conditions, credit lines to financial intermediaries. But these credit lines are in no way subsidized, and direct grants are often preferred. Nevertheless, the World Bankâ&#x20AC;&#x2122;s interest rates are purposely positioned in the lower range of the market.

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The World Bank supports the development of the agricultural sector as part of its overall policy of poverty reduction and food security. Targeted and subsidized agricultural credits are an important historical component of its support to the agricultural sector. This model of agricultural credit began to be criticized in the 1970s. The World Bank’s agricultural credit policy, published in 1975, opposed interest rate subsidies, except in exceptional circumstances in which the beneficial effects of the subsidy could be guaranteed. The volumes of credit lines corresponding to targeted and subsidized agricultural loans nonetheless increased significantly during this period. It was at the end of the 1980s that these programs began a decline, which continued in the 1990s with the closure or rapid suspension of all agricultural credit projects coming within the framework of the former paradigm. In the beginning of the 1990s, internal discussions on subsidized credit took place within the World Bank. The 1993 publication of the Operations Evaluations Department’s report A Review of Bank Lending for Agricultural Credit and Rural Finance (1948-1992), attracted considerable attention, as it on the one hand acknowledged the limits of subsidized credit lines for developing the financial sector, but on the other also pointed out the merits of this type of support in terms of development of the agricultural sector, the many perverse effects wrongly attributed to subsidization, and the need not to terminate this type of financing abruptly. As part of the widespread shift by international donors to the “new paradigm,” the World Bank then replaced operations based on granting agricultural credit with a more overall rural financing approach that sought to provide capacity building for financial institutions in order to facilitate their operations in rural areas. The lack of strategic documents focusing specifically on agricultural finance illustrates its limited influence on the World Bank’s development policy. In the last decade, the World Bank has launched few interventions specifically for agricultural finance support. In the beginning of the 2000s, agricultural financing was even considered to have little prospect for developing on a viable economic model, and it is only recently that the World Bank has re-included a full-fledged agricultural finance section in its policy for rural finance support. The current World Bank strategy for the development of rural finance is based on three levels: micro, meso, and macro. In the World Bank’s micro-level interventions, the granting of credit lines to financial intermediaries is possible, but very restricted, so as not to disturb the functioning of the financial market. For example, the interest rates offered to these financial

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intermediaries are not subsidized, the credit lines must be accessible to all the institutions of the intervention zone being considered, and the financial institutions must meet certain criteria established by specific guidelines. In 2009, for example, the World Bank formed AgriFin, an agricultural finance support fund financed by the Bill and Melinda Gates Foundation. It strives to show that financial services to smallholder farmers and other rural businesses can be profitable for financial institutions, and the fund provides these latter with direct grants to reinforce their technical capacities. Another example is the matching grant facility, which offers grants to smallholder farmers, via agricultural organizations, to further equipment purchases. These grants are systematically accompanied by a training offer prior to the financing, and the amount of the grant cannot exceed half of the amount of the assets purchased. The other half is financed by the market, via credit granted by a financial intermediary. While World Bank policy is not to subsidize interest rates, it nonetheless has leeway in setting its interest rates. This possibility enables it to offer financial intermediaries and governments interest rates positioned in the lower range of rates effectively offered by the markets in which it intervenes, especially so that the cost of World Bank resources remains comparable to those of the resources offered by other international donors to these same parties.

Subsidized credit lines are no longer offered by the International Fund for Agricultural Development Summary The granting of subsidized credit was IFADâ&#x20AC;&#x2122;s traditional form of action to support agricultural development, but it has been gradually replaced by other forms of action. IFAD actions to support inclusive rural financial systems focus mainly on the micro level and, to a lesser extent, on the meso level. Macro-level actions are rarer and are nearly always carried out in partnership with players that have extensive experience in this type of intervention. IFADâ&#x20AC;&#x2122;s policy is to encourage its agents to determine its support to agricultural financing according to an analysis of demand established specifically for each action. The two types of tools available are credit lines and direct grants. IFAD policy discourages credit lines, the granting of which is subject to many conditions. Equity investment and financing in the form of direct grants are presented as more suitable forms of intervention, but their use is subject to certain changes in IFAD policy.

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IFAD’s purpose is to finance development projects, specifically in rural areas. Development of agriculture and agricultural finance are thus the core activities of this institution. Its strategy for support to agricultural financing has been studied from several documents and interviews. IFAD’s Rural Finance Policy (RFP) document (2000), updated in 2009 (IFAD, 2009), following an evaluation in 2007 (IFAD, 2007), describes its policy in detail. IFAD’s 2010 document specifies the recommended approach for implementing its rural finance policy point by point. The review by Meyer (2011) is the fruit of an initiative by partners of the “Improving Capacity Building in Rural Finance” (CABFIN) project, of which IFAD is a member. This review states that, despite its status as a review, its objective is to act as a practical guide for all the CABFIN members and to be used in addition to current guides. Finally, three technical notes in the process of being finalized deal with credit lines, matching grants, and guarantee funds respectively. Interviews with Michael Hamp, Senior Advisor in Rural Finance, and Benoît Thierry, Country Program Manager for Nepal and Thailand, made it possible to fine-tune several points. IFAD’s traditional form of intervention to support agricultural development is the granting of subsidized credit lines, even though these have been gradually replaced by other forms of intervention. Interventions at the micro level represent IFAD’s core action, with around 80% of support for the development of rural financial systems positioned at this level. The meso level is developing more and more, but intervention at this level, without a partner, is not part of the core strategy of IFAD. This is especially due to the time spans of this type of intervention, which are too long. Finally, macro-level interventions are rarer and are carried out nearly exclusively with partners that have extensive experience with this type of intervention. IFAD emphasizes that the skills and timeframe required for this type of intervention do not correspond to its basic purpose. Because of budget limitations, IFAD is seeking to achieve improvements in effectiveness for the 2013-2015 period. A new more pragmatic approach could consist in carrying out fewer projects but at a greater scale. This strategy would make it possible to develop more large-scale projects that target the development of rural finance (rather than projects in which rural finance is considered as a small component) and that deal with the three levels of support (micro, meso, macro). IFAD gives priority to a bottom-up approach in determining its interventions. The choice of the form of intervention is thus closely associated with an analysis of the finance request; this makes it possible to identify suitable support aspects to develop

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a finance offer adapted to it. IFAD interventions to support an agricultural finance offer can take the form of credit lines or direct grants. These latter can be global and work on developing support that can benefit several countries. They can also be associated with a specific line of credit for a given country, for example to encourage the government to invest in finance projects that show promise but that are not priorities for the government. These grants generally represent a small share of the total amount of support. Finally these direct grants can also be distributed as part of matching grants to finance specific productive investments. The beneficiaries contribute to a significant share of such investments, by providing funds or assets and, in some cases, by taking out a loan from a financial intermediary. IFAD’s current policy is not very favorable to credit-line interventions, including for non-subsidized credit lines. When IFAD grants credit lines to financial intermediaries working in retail or wholesale markets, they are subject to many very precise conditions (e.g., lack of liquidity in the market, management of the credit lines by private actors and not government institutions, transparent reporting , adequate supervision, etc.). Even though equity investments are not part of the range of tools available to IFAD, the credit lines can be used by the beneficiary governments, sometimes via specialized intermediaries, to acquire equity investments in financial institutions working in rural financial markets. With an aim to developing equity investment, IFAD’s 2009 Rural Finance Policy suggests working “directly with rural finance institutions and the private sector. ” The 2009 RFP thus sets equity investment against credit lines, insofar as the former stimulate rather than curb the mobilization of alternative financial resources. Furthermore the RFP recommends increasing direct grants allocated to rural finance.

KfW’s approach focuses solely on the financial sector, with priority on agricultural development Summary KfW is in charge of implementing finance development as part of the policy defined by Germany’s Federal Ministry for Economic Cooperation and Development (BMZ). Support for rural development, and especially development of sustainable agriculture to improve food security, has been defined as one of the priorities of the Ministry. Germany was one of the first countries to adopt a systemic approach to define its strategy for developing the financial sector, following the change in the development financing paradigm. Agricultural financing is dealt with via the development of the financial sector for now, but it has been decided recently that a more specific approach is required. As at other institutions, agronomists and financial experts do

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not view agricultural financing as having the same objectives. This leads to internal debates, especially regarding the limitation of resources for interventions imposed by the new rural finance paradigm. KfW is very active in supporting financial institutions as a shareholder, lender, or funder of technical assistance. Support for the development of agricultural financing is done by giving priority to this sector within the overall approaches to financial sector development. In practice, some interventions combine subsidies and credits to the end beneficiary for financing investments, in particular by taking into account local practices. KfW is in charge of implementing German finance cooperation, as part of policy defined by the BMZ. The Ministry’s strategy in support to rural development is laid out in an overall strategy document published in 2011. A specific strategic document is currently being drafted on the promotion of sustainable agriculture to contribute to food security ( Entwicklungspolitisches Konzept zur Forderung einer nachhaltigen Landwirtschaft als Beitrag zur Ernahrungssicherung). These documents do not specifically deal with the question of financing and simply mention savings and investment among the important tools for implementing rural development policy. Since the 2008 food crisis, support to rural development, and especially development of sustainable agriculture, has been defined as one of the priorities of German development cooperation policy, with the goal of improving food security. The case study of KfW’s strategy is based on a literature review and on two interviews. The source documents are the memorandum on BMZ sectoral policy on the development of the financial system (BMZ, 2004), the BMZ strategic memorandum on food security (BMZ, 2011), the overall policy document on agricultural finance in Africa (GIZ et al., 2012), the report by the KfW evaluation unit for 2009-2010 (KfW, 2011), and the financial cooperation procedures (KfW, 2003). We were also provided with four ex-post evaluations in the field of agricultural finance, concerning Accessbank in Azerbaijan (KfW Evaluation Department, 2009 a ), the Dakahliya rural finance program (KfW Evaluation Department, 2009 b ), UNCACEM in Mauritania (KfW Evaluation Department, 2007), and the BNA in Tunisia (KfW Evaluation Department, 2005). Interviews were carried out with Claudia Schmerler, Senior Financial Sector Economist in charge of agricultural financing within KfW’s Financial Sector Development division, and Christoph Kessler, head of KfW’s Agricultural and Natural Resources division.

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Germany was one of the first countries to adopt a systemic approach to define its strategy for finance sector development, this within the framework of the change in the finance development paradigm: in 1993-1994 it produced its first financial sector strategy document, with a cross-cutting strategy applicable to all sectors of the economy (BMZ, 1994). Currently, agricultural financing is dealt with in an overall strategy document concerning financial sector development (BMZ, 2004). A new strategy document dealing with agricultural finance is currently being drafted; this shows that a specific approach has been judged necessary. The German Economic Cooperation and Development Ministry also refers to documents produced by international consultation groups, in particular through the “Making Finance Work for Africa” project. Within KfW, agronomists and financial experts do not view agricultural financing as having the same objectives. This leads to internal debates, especially regarding the limitation of resources for interventions imposed by the new rural finance paradigm. Agronomists above all seek to have instruments with which they can finance agricultural development actions. They measure the impact and sustainability of actions at the level of agricultural value chains and consider the financial institutions as means to achieve their objective. Financial experts are concerned with the sustainability of access to finance, and thus of the financial system. It is thus within the framework of approaches adopted to enlarge and develop the financial system that German development cooperation supports the development of agricultural financing. KfW is very active in supporting financial institutions. It may act as shareholder, lender (with very concessional terms, depending on the case), or provide the funding for technical assistance. It can do so by using existing financial institutions, or by creating them. Loans to financial institutions for financing agricultural investment are long-term loans, preferably in local currency, when its intervention conditions enable it to do so. For enlarging and developing the financial system, the Ministry supports different types of approaches: “Upgrading” (the professionalization and institutionalization of NGOs), “Downscaling” (setting up an SME-oriented activity at commercial banks); “Greenfield” (creation of new financial institutions), and “Linkage” (establishing contact between pre-existing banks and solidarity groups). Support for the development of agricultural financing is done by giving priority to this sector within the overall approaches to financial sector development. Whatever its position in the partnership, KfW supports its partners’ strategy and tries to influence it so that it is oriented toward development of rural areas when it makes sense for the institution. This may involve actions in the institution’s business plan,

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if KfW is a shareholder, or technical assistance to develop specific agricultural credit financial products. More specifically concerning “the target group of rural clients,” the Ministry considers that “ to achieve sufficient reach, it will be necessary to adjust the financial instruments or develop new ones to meet the special conditions of rural areas and agricultural finance. These instruments would above all include improvements to risk management and the introduction and use of modern guarantee mechanisms, as well as the deployment of inexpensive agencies (e.g. mobile windows) close to customers, in order to reduce transaction costs ” (BMZ, 2004). In terms of support to rural finance, KfW is also an investor in the Rural Impulse Fund, which gives preference to microfinance institutions oriented toward rural finance. This support takes place through commercial credit lines granted to viable microfinance institutions. The Ministry adopts a pragmatic approach on some aspects, different from freemarket positions. For example, it advises continued support to public development banks that operate correctly. The Ministry has financed many development banks and has seen very mixed results, with many negative ex-post evaluations of this type of intervention. But it maintains a pragmatic position, written down in its strategy documents, which observes that “ some public development banks, mostly in Asia, have started up considerable reforms in recent years. These financial institutions play a special role in providing financial services to rural populations and to regional and local authorities, where purely private commercial sector approaches continue to fail frequently ” (BMZ, 2004). Based on this, it advocates the adoption of an open approach to financing assistance to the public and private bank sectors, based on the actions and governance of the institutions. In practice, some interventions combine subsidies and credits to the end beneficiary for financing investments, in particular by taking into account local practices. In Kenya, for example, KfW is conducting a small-scale irrigation project in an area with strong agricultural potential, whose production will go to export markets and Nairobi. As part of this project, KfW is providing a credit line to the Kenyan government, with very concessional loan conditions defined by the International Development Association (IDA), which on-lends it on concessional terms to two private banks recruited through a bid for tender. These private banks then distribute it to smallholder farmers in the form of crop credits and investment credits, on commercial terms. The investment credits enjoy a subsidy of 50%, also released by the bank. The subsidy portion, which is high in this context of profitable commercial agriculture, was set because there are projects offering high levels of grants in the same zone

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(African Development Bank – AfDB and IFAD). The Agriculture and Natural Resources Division considers that, for agricultural investments whose aim is to change mode of production, there can in some cases be situations requiring financing with subsidies.

USAID uses partial portfolio guarantees to back up intervention in the agricultural sector to fight sustainably against hunger Summary The overall mission of USAID is to help countries recover from disasters, lift themselves out of poverty, and start up democratic reforms. Development of the agricultural sector, especially through access to the USAID financing component, is thereby part of this mission. Like numerous international donors, USAID financed, mainly in the 1960s and 1970s, many agricultural credit programs whose performances were controversial. USAID increased its involvement following the G20 Summit of 2009, during which President Obama asked Congress to double its agricultural development effort in order to fight sustainably against hunger, and proposed USAID to lead the effort. USAID interventions in agricultural development are structured around four major themes that seek to increase agricultural productivity and improve access to markets for producers. The development of agricultural finance is not a strategic theme in itself, but it contributes to several of these themes. The three forms of intervention used by USAID to support agricultural finance are: portfolio guarantees, financing technical assistance specific to financial intermediaries, and financing technical assistance to reinforce the demand for financial products. The objective of the portfolio guarantee is to induce banks to start up agricultural finance activities that they judge risky, by sharing the risk with them. There are no exit interest rate conditions attached, and impact on these rates is not an objective. Our study of USAID strategy is based chiefly on a literature review and an interview with a USAID representative. The three main source documents are the USAID Agricultural Strategy (USAID, 2004), its Policy Framework 2011-2015 (USAID, 2011 a ), and the impact brief of USAID’s Development Credit Authority (DCA) (USAID, 2011b). The interview was carried out with Mr. Kofi Boakye, in charge of East and Southern Africa at DCA. USAID financed many agricultural credit projects between 1950 and 1985. These projects sought to accelerate adoption of new technologies on small farms. The objective was to help the development of smallholder farmers by making up for their lack of capital and by reducing their reluctance to take risks, thanks to subsidized

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rates. USAID would provide credit lines to a country’s central bank or agricultural development bank, which were then redistributed by financial intermediaries at the local level, to targeted populations and for specific purposes (improved seeds, fertilizers, pesticides, equipment, etc.). The projects financed turned out to have mediocre or poor performance. From 1973, the year it launched an extensive evaluation of its agricultural credit programs, USAID sought to learn lessons from its experience, and it changed policy direction. Nearly two decades later, during the G20 Summit and under the impulse of President Obama, USAID saw its role and involvement in support for global agricultural development increase. Though not specialized in rural finance development, USAID does work in this area through several of its areas of agricultural development support, with the goal of increasing farmers’ productivity and their market access. There are four areas of intervention: promoting producers’ opportunities and capacities to market their products; improving the social, economic, and environmental viability of agriculture; mobilizing science and technologies to reinforce innovation capacities; and, finally reinforcing education, agricultural training, and research. USAID has two ways of working with financial institutions: through partial portfolio guarantees for financial institutions involved in financing agriculture and through technical assistance to some financial institutions that benefit from its guarantees. The main objective of the portfolio guarantee is to induce banks to start up financing agricultural finance activities that they judge risky, by sharing the risk with them. There are no exit interest rate conditions attached, and impact on these rates is not an objective. The guarantee moreover includes a contractual clause stating that the financial institution cannot benefit from this guarantee if it receives a subsidized credit loan for the same portfolio. In theory, the DCA, which manages the partial portfolio guarantees, can grant credit lines. [ 9 ] However, it rarely uses this tool, which requires development-bank skills and an adequate portfolio-monitoring organization. Nonetheless, our interviews indicate that it is not impossible that USAID develops this tool in the future.

[9] The 1998 Appropriation Act, adopted by Congress in October of that year, enables USAID to grant loans and guarantees for all projects consistent with the development objectives defined in the Foreign Assistance Act.

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Finally, USAID also intervenes indirectly to support the supply side (financial institutions), as it carries out demand-oriented actions by proposing technical assistance to producers and their organizations. This “access to finance”-oriented intervention may include training actions for the demand side and actions to create favorable conditions for the development of rural finance (markets, technical know-how, quality of seeds and inputs, etc).

2.2. Donor positions on subsidized credit lines Summary Donors do share some positions on certain aspects of subsidized credit lines. However, whereas the World Bank and KfW are strongly opposed to subsidized credit, IFAD—without being favorable to it—tolerates it in certain special circumstances and under specific conditions, and USAID, which in principle is opposed to any form of subsidization, does not credit it with the negative effects that the others do.

The World Bank is strongly opposed to subsidization at all levels Following heavy criticism of its past agricultural credit subsidization practices, the World Bank is today strongly opposed to subsidized credit, be it credit proposed to the end client or credit lines for financial intermediaries. It considers that interest rate subsidization does not always reach its target, and that the instrument is sometimes misappropriated to benefit the most influential stakeholders. They furthermore postulate that the funds are not always used, as the market is lacking in demand and in competent intermediaries to distribute them. Subsidized credits can also represent an unjustified advantage for the financial intermediaries that lend them, to the detriment of the development of the retail market (representing in particular an obstacle to other institutions entering the finance market). Finally, the World Bank views that there is broad impact from market distortions, which also affect agricultural markets and value chains (overuse of fertilizer, for example). The World Bank’s strong opposition to interest rate subsidies applies not only to the agricultural sector, but also other activities, and this for the same reasons (misappropriation of funds by the powerful, market distortions preventing new players from entering the market, etc.).

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IFAD is opposed to subsidization of exit interest rates to end beneficiaries, but leaves its operational teams leeway to propose it when the situation requires The following statements from the IFAD Decision Tools for Rural Finance (IFAD, 2010), act as a good introduction to the institution’s current position regarding subsidization: “Financial services that focus on on-farm activities and agricultural businesses, without necessarily targeting poor people. Fresh thinking has identified some of the key features of successful agricultural microfinance, replacing the heavily subsidized, unsustainable and unsuccessful approaches of the past. ” Even though IFAD looks down upon credit lines, its position is less rigid than that of the World Bank. With regard to loans granted to financial intermediaries active in the retail financial markets, IFAD indicates that subsidization is not desirable but can be tolerated and remains conceivable under certain conditions. The choice of subsidizing a credit line or not depends on the specific characteristics of each project. In certain cases, the subsidization can be defined via an established formula according to market rates. However, this approach is not systematic. On the other hand, IFAD has a much stricter position on the subsidization of exit interest rates offered to end beneficiaries. Their 2009 rural finance policy recommends “ not [to] subsidize interest rates at client level or support the establishment of interest rate caps or other mechanisms that distort markets. ” IFAD is opposed to the use of credit lines and, in particular, the subsidization of these lines. This is partially from the poor historical results of credit programs for agriculture, be they credits guaranteed by states and lent directly to farmers, or lines of credit granted to agricultural development banks. IFAD also notes that, in the past, the drop in repayment rates endangered some programs because of the size of losses generated. It nonetheless recognizes that these programs took place in a context in which the regulation and supervision of financial institutions was unsuitable, and the culture of easy money very widespread. While the programs seem to have had limited impact due to their difficulties, the grants nevertheless seem to have distorted rural financial markets (IFAD, 2000). Some of the justifications of this policy unfavorable to credit lines and subsidization of interest rates are in common with those of the World Bank. In terms of market distortions and of putting into question the sustainability of the supply, IFAD considers that exit interest rates that are subsidized—and thus too low—act as a barrier to market entry and risk discouraging some lenders from working in the zones concerned. Furthermore, subsidized interest rates do not encourage financial institutions to collect savings or to look for other kinds of financing, thereby affecting the viability of these financial institutions. Finally, subsidization can put into question the sustainability of the supply, insofar as these rates may prevent lenders from recovering all of their costs.

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With regard to demand, IFAD, like the World Bank, views that subsidized rates can have perverse effects, as they may attract persons with influence who misappropriate the funds. It also believes that subsidization affects the culture of repayment because of the “gift effect.” Finally, its decision tools (IFAD, 2010) state that subsidization of interest rates undermines interventions by donors that do not subsidize their rates in the beneficiary zones, and are thus likely to reduce the amount of total aid they offer in a given zone. However, according to the IFAD personnel interviewed, gaps between IFAD policy and practical implementation in the field may exist. Definition of the characteristics of projects is in fact the responsibility of the operational teams. The IFAD policies guide the teams, without necessarily restricting them. The teams in charge of defining IFAD policy play a consultative role in project validation. This way, some projects may include—subject to approval by the decision-making bodies—a subsidization component including at the end-client level, even though these practices are not always in accordance with IFAD’s policy.

KfW is opposed to interest rate subsidies, in line with the Kampala principles Among the donors reviewed, it is perhaps KfW that most strongly shares the World Bank’s opposition to subsidization, especially since the adoption of the formalized financial system approach in 1994. The German Economic Cooperation and Development Ministry considers the following, in its overall approach to the financial sector: “ Interest rates other than market interest rates benefit customers who already have access to credit. Many poverty-reduction projects in developing countries have shown that borrowers are capable of paying positive real interest rates at market conditions. In the financial system approaches by BMZ, interest rates should be in line with the market ” (BMZ, 1994). This applies outside of specific international agreements, such as that for environmental loans to the Global Environment Facility (GEF). KfW acknowledges that the market rates are not always easy to determine, especially when there is no market. In this case, reference rates are defined for discussion, with the goal of covering costs. The work carried out as part of the “Making Finance Work for Africa” (MFW4A) project of the German development cooperation agency ( Deutsche Gesellschaft fur Internationale Zusammenarbeit – GIZ) strengthens this position opposed to interest rate subsidies. GIZ has adopted the Kampala principles set out following the Kampala Conference of June 2011, which insists on the need to enable the stakeholders in charge of loan distribution to have access to forms of long-term financing. The overall

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policy document on agricultural finance in Africa, which is the practical policy of these principles, nevertheless recommends, when implementing “smart subsidies,” avoiding subsidies for inputs, for interest rates for clients, and for production. Generally speaking, KfW does not directly subsidize end users. If small-scale producers do not have access to credit, subsidies can nonetheless be considered within a different framework, in subsistence programs or in transition phases (subsidies for activity startup, direct advice, etc.). “ In the longer term, these ensure that poor sections of the population also become eligible as bankable clients, able to pay cost-effective interest and the charges. ” (BMZ, 2004). German development cooperation thus identifies the need to be flexible in some cases with regard to the rule of not subsidizing end beneficiaries, this with the goal of enabling these populations to become bankable. This flexibility concerns subsidies for supervision, but not the subsidization of interest rates.

USAID: a flexible position, related to the inexistence of finance markets for small farms in most developing countries, which cancels out the risk of market distortion Contrary to other donors, none of the literature reviewed seems to clearly specify the official stance of USAID on interest rate subsidies. USAID is by principle opposed to any form of interest rate subsidies at any level. And there seems to be no internal debate currently on the appropriateness of using this tool, namely because USAID does not grant credit lines in the field of agricultural financing. According to our interviews, if the DCA were to initiate credit lines to financial institutions in the future, it would probably do so at a rate lower than those of the market, thanks to its privileged access to US Treasury resources, but without subsidization at the end-client level. USAID’s outlook with regard to possible perverse effects and market distortions due to interest rate subsidies is a bit different from that of the other donors. Its view is that the subsidization programs set up by other donors, be it at the financial institution level or the end-borrower level, do not necessarily have perverse effects in distorting competition, since most developing countries do not have a market for financing small farms. Generally speaking, few financial institutions exist in these markets, and farmers would not be able to afford their rates anyway.

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Conclusion Along with the change in paradigm in rural finance, all the donors interviewed have witnessed in-depth change in how they intervene in agricultural financing. The operational teams involved in rural development encounter difficulties in setting up financing for agricultural development actions due to the constraints imposed by the new paradigm. This leads to debate between the “agronomists” and the “financial experts.”

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3. Analysis of arguments for and against the use of subsidization 3.1. Introduction Summary Assessing the effects of interest rate subsidies comes up against the problem of clearly determining the relationship between the effects observed and the specific causes. The effects of subsidization are in fact very much related to the capacities and objectives of the institutions that distribute subsidized credit. They are moreover inseparable from the effects of other measures to support agriculture and agricultural funding carried out over the same period. Furthermore, the level of structuring of the financial sector is, like the agricultural sector, often not sufficiently taken into account in the analysis. Literature on the topic, which is rather opposed to subsidization, regularly mentions situations referring to subsidized credit programs of the 1970s and 1980s that were part of the former paradigm. In these programs, subsidized credit rates were often set up directly within the framework of development programs, without going through financial institutions. These programs lacked competence in loan management, and their objectives were defined in terms of impact on agriculture and not in terms of quality of credit. More often than not, the outcome of credit repayment was poor. When the loans were issued by financial institutions, it was chiefly by public agricultural credit banks. Many of these were faced with political interference and thus had limited management capacity and autonomy. Furthermore, interest rate subsidies were sometimes combined with policies that sought to force the granting of loans (for example, in the United States). The result of this was rapid deterioration in repayment and, ultimately, significant losses.

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Because of the shift from the former to the new paradigm in the 1990s, recent literature is more often than not opposed to subsidization. The documents supporting it highlight the positive impacts observed in terms of agricultural development in a certain number of projects. They dismiss certain perverse effects falsely attributed to subsidization but do not take a position with regard to the effects on the development of financial markets that serve the agricultural sector or on the sustainability of the financial offer associated with subsidization. Furthermore, financial market liberalization in the developing countries and termination of the majority of interest rate subsidy programs that were part of the former paradigm did not lead to the positive effects that had been expected. Further, the perverse effects that some people had attributed to subsidization still remained. Therefore, as mentioned by the FAO document on the subsidization of interest rates in rural areas (FAO, 1994), the impact of other economic policies was probably stronger than that of modification. For example, the treasury policies set up by states with strong liquidity needs had an impact on banks, wherein the latter preferred either to invest in treasury bonds with very lucrative interest rates rather than lend to the agricultural sector, or on the contrary to compensate the low level of interest paid on compulsory reserves (that regulations set at a high level) by very high interest rates in their activities to finance the economy, including the agricultural sector. The several studies that have carried out a cost-benefit comparison of subsidization programs have put forward an incorrect analysis of how to attribute the effects of the different measures implemented. The estimated effects are thereby attributed by default to subsidization, even though other measures could have contributed to generating the impacts analyzed.

3.2. Presentation of the pros and cons The pros and cons regarding interest rate subsidies that we have identified can be divided into two categories. Some concern the interest rate subsidy tool in general, and others are specific to agricultural sector financing. In all, seven major categories of issues emerge: 1. How the markets work: pros and cons related to the forces of the credit market and impact on the agricultural market, both from theoretical and practical points of view. 2. Sustainability: pros and cons related to whether or not subsidized interest rates have the ability to develop a sustainable supply of credit to the agricultural sector.

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3. Reach: pros and cons related to the customer target reached and its size. 4. Cost: pros and cons related to the cost of interest rate subsidy programs. 5. Beneficiaries’ capacities: pros and cons related to the impact of interest rate subsidy programs on the behavior of beneficiaries and their judgment capacity. 6. State involvement: pros and cons related to public policies and state intervention. 7. Donors: pros and cons dealing with the methods of donor intervention, with subsidized credit for the end beneficiary being one of the support tools. In each category, there are both pros and cons for subsidization, but in most cases they must be put into perspective.

Frequent confusion In the literature on interest rate subsidies for the end borrower, interest rate subsidies are often confused with caps on exit interest rates; this consists in financial intermediaries in the retail market setting a rate lower than market rates, thanks to a form of external subsidy provided to that intermediary. The level of subsidization of interest rates can be set in consultation with the donor or the government and result in a maximum interest rate to apply to specified loans, which are financed based on low-cost refinancing. Setting a maximum interest rate in this situation makes it possible to guarantee the redistribution of all or some of the interest rate subsidization to the end beneficiary. On the other hand, interest rate ceilings consist in third parties (government, regulatory authorities, etc.) setting a maximum exit interest rate that one or several lenders do not have the right to exceed for certain types of loans, regardless of whether or not these lenders are subsidized. Interest rate ceilings have perverse effects because they limit the ability of the institutions concerned to set their own exit interest rates at a level that enables them to cover their costs and implies that they cannot make a profit serving customers who cost them dearly. Likewise, subsidized credit and forced directed credit are often confused, because subsidized credit is necessarily directed, insofar as—like any subsidization—it must define a precise target using eligibility criteria. If the credit is just directed, the financial intermediary maintains freedom in selecting its borrowers. The problem occurs when the directed credit is forced, i.e., when the financial intermediaries concerned are obliged to grant loans to certain targets and cannot select their borrowers, as was the case during the financial crisis in the agricultural sector in the United States.

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Furthermore, many of the arguments encountered in existing literature do not apply specifically to subsidized credit. The facts highlighted are generally true, but may also be true for any subsidy or any loan. Attempts at misappropriation by persons with influence, for example can be observed in all subsidization programs.

3.3. Arguments for and against subsidization as a tool of intervention Does subsidized credit supply endanger financial intermediaries? Summary One disadvantage of subsidization is that it is an obstacle to the transparency of the cost of credit and that it gives potential customers the habit of prices lower than real costs (an argument against). To prevent this perverse effect, it is often recommended to prefer credit combined with a grant rather than subsidized credit; however, this system is more expensive and thereby reduces the effectiveness of the subsidy. Good communication can also improve transparency. Generally speaking, the quality of the distribution mechanism will be more important than its form. Opponents of interest rate subsidies consider that, when exit interest rates are lower than inflation, this subsidization hinders the establishment of an efficient and sustainable credit supply with regard to impact on risk for financial intermediaries, to the development of a suitable resources policy, and to the preservation of capital (argument against). However, this risk of making the situation of the financial intermediaries insecure can be tempered by suitable forms of implementation. In comparison with subsidies directly distributed by donor programs, the subsidization of interest rates of loans distributed by independent financial intermediaries facilitates the setting up of the exit strategy, thereby reinforcing the sustainability of the supply developed thanks to the intervention (argument for). For some people, access to â&#x20AC;&#x153;inexpensiveâ&#x20AC;? credit nevertheless encourages a poor repayment culture (argument against). But the unsatisfactory results in repayment have been observed within financial intermediaries that the lack the capability to analyze and monitor their agricultural portfolio, or that are limited in their ability to select customers. These poor results thus ensue not from subsidization but from the methods of managing the portfolio concerned.

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The three arguments against interest rate subsidies should be put into perspective, as they occur only when there are insufficiencies in the implementation of the program. They can best be tempered by precautions in implementation. The argument for interest rate subsidies represents an advantage compared to simple grants. One risk of interest rate subsidies is that it sends customers the wrong information about the cost of the credit, which leads to their turning away from financial institutions at the end of the interest rate subsidy program. This reality must be taken into account as soon as subsidized loan programs are set up, via communication on the portion that has been subsidized. This would help mitigate the negative effect on the culture of credit. International experience shows that, at the end of subsidized loan programs, demand for credit decreases. Indeed, while farms with insufficient profitability stop using credit, the majority of modernized farms accept indebtedness at market rates when they have no other option. Subsidization of the final interest rate is practically equivalent to grant distribution that is conditional on obtaining credit, and it rounds out this latter in order to reduce the cost of an investment for the beneficiary. The differences with this type of mechanism (implemented, for example, by KfW in Kenya) are on the one hand the lack of transparency regarding the interest rates of the subsidization mechanism and, on the other, a less cumbersome management system in the case of subsidization, insofar as it can rely on the bank’s infrastructure. Generally speaking, regardless of whether it is a subsidy in the form of subsidized interest rates or other forms of grants, the quality of the distribution system is the basis for preventing perverse effects. Indeed, a “bad” program distributing grants will have more perverse effects than a “good” program providing subsidized interest rates, and vice versa. With regard to sustainability of the supply, subsidization can be analyzed as a factor behind the destabilization of financial intermediaries and be held responsible for the increase of their risk at several levels. First of all, subsidization is an incentive to quickly increase the number of loans to the agricultural sector. Financial intermediaries with weak capacities of evaluation poorly measure and are exposed to risks regarding the quality of their portfolio and the sustainability of their supply. Next, subsidization can lead financial intermediaries to lend to borrowers with a higher risk profile. The fact that subsidization encourages financial institutions to finance not very profitable agricultural activities via credit is interpreted as being orientation toward high-risk clients. Craig and Thomson (2003) consider that this can act as a significant risk for American community banks (and for the investors of these banks), as the least profitable

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farms also have a higher risk profile. The increase in risk for financial institutions linked to poorly controlled development of their agricultural credit portfolio can nonetheless be mitigated by appropriate technical assistance measures. Furthermore, as subsidized credit lines offer access to an inexpensive resource, they do not encourage financial intermediaries to look for alternative sources of financing. This can thus ultimately put into question their financial viability after the termination of the subsidized credit line. In addition, the financing conditions of subsidized loan programs have, in the past, often led financial intermediaries distributing subsidized credit to consider attracting deposits as secondary and not to make use of this alternative source of financing. However, this bias could be corrected by the promotion of deposits in the design of programs that include a subsidized credit line. Another argument against subsidization, when exit interest rates are inferior to inflation, is that they lead to losses in capital that are harmful for the development of a sustainable agricultural finance offer. This argument, often encountered in the desk review, is too simplistic, insofar as it does not take into account all of the underlying costs from which the interest rate results. Any losses that have repercussions on the capital are due to rates that did not make it possible to cover the total costs, i.e. the total of the transaction costs, the cost of resources (including inflation), and the cost of risk. Inflation is indeed one of the parameters of the equation that determines if the interest rates cover the costs, but this is not the only one. Subsidization of exit interest rates is possible only if it is combined with a form of subsidization that takes into account all the costs. In comparison to subsidies directly distributed by the donor programs, subsidization of interest rates of loans granted by financial intermediaries independent of the donor facilitates the setting up of an exit strategy for the external support, thereby reinforcing the sustainability of the supply that has been developed. Compared to grants for which distribution by an independent intermediary is less obvious, this specificity has the advantage of facilitating the donor’s exit strategy, as the financial intermediary does not depend on this subsidized loan service. The intervention can be taken over by loans distributed by the financial intermediary, which will be able to develop its activities in financing the sector. Some opponents of subsidized interest rates suggest that the poor repayment behavior observed in many subsidized credit programs are encouraged by the “gift” effect created by this subsidization. However, as there have been varied results in portfolio quality among the financial intermediaries involved in subsidization programs, it is not possible to confirm these assertions. A comparative study of six

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Asian financial institutions (Meyer and Nagarajan, 2000) involved in subsidization programs mentions good repayment rates as a factor of success. In particular, the Bank for Agriculture and Agricultural Cooperatives (BAAC) in Thailand, Bank Rakyat Indonesia (BRI), and Grameen Bank in Bangladesh are mentioned. The CECAM rural microfinance network of Madagascar, which has developed a program of investment credit at subsidized rates, is mentioned as an example of portfolio quality. The credit and portfolio-management methodology, the recovery procedures, the fee scale for arrears, and the culture of repayment (encouraged by setting up savings programs), as well as the existence of central credit registers, seem to have more influence on the quality of the portfolio than does the interest rate of the credit. Poor repayment thus seems to be due to the quality of management by the financial intermediary rather than to interest rate level. The poor repayment performances of many subsidized loan programs entrusted, as part of the former paradigm, to poorly managed development banks or to agricultural development projects have thus been mistakenly attributed to subsidization. Sometimes, the cause of arrears is also the subsidization program methods that impose constraints on financial intermediaries in their selection of loan applications and in applying their risk analysis methodology. The rare measures of forced credit are indeed acknowledged to have harmful impact on portfolio quality, and thus on the sustainability of the finance offer proposed to the beneficiaries.

Subsidization can lead to misappropriation Summary Like any kind of subsidy or grant, interest rate subsidies attract persons with influence, and there is often accusation that support benefits are misappropriated from their initial purpose (argument against). Selection of beneficiaries by professional and independent financial intermediaries can greatly remedy these perverse effects. This argument against interest rate subsidies can thus be tempered by suitable forms of implementation. As with all forms of distribution of resources at low or no cost, subsidization can lead to misappropriation. Fund misappropriation has been observed for some projects, but this can occur for all forms of grants or subsidy, and the danger is not specifically linked to subsidization of interest rates. On the contrary, distribution of subsidies in the form of subsidized credit limits this perverse effect. Firstly, use of subsidized credit as a means of aid distribution means the subsidization has a non-negligible cost; this therefore reduces the attraction of these funds compared to resources

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distributed in the form of pure grants. The need to repay loans helps to make sure that only individuals with serious intentions receive donations. Secondly, this problem is related more to the independence and discernment of the distributing financial intermediaries than to the interest rates. Even though public banks are often associated with problems of interference from their governments, each one in reality has its own specific operating method. The development players interviewed as part of the study mention several successful experiences with this type of partner. The selection of the partner that lends the credit is thus a key factor in the success of programs of subsidized interest rates offered to end clients.

An expensive system Summary The systems used for subsidization are expensive, especially for auditing, and this has an influence on the cost of this type of intervention (argument against). However, comparison cannot be made with non-subsidized credit distribution, because of the nature of subsidized interest rates. In this respect, we can on the contrary observe that subsidization of interest rates reduces the cost of subsidization implementation, as it uses an existing distribution system (argument for). The cost argument against subsidized interest rates must thus be put into perspective. The systems used for subsidization are expensive, especially for auditing. Strict control of the use of funds is essential in any system of subsidization. It is based, at the time when it is set up, on strict rules of access to the subsidy, precise decision-making procedures, and clear attribution of responsibilities. An independent auditing system is also necessary to ensure that all these rules are properly applied and the subsidies properly distributed during the setting-up process and afterwards. Auditing must be carried out thoroughly on supporting documents, as well as on-site for a sample of beneficiaries. Compared to direct grants that are not reimbursed by beneficiaries, the credit aspect requires more monitoring: subsidization of interest rates requires a system for selecting borrowers, for distributing funds, and for following up repayments and arrears. In past experiences, these systems have often been developed specifically within the framework of subsidized credit programs, directly by donors or governments. In this case, the cost of distributing subsidized credit is significant for the program and can even become dominant if the volumes of subsidization decrease (as happened in the United States). On the other hand, when subsidized credit is distributed by existing professional financial intermediaries, the cost of the distribution system is not borne by the program,

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and the granting of subsidized credit is therefore less expensive than providing direct grants, for which the donor must set up its own system for selecting the end beneficiaries.

A capacity-building opportunity for selected beneficiaries Summary Some critics of subsidized credit programs have attacked the significant resources implemented to monitor loans traditionally distributed directly by specialized public intermediaries. But this long-term monitoring facilitates the setting up of supervision that helps end-beneficiary capacity building, which is a key element of success in programs seeking a change in farmersâ&#x20AC;&#x2122; practices (argument for). Furthermore, thanks to the use of credit as a means of distributing the financial support, the beneficiaries of this aid become the customers of a financial service rather than aid beneficiaries, thereby limiting the development of a welfare culture traditionally associated with subsidies with nothing demanded in return (argument for). Furthermore, the repayment obligation means that serious borrowers will be selected, thereby increasing the effectiveness of the subsidies (argument for). Subsidization can lead to promoting indebtedness among borrowers, as farmers can feel an incentive to become indebted in order to benefit from the support that is offered (argument against). But this argument must be qualified by the fact that the risk can be tempered by suitable methods of implementation: distribution by professional and independent financial intermediaries can remedy this type of bias. As we have seen, credit subsidization is often accused of being too expensive, even though it can be distributed by existing financial intermediaries. This reduces the cost of the subsidy, in comparison with other subsidies for which administration systems must be established. In addition, long-term monitoring linked to the period of repayment enables monitoring that facilitates the setting up of training for beneficiaries. We can in fact see that the failure of modernization programs to provide new technologies is often related to the lack of command of the latter. The historical analysis has shown that farmer-borrowers may need support in the financial management and development planning of their farms, as well as in the use of new agricultural resources they have at their disposal thanks to access to credit. Subsidized credit programs are thus better suited to monitoring beneficiary performance than are direct grants. And while direct grants do not structurally require monitoring, monitoring is needed to evaluate outcomes whatever the type of grant or subsidy.

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Furthermore, beneficiaries of interest rate subsidies have the status of loan applicants and not of grant recipients. They are responsible for repayment. This helps avoid development of the welfare culture created by grants demanding nothing in return. Interest rate subsidies are also more of an incentive for beneficiaries to better invest and use their investment, insofar as return on their investment is needed to repay the loan. In contrast, a poorly used grant will be a waste of public funds but will not put the beneficiary into difficulty. According to an OECD reflection document on the financing of agricultural investment (OECD, 1970), “[While interest rate subsidy measures are used selectively], governmental aid via interest rate subsidies is likely to encourage, in a relatively short time, the making of economically reasonable investments: debt service is such that the financial burden forces the farmer to respect certain principles with regard to the orientation and management of his enterprise in the long term. ” This point is especially significant when it comes to encouraging environmentally-friendly investments (equipment that is often more expensive). Distribution of aid in the form of interest rate subsidies makes it possible to implement one of Meyer’s recommendations (2011) concerning grants to economic entities: “Developing a cost-recovery mechanism can help ensure that only people with serious intentions receive grants.” Not only serious intentions, but also acceptance of indebtedness is required. Opponents of interest rate subsidies criticize the obligation to become indebted in order to have access to aid; however, while it is true that subsidization can be an incentive to borrow, this incentive is not necessarily harmful. As seen previously, subsidization makes it possible to develop credit demand while decreasing the risk taken by the farmer, which is important for farmer populations generally adverse to risk. Here, the lending by competent financial intermediaries plays a crucial role in the selection of solvent borrowers within demand that has been expanded thanks to subsidization. The phenomenon of over-indebtedness can thereby be limited, as long as the financial intermediaries have the means and capacities to make a good-quality selection. The general environment also plays an important role here, in particular through the existence of central credit registers or systems of information exchange between financial intermediaries on borrower indebtedness.

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A form of intervention that can orient market dynamics in accordance with public policies Summary Subsidized financing is a form of intervention that can orient market dynamics in accordance with public policies. Its leverage makes it possible to reinforce state action in comparison with pure grants (argument for). Like any public policy instrument, it can be affected by problems of governance (argument against). The special case of programs of subsidies distributed by public banks subject to state interference is sometimes wrongly generalized as an argument of the riskiness of subsidization, in terms of possible interventions by persons with influence. Examples from Asia (that of Thailand, among others) show that public banks, like subsidization programs, can be effective when the environmental conditions are met. The definition of public policies is a huge topic that goes beyond the range of this study. The need for government interventions arises in particular in situations in which competitive markets are inefficient, as is the case for agricultural financing. The failure of some government interventions must not lead to weakening them, but to improving their design. The limits of this type of intervention reside in the difficulty of anticipating all the effects of an intervention on the markets and in ensuring that the interventions decided as part of public policy implementation are carried out in accordance with political objectives aiming for the common good, and that they are not misappropriated to serve private interests. It is true that the governance structure of public banks and their dependence on subsidies, which ensues from the obligation of low exit interest rates, makes them vulnerable to public interference. However, this problem is not linked to the subsidization tool, but to the fact that this credit is distributed by public banks subject to destabilizing state interventions (the most frequent being interference in the selection of borrowers or deferral of payments). The situation of these banks is even more fragile when the share of subsidized credits in their portfolio is large (which makes them dependent on concessional sources of financing) and when the conditions associated with this credit prevent them from choosing their customers freely (subsidies of high interest rates, precise directives regarding priority segments, Meyer and Nagarajan, 2000). Nonetheless, not all public banks are confronted with this problem. Furthermore, the distribution of subsidized loans is increasingly entrusted to private financial intermediaries.

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Impact of support in the form of subsidization, for the donors Summary Some donors have easier access to resources in the form of subsidized credit lines than in the form of grants. The local financial market is an important element in determining loan conditions that will make it possible to support an agricultural development program. It is affected by intervention from other donors. Subsidization of interest rates enables interventions without grant resources for some donors that benefit from privileged access to concessional resources. Support for end beneficiaries can then be provided more effectively and more rapidly than with grants, which can have more complicated release mechanisms. However, some donors refuse to intervene in areas where subsidized loan programs have been established. Conversely, in areas where a subsidized loan supply exists, be it via donor intervention or government intervention, programs based on market-rate credit have difficulty intervening effectively because the farmers there prefer the subsidized loans. In both cases, subsidization can therefore finally reduce the total amount of aid targeting these areas.

3.4. Arguments for and against subsidization within the specific framework of agricultural financing The financial service market for the agricultural sector is not very well developed, and has little supply or solvent demand Summary It is generally recognized that agricultural credit markets do not work perfectly, and that this can justify government interventions to meet the demand (argument for). The perverse macroeconomic effects put forward by opponents of subsidization, especially in terms of distortions of the rural credit and agricultural markets (argument against), must be put into perspective. Indeed, agricultural credit markets are very often practically inexistent and therefore do not run the risk of distortion. Economic theory also states that incomplete markets cannot find a balance; the problem in this case is development of the credit supply. Furthermore, the markets do not take into account the positive externalities of agricultural development, especially in terms of social impact, thereby justifying government interventions (argument for).

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Literature on the topic is in agreement on the fact that market forces cannot correctly meet the credit needs of rural areas and agricultural activities. One reason is that there are few financial intermediaries present in these areas (i.e., it is an â&#x20AC;&#x153;incomplete marketâ&#x20AC;?). Those that do venture into this market struggle with structural problems that are difficult to overcome and that increase their costs, especially low density of population in some areas and the lack of infrastructure. Furthermore, for borrowers, farm profitability may seem insufficient to cover the costs of loan distribution. These conditions are not conducive to the establishment of market interest rates. And, as some externalities (e.g. social impact) are not taken into account by the markets, support for the development of an agricultural credit market seems necessary, thereby justifying interest rate subsidies. It is important to note that these arguments are not specific to the problems of subsidization of rates for the end client. Rather, they give broader justification of the need to support the development of the agricultural finance market. This issue is part of the wider debate on the appropriateness of interventions in the agricultural finance market. The choice of the subsidization tool is made after the decision to support the financing of the agricultural sector. This theory is backed up by the observation that, despite several decades of market liberalization, formal agricultural finance markets are still more or less inexistent in some rural areas. This is proof that the shift to the new financial sector paradigm and liberalization have not enabled markets to play their role in these areas. Interest rate subsidies can thus be a tool to help initiate the development of an agricultural finance market, by initially making up for the gap between farm profitability and the level of interest rates of loans determined by the underlying costs. This way, subsidization encourages the simultaneous development of the technical and financial capacities needed to gradually achieve independence from subsidization. Interest rate subsidies, in combination with other supports, would thus act as a catalyst for the development of agricultural finance markets, especially by encouraging some financial intermediaries to focus increasingly on the agricultural sector. Despite imperfections in how markets operate, opponents of subsidization highlight the perverse macroeconomic effects of interest rate subsidies, especially in terms of market distortions [ 10 ] for the end client. Market distortions are harmful to lenders [10] The two distortions here mentioned are also discussed in the following section, from the point of view of sustainability of the offer.

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whose interest rates are not subsidized: the distortions either prevent them from entering the market, or force them to abandon it. It is the farmers who will suffer from the non-development of a sustainable credit offer when the subsidization comes to an end. The impact is also negative on the conditions offered to farmers for savings. This is because the low exit interest rates induce the financial intermediaries to limit interest on savings, with the assumption that maintaining these exit interest rates after the end of the interest rate subsidy program will require a low resource cost. However, if interest rates on savings are low, the rural population will not invest its savings in the financial markets. Nevertheless, these arguments remain theoretical points that have not yet been proven. None of the economic studies in the desk research were able to provide clear quantitative proof with regard to the effects of the various measures.

Assertions to the effect that farmers are less sensitive to interest rates are controversial Summary One argument against interest rate subsidies is that agricultural producers are less sensitive to access to credit than to the interest rate practiced and that, consequently, interest rate subsidies should not lead to increase in agricultural credit demand (argument against). While access to credit must undeniably be a prerequisite, we can see that the phenomenon of adverse selection put forward by economic theory implies that the quality of demand increases when interest rates decrease; this has the effect of increasing solvent demand (argument for). The ensuing growth in formal credit is a tool for fighting exorbitant rates. Furthermore, the conclusions of studies on sensitivity to interest rates must be put into perspective; they tend rather to show that micro-entrepreneurs are relatively sensitive to interest rates. The development of a farm moreover needs considerable structural investments that require the use of medium- or long-term loans, for which the impact of interest rates is much more significant than that of short-term loans traditionally used by micro-entrepreneurs (argument for). On the demand side, it can be asked whether farmers are that sensitive to the levels of interest rates practiced and whether interest rates influence demand. Opponents of interest rate subsidies respond that farmers suffer more from the lack of access to credit supply than to the level of interest rates. They believe that farmersâ&#x20AC;&#x2122; sensitivity to interest rates is limited. Because of the seasonality of their activity, they are allegedly more sensitive to non-monetary conditions (such as the repayment schedule) than

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to the level of interest rates. While these observations are accurate, they do not take away from the value of interest rate subsidies, as priority in many cases is access to credit. In such cases where the supply does not exist, it must be developed before we can talk about subsidized credit. Next, the agricultural credit products must be determined, whatever their conditions (interest rate subsidies or not), taking into account non-monetary constraints (mainly in terms of schedule and loan life). Several documents put into perspective the importance of these observations. “Subsidies as an Instrument in Agricultural Finance: a Review,” published by the CABFIN group, is clearly opposed to interest rate subsidies. However, this document implies that farmers are sensitive to rates because one of the negative impacts of subsidization is that, when demand increases, financial institutions must “ration” credit, with the risk of giving priority to applications by rich producers with political connections. This review refers to studies, with or without specialization in an agricultural clientele, that evaluate the sensitivity of micro-entrepreneurs to interest rate levels. For example, an experiment carried out by Compartamos in Mexico (“Access to Finance,” Karlan Dean and Jonathan Morduch, 2010, in Meyer, 2011) showed that demand increased when interest rates were reduced by 0.5 percentage point on a cluster of customers. Another experiment, carried out in Bangladesh, showed a significant change in behavior of borrowers, who paid back their loans more quickly following a significant increase in interest rates (“Do Interest Rates Matter? Credit Demand in the Dhaka slums,” Dehejia, Montgomery and Morduch, 2009, in Meyer 2011). Finally, a study carried out in China, specifically on farm households, concluded that only 20% of borrowers with the poorest risk profiles had a totally inelastic demand, while the others had an elastic or very elastic demand. In the case of farms in particular, these various observations are all the more valid because the loan life is longer. Microcredit is generally short-term, but financing for investments whose profitability is deferred over time (planting, young animals, etc.) or for investments for farm modernization requires access to long-term credit, for which the impact of interest rate levels are stronger the longer the loan life is. Subsidization can then make sense in these cases. The purpose of the credit and therefore the nature of the project financed are therefore to be taken into account: even if the most important aspect for this type of financing is to adapt the other characteristics of the loan to special scenarios (maturity, total or partial grace periods in the schedule), subsidization can make sense if the interest rates are too high for long-term loans.

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The phenomenon of adverse selection, discussed by the American economist Joseph Stiglitz in 1993, sees a correlation between the levels of interest rate and the type of borrower: high interest rates seem to be associated with credit markets whose demand is formed by not very reliable borrowers. The most reasonable borrowers are left out of the market when the level of interest rates rises, and this increases the amount of repayments or the loan life, as well as the risk of not being able to meet the repayments of a possible loan. In this case, the banks can no longer select the good borrowers, because they have withdrawn themselves from the market. Conversely, when interest rates decreaseâ&#x20AC;&#x201D;through subsidization for exampleâ&#x20AC;&#x201D;borrowers enter the market again, and banks can once again choose their clients from a demand whose makeup does not have a negative bias. With regard to farm profitability, having to meet high interest rates requires better profitability so that an investment can pay for the interest charges. In the case of not very high interest rates, less profitability is required. This automatically increases the number of bankable applications. The market increases, enabling financial intermediaries to take advantage of economies of scale, and thereby makes it possible to open up to markets that had been inaccessible until then. Consequently, by encouraging the growth of formal credit through the increase of solvent demand and the promotion of a suitable credit supply, subsidization can contribute to reducing the volume of loans lent at exorbitant rates.

The impact of interest rate subsidies on the rationalization of agricultural production: a topic for debate Summary The critics of interest rate subsidies consider that these can curb the rationalization of agricultural production and wind up maintaining not very profitable activities (argument against). But this takes into account neither the impact of investments on farm profitability, which can justify subsidization as an occasional boost, nor social externalities. The low profitability of many agricultural activities is, on the other hand, an appropriate argument to justify the use of subsidized rates in well-targeted cases (argument for). In cases where the purpose of subsidization is to further structural evolutions that enable farms to achieve a profitability that will then enable them to borrow at commercial rates, sustainability does not require an ongoing supply of low-interest loans (argument for).

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Some commentators go even further in their analysis of profitability and talk about rationalization of agricultural production. Critics of subsidization consider that these can curb the rationalization of agricultural production and wind up maintaining not very profitable activities. Doliguez and Wampfler (2007) quote the works of economists (Servolin, 1972; Mollard, 1978; Cavailhes, 1981; Coulomb, 1993) that tend to show that the profitability of capital in agriculture is lower than in other sectors. This is explained by the fact that farmers do not seek extra profits once they are capable of making their activities sustainable and of making money from them. This limits the capacity of farms to pay high interest rates. Justifying subsidization by the low profitability of farms (compared to industrial or service businesses) must nonetheless be studied case by case, given the diversity of situations of farms (form, size, nature of activities) and of agricultural markets (price and market environment, level of pay from work, etc.). The agricultural market forces naturally push aside the less profitable farms, which are gradually absorbed or replaced by bigger and more efficient ones. Critics therefore accuse subsidization of financing farms that are not very profitable and of thus keeping them in business; this would hinder the rationalization of agricultural production or its reorientation toward more promising value chains and the resulting benefits that the economy of the countries concerned could have gained from it. But this argument does not take into account the fact that subsidized credit can be used to finance investments that would change production structure. They would thus improve the profitability of the farms financed, enabling them to work in normal market conditions afterwards. This has been confirmed by some observers, especially in the early 1990s at the World Bankâ&#x20AC;&#x2122;s Operations Evaluation Department, which noted the beneficial impact of certain programs that incorporated interest rate subsidies on the farms supported (WB Independent Evaluation Group, 1994). This beneficial impact can be seen in the increase of agricultural production and the improvement of farm assets. If the objective of interventions to support the development of agricultural finance supply is ultimately the development of the beneficiary farms, it seems that subsidization can effectively provide positive results along these lines, when it is implemented under the right conditions. A key factor for success is good targeting of the farms that are supported, especially by taking into account their prospects for profitability. Involvement by a financial intermediary can facilitate the targeting of this type of farm, thanks to the analysis skills that are essential to its activity. The targeting determines the type of development that will be encouraged: if the subsidization focuses on the financing of value chains and/or specific production, it may further excessive concentration on certain sub-sectors (e.g., cotton) or types of farms with high-intensive capital (to the detriment of family farms).

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Nor does the above argument take into account the development context of France or the United States. In these two countries, concentration of the agricultural sector took place during the last century, when industry was already developed and the tertiary sector in the process of developing. These two sectors thus needed the surplus labor left over from farms. This change is not systematically transposable in developing countries. In countries where industry and services are not developed enough to absorb a significant amount of labor, rapid concentration of agriculture without significant parallel growth of other sectors can, on the contrary, lead to increase in unemployment and urban poverty. This is therefore not necessarily the right solution, especially in the context of very strong demographic growth with increase in population of both urban and rural areas. As we have seen, subsidized credit can be used to finance investments that will change production structure. The impact will be improved profitability of the farms financed. In this case, once the changes are made and profitability improved, the farm will be able to borrow at market rates. It is important here to make the right distinction between the sustainability of impact on agriculture and the sustainability of the financial offer. Here, impact is measured on the agricultural sector, and its sustainability can be ensured without a continued supply of low-interest loans. Financing can continue at market rates if the farmers are put into contact with a financial intermediary.

Leverage on resources and orientation toward viable beneficiaries Summary The subsidization tool has specific characteristics compared to other forms of agricultural support. Although some farmers can be excluded from the financial support offered by subsidization because they do not have access to credit (argument against), the selection made by the financial intermediaries presents the advantage of improving the targeting of beneficiaries. Assuming they have identical available resources, the subsidization tool enables broader reach than do direct grants, thanks to a bigger lever affect (argument for). Interventions in the form of guarantees have an even broader reach but do not solve the problem of profitability. One of the faults mentioned by critics of interest rate subsidies as a tool for supporting agricultural financing is that farms that disqualify from credit are left behind in aid distributed in the form of credits. But supporters of subsidization respond that it is more advantageous to have the financial intermediaries select the farms most apt to

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develop, if we consider the goals of economic development and of targeting the subsidies with maximum effectiveness. According to this theory, these farms would go out of business in any event, even without the existence of interest rate subsidy programs. It would therefore seem to be better to avoid providing subsidies for non-viable farms. Finally, the World Bank review (OED, 1993, quoted by Buttari, 1995) points out that there may have been unwarranted criticism of targeting, because of mistaken evaluation of the size of the beneficiary farms. In the cases inventoried, it was not the smallest farms that benefited from the subsidy, but medium-sized farms that had trouble accessing credit and that could thus apply for this support. Furthermore, some studies are inconsistent in that they criticize both the massive financing of non-profitable farms by subsidization programs and the fact that some farmers are left behind by them. This inconsistency is typical of the tendency to gather the arguments â&#x20AC;&#x153;against,â&#x20AC;? without specifying the different contexts to which they apply. The use of subsidization also provides the advantage of financing a greater number of end beneficiaries than do direct grants. Direct grants with an equivalent amount of resources are often insufficient to meet the needs. However, it is possible to get around the limits in the reach of grants by combining grants and loans, as for certain types of grants that require something in return from the beneficiary. Some players that are little inclined to subsidize rates put forward portfolio guarantees as an instrument to help develop the financing of the agricultural sector. Guarantees do provide an even greater leverage than does subsidization. However, they cannot reach the same segments of farmers. They generally do not provide enough incentive to financial intermediaries for becoming involved in the financing of small family farms, and they do not solve the problem of the gap between the cost of medium-/ long-term credit and profitability of activities.

A form of legitimate support from public authorities? Summary While they do not claim to be able to solve the rural infrastructure deficit over the long term, interest rate subsidies can temporarily make up for the loss suffered by farmers if public authorities have not provided adequate infrastructure (argument for). Transportation, electricity, and telecommunications infrastructures are the responsibility of the public authorities. For farmers in rural areas where such infrastructures

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are limited, the cost of transactions with the agencies of financial intermediaries can be expensive or even excessively expensive. Some studies estimate that the nonfinancial cost (transportation, etc.) of credit in northeastern Brazil is between 10 and 13% of the amount of the loan, regardless of the loan life. In Nigeria, Ohio State University (OSU, 1987) found non-financial costs for seed loans ranging from 10.8 to 13.1 % of the amount of the loan (Pizzaro, 1994). The infrastructure deficit (in transportation, electricity, telecommunications, etc.) also makes transaction costs more expensive for the financial intermediaries. It therefore has an impact on how rural markets work and access to markets for selling productionâ&#x20AC;&#x201D;and therefore on the profitability of rural businesses. In this light, interest rate subsidies can be viewed to compensate these constraints, at least for as long as public policies do not improve the quality of rural infrastructures. Subsidized interest rates do not eliminate the causes of overly expensive transaction costs over the long term, but they do make it possible to limit the consequences for farmers.

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4. Recommendations Summary Interest rate subsidies are a special form of grant distribution to support agricultural development. They cannot be an isolated measure: as a public policy tool, their use must come within a coherent, global, and long-term system of public support for the development of family farming. Providing interest rate subsidies has advantages and disadvantages compared to direct grants. The quality of the distribution mechanism is the most important factor for preventing perverse effects. These recommendations concern the implementation of actions that include subsidization of loans for the end beneficiary. They are based on the lessons learned from the historical analysis, from research carried out on the subject, and from analysis of arguments for and against subsidization. If a subsidization system is set up, it must meet clear political objectives. If it does not implement a predefined public policy—in this case the development of agriculture (or a certain type of agriculture)—it has no meaning. Implementation of such a program therefore makes sense only in countries that have an agricultural policy and that are prepared to implement the program without direct state interference, which risks diverting the program from its original objectives and from transparent operation. Special attention must thus be paid to the practices of governmental bodies, as in the case of implementing any grant. Donor interventions in the form of subsidization of exit interest rates must be part of existing public policies in the beneficiary country and meet the latter’s objectives, even if it is a non-sovereign intervention (direct loan to a financial intermediary, without state involvement). Interest rate subsidies are one of many public policy tools. Their role is not to solve all the problems of agricultural financing, but to round out other interventions to support the financial sector. The recommendations, organized into three areas, concern the intervention context, the forms of implementation, and supervisory measures.

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4.1. Recommendations regarding the intervention context Relying on good-quality financial intermediaries in a functional financial system Summary Interest rate subsidies are a form of subsidy that relies on the financial sector. As such, it cannot be effective if the financial system works poorly. Prior analysis of the agricultural finance situation is essential to avoid weakening the existing system. If there is no local financial intermediary to distribute the subsidized loans, the government interventions will have to first of all focus on creating such an intermediary before considering the setting up of subsidized credit. In the event of serious dysfunction in the financial sector, the subsidization tool cannot be implemented under satisfactory conditions and will be ineffective. Unfavorable conditions include hyperinflation or fluctuating inflation. Subsidization cannot have a decisive effect when the state taxes the financial sector in a way that discourages the activity and increases its cost, making financial intermediation ineffective (high taxes on financial operations or very high compulsory reserves). The conditions for setting up a support program using interest rate subsidies have not been met if (i) the financial intermediaries lack professionalism and/or diligence (i.e., there is lack of transparency, absence of reliable activity report, high risk of corrupt practices, etc.) and the interventionâ&#x20AC;&#x2122;s supervisory authorities are not effective, or (ii) if there is no financial intermediary where the intervention is to take place. Before setting up an intervention, it is essential to study the agricultural financing system, including financing by the financial sector and financing by trade partners within value chains. The interventions being considered must be analyzed in the light of the impact they could have on the mechanisms of existing agricultural financing networks, so as not to weaken them. It is also important to evaluate whether capacities to use the subsidy well exist in the sector. If the prior analysis identifies considerable shortcomings in the financial sector, such as financial intermediaries in a vulnerable situation or an insufficient presence in rural areas, a phase to set up a distribution channel will be necessary before considering an interest rate subsidy program. If there is no existing market, this can enable the creation of one or more institutions, or help one or more institutions start working in the target areas. It is important to avoid the setting up of programs in which subsidized credit is distributed by ineffective and poorly managed financial intermediaries, or by financial intermediaries that would cover the sector out of opportunism. In

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order to operate correctly when there is no good-quality financial intermediary working with the target clientele, the first priority will be to enable access by agricultural value-chain entrepreneurs to financial services. This will involve supporting financial intermediaries that wish to develop in this sector but that cannot do so at affordable rates for the demand (due to a still insufficient scale). Subsidization is the basic tool for creating a financial intermediary, or helping an existing one start working in targeted rural areas. It can apply to technical assistance or to operating costs, on a degressive basis. For the financial intermediary, subsidization can be an extra tool for developing its activity. To start up sustainable financial services, it is important to subsidize the financial intermediary’s resources, so that it can lend at “market” conditions. If no market exists, the objective will be to set up interest rates that will enable the financial intermediary to cover its long-term costs (i.e. its estimated costs if it enjoys sustained growth). Subsidies to financial intermediaries can be provided by different mechanisms: direct grants or subsidized resources, for which all or part of the subsidy is maintained at the financial intermediary level. The subsidized share of subsidized resources can be allocated to the end beneficiary via subsidized exit interest rates—or to the financial intermediary, enabling it to increase its margin. Subsidies dispensed by a subsidized resource mechanism have the advantage of being proportional to the activity (and thus of encouraging the financial intermediary to meet the set objective); the disadvantage is that disbursement is mainly carried out when the program is well underway, even though the financial intermediary needs to invest mostly at the launch phase. Suitability thus depends on the capacity of the financial intermediary to pre-finance the investment needed to launch a new agricultural credit product. When a financial intermediary begins activities, it is better if it first sets up short-term credit, so that it can build its knowledge of the market. Interest rate subsidies are not always justifiable in the case of short-term credit. The time for considering setting up subsidized credit to finance investments comes later.

Like any form of support involving credit, subsidization makes sense only for profitable investments in a favorable and stable context Summary Before deciding on the types of credit to subsidize, analysis of the profitability of investments to be encouraged and of the conditions of this profitability must be carried out.

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For farmers investing thanks to interest rate subsidies, favorable economic conditions enabling them to sell their products must exist. There must also be no risk of distortion on the domestic markets due to state interventions (e.g. caps on the prices of agricultural products to limit the food expenditures of the urban population) or to outside food aid. Government policy must encourage investment by establishing facilities and stimulation measures, and it must exercise a reasonable tax policy. Furthermore, research and agricultural extension bodies that can provide supervisory, technical, and management measures must help the entrepreneurs of the value chains receiving subsidized credit to use their investments well, by helping them to develop their production techniques adequately. Finally, the beneficiary’s projected operating account must cover the cost of the credit and make the financed investment sustainable.

4.2. Recommendations concerning how to implement the subsidization tool Identify the objectives of the subsidization properly Summary There are two ways to apply subsidized interest rates for the end client, with a goal of supporting economic development. The method of implementation will be different for each one, and they will involve different exit strategies. The implementation might be a one-off measure to finance the structural evolutions of the agricultural sector or to orient it toward techniques or investments concerned with positive externalities (in particular “green financing”). It may also seek to launch investment-oriented credit activity designed to be permanent. The subsidization tool can be used with two very different strategic objectives: to finance structural evolutions, or to support the launch a sustainable investment financing activity by a financial intermediary. When this tool is designed as an “occasional” measure to finance structural evolutions in the agricultural sector, it puts into motion a form of Keynesian policy that seeks to start up a virtuous circle: investments enabling modernization and change in the conditions for profitability of the agricultural activity (increase in the production and income of agricultural entrepreneurs) and continued operation of the farm under improved conditions no longer requiring the use of subsidized loans. This is what was done in France within the framework of the policy on agricultural structures, launched in the 1960s.

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These measures can be occasional, insofar as farms that have invested in assets are expected to be able to continue their activity using loans at market interest rates. However, in past international cases, they have been given a long-term perspective in order to reach a significant impact in the agricultural sector. Changes in techniques or equipment with the environment in mind also fall within this category; in this case, change does not lead to improvement in profitability in strictly financial terms but in improvement in global profitability. It then makes sense that it is not the farmers who pay for the positive externalities generated, and that the cost differential be covered entirely by government intervention. Interest rate subsidies can also be used as a temporary measure to help financial intermediaries start up a new investment-oriented credit activity, thereby acting as a catalyst. In this case, subsidization has a dual role. The first role consists in supporting one or several financial intermediaries in launching a new loan product or in serving a new segment of clientele: in this case, the purpose is to compensate the heightened cost of launching such an activity, by using subsidization to set an interest rate under the break-even rate. Such subsidization can be expected to be gradually decline as the skills of the financial intermediary and of the activity develop. If this happens, the unit costs of the subsidization will decrease, and it will wind up disappearing. The second role is to encourage farmers to invest; this is a way to overcome farmersâ&#x20AC;&#x2122; eventual reluctance to change their practices. Here as well, it is possible to reduce the subsidization in the long term, once the profitability of the investment concerned is demonstrated by practice, and the risk taken by the farmer has diminished accordingly. Subsidization has often played the role of social measure to support small farms. It has very often been used for political purposes to transfer income to farmers (especially in France, the United States, and Brazil). This may be part of a policy with social objectives, to help maintain a sector made up of small farms (to prevent rural exodus and increase in unemployment and in urban poverty). In this case, it is a long-term measure that will not be able to cover its costs and that will therefore require adequate budget spending. This is generally more up to the state budget then to international aid.

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4.2.1. A healthy subsidization system that is regularly evaluated and audited Distribute subsidized loans via good-quality financial intermediaries recruited through an open selection process Summary The selection of partners in charge of distributing the subsidized credit is key to the success of the program. The opportunity to participate should be open to all financial intermediaries that meet certain criteria. The process should make it possible to welcome any new partners. Many subsidized credit programs have been poorly managed because of the distribution structure of the loans, often by non-financial and non-sustainable programs or by public banks suffering from poor management and state interference. In line with the new paradigm of rural finance, it is recommended that these programs be distributed by professional and sustainable financial intermediaries. These partner lenders are the â&#x20AC;&#x153;implementation agenciesâ&#x20AC;? of a subsidization program. The success of the latter depends on the quality of these financial intermediaries. It is therefore important to evaluate them beforehand with regard to their management, their client relations, the effectiveness of their operations (examination of applications, waiting periods, and customer management), the quality of their portfolio, and their governance. To set up the program without financial market distortion, the recruitment of partner lenders must be done transparently, based on calls for proposals; be designed to recruit several financial intermediaries, so as not to privilege a single partner with monopolistic profits; and open up regularly to the possibility of new financial intermediaries joining the program, so as not to exclude new participants from the market.

Ensure that the financial intermediaries can make their lending decisions independently Summary The implementation mechanism must provide for the financial intermediaries to be able to make their decision to grant loans independently. They must be free to select their customers from within the identified target clientele. It is the financial intermediary that must, at least partially, assume the risk for subsidized loans.

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Two types of dysfunction have led to poor results in the past. The first is interference from the state or from persons with influence in the system of subsidized loan distribution, which has led to persons with influence siphoning off the aid. The second is that the obligation to lend to any beneficiary meeting certain criteria has led to lack of control over risk and to dissuading the financial intermediary from taking on full responsibility. These experiences teach us that the partner financial intermediaries must have complete independence when granting subsidized loans, and they must assume the risk of the loan—at least partially—in order to fulfill their role of selecting good-quality borrowers. This freedom of choice does not mean that specific eligibility rules for access to subsidized loans cannot be set in order to limit windfall effects. The financial intermediaries must be explicitly protected from state interference.

Adapt the volume of the intervention to the need and capacities of the partner financial intermediaries Summary The total volume of the intervention must be large enough to avoid distortion in terms of competition among farmers. At the same time, the volume of the intervention entrusted to each partner lender must take into account the latter’s capacities, so as not to create unbalances in its activity. Access to a subsidized loan means access to a partial subsidy for investment. If the subsidized loan volume is reduced, only some farmers will be able to benefit from it. This will create distortion on the agricultural production market, as it favors those who get served first. When the subsidized loan volume is too low, there can be a crowding-out effect, by which the best farmers will be chosen in the best of cases. But in any event it creates disparities, and it is also probably more likely that individuals with connections in the decision-making channels will be chosen. The process can be reasoned in terms of privileging model farmers, if the introduction of a new mode of production is involved. However, without support measures, it will be difficult to promote the latter. At the same time, the volume of subsidized loans that each financial intermediary establishes must be thought out in terms of its capacities. If the credit distribution goals are set too high and encouraged by strong incentive measures, the financial intermediary may turn away from its existing activity to focus its skills on subsidized loan distribution, for which its competency is not as great. The end of the project will

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see a decrease in not only the financial intermediary’s independent activities, but also its level of competency in them. In short, the project may have negative overall impact on the financial intermediary and thereby on the sustainability of the financial services supply. This impact on the financial intermediary can be felt at two levels. The first is on its lending activity, as the subsidized loan distribution may imperil its existing products used for the same financing purposes. It is therefore important to analyze this aspect when defining transition strategies. Human resources and operating resources may also be diverted from credit intended for other purposes, and the financial institution may be discouraged from marketing its existing products. The second level of impact concerns the financial intermediary’s activities related to savings and access to resources: if the subsidization is carried out based on subsidized credit lines, the financial intermediary may no longer use its usual suppliers of resources and thereby make fewer efforts to promote savings. To avoid this type of perverse effect, it is best to limit the volume of subsidized loans entrusted to each financial intermediary according to its existing activity. For example, if the financial intermediary already conducts an activity in rural areas, a reasonable proportion should be set between its existing loan portfolio and the subsidized loans to distribute. Analysis must be carried out case by case based on an evaluation of the activity of each financial intermediary and the real consequences on the operating of its subsidized loan distribution (What are its implementation strategy and transition strategy?). Crédit Agricole in France is an example of a financial intermediary which was able to develop its activities successfully, despite the fact that a significant proportion of those activities were devoted to subsidized loans. But this was possible in a situation with an ongoing policy of heavy use of subsidization to support agriculture, backed up by state support for this institution. It is not a model that can be applied everywhere. Thus, there are other cases of financial intermediaries that were partners to development programs for the distribution of subsidized loans and that abandoned their other activities, in particular savings deposits, to set up these programs (e.g. IFAD project in Nepal).

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Evaluate the subsidization system regularly Summary The systemâ&#x20AC;&#x2122;s relevancy must be evaluated regularly in order to allow for adjustments. Performance objectives will have to be determined and will be one of the bases of evaluation. They may include objectives for developing savings in order to encourage bank use. Regular evaluations must be carried out as the project unfolds, in order to take into account changes in the environment as well as the programâ&#x20AC;&#x2122;s impact on both the partner financial intermediaries and the end beneficiaries. Such evaluations can adjust the project system if necessary and ensure that it is being implemented properly, by taking into account its impact at various levels. With regard to the agricultural environment, and especially the evolution of agricultural markets and practices, it is important to make sure that the investments promoted by the project in the new context are appropriate. It is also necessary to monitor the evolution of the financial services supply in the target areas (existence of financial intermediaries, conditions of financial products offered, evolution of volumes, competition situation); this can lead to identifying new potential partners. The impact on the partner financial intermediaries must also be evaluated regularly. This includes impact on the evolution of their financial services (conditions and volumes, credit and savings), the evolution of the organization, and the evolution of their competencies in the sector. At the beneficiary level, the main aspects to evaluate are the proper technical usage of investments, their profitability, the evolution of the overall economic situation, the evolution of savings deposited in the financial sector, and the use of financial services. Proper implementation of the project overall should also be evaluated regularly: reaching set goals, proper implementation of the system to check eligibility conditions, good impact from the subsidization on the end beneficiary, and effective distribution costs for the financial intermediary. The protocol agreement with the financial intermediaries must include quantitative performance measures that will be followed regularly, especially during these evaluations. Impact evaluations based especially on the continued collection of quantitative data should continue over the long term (at least during the entire loan repayment period), in order to measure the impact on the end beneficiaries of the project, on the sector

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(identification of possible imitation phenomena), and on the partner financial intermediaries. These evaluations will have to focus in particular on the appropriateness of the use of subsidization in order to meet the program objectives.

Establish an effective and lightweight auditing system Summary The auditing system is essential to avoid the perverse effects of the subsidy systems, so that they do not benefit certain categories of population or financial intermediaries. It must remain lightweight to keep costs down. In any subsidy system, auditing is essential to make sure that the subsidies reach the targeted beneficiaries according to the defined eligibility criteria. A system of permanent auditing must thus be set up. Auditing must be done systematically on documents and above all on a sample of cases on-site. It is important to enact the recommendations of the auditing reports. The protocol agreement must provide for penalties and possible early withdrawal of the project if the eligibility criteria are not respected. While cost must be a factor when choosing the auditor, the latter must also have good incentive to carry out the auditing correctly. The auditor chosen may be a consortium made up of a local accounting firm and one or more reliable technical partners not involved in the project, which will be paid a set annual fee. Choosing reliable technical partners is difficult: it is rare to find organizations that are technically competent, available for the length of the project, and impartial. The choice is nevertheless essential for any program that includes grant or subsidy distribution. In the case of setting up interest rate subsidies based on the financial intermediaryâ&#x20AC;&#x2122;s own resources, subsidized via an interest rate subsidy fund, payment of the subsidies can take place only after the investment has been made, and after presentation of supporting documents. This is what is practiced in Madagascar as part of the program of the United Nations Capital Development Fund (UNCDF) and the European Union, which was launched with the CECAM network and extended to the entire microfinance network. In this case, the financial intermediary sets up credit with subsidized conditions and receives payment of the financial compensation for the subsidization on an annual basis, after the receipts of the investments are presented.

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Plan the exit strategy from the program design phase Summary Like in any grant/subsidy program, the exit strategy must be planned from the setting up of the intervention. The customers will have to be informed about the subsidization of the interest rates, so as to prepare them for when market conditions will come into effect at the end of the program. The exit strategy has to be planned differently, according to whether the program is a one-off measure to finance structural evolutions in the agricultural sector, or the launch of a permanent activity for investment credit. If the program is a one-off measure to finance structural evolutions in the agricultural sector, it will be necessary to evaluate how much time will be required for the loan implementation phase to achieve the aims in terms of these structural evolutions. The use of international aid to support the program can be considered for the entire planned length of the program, under the condition that it unfolds properly. International aid only during the start-up phase can also be considered: if initial investments are of an exemplary nature, the financing can be replaced by local budget resources, which may be made available under less favorable conditions. At the end of the program, the financial intermediary will in any event not continue to offer the loan under subsidized conditions. According to demand and the evolution of profitability in the sector, it will perhaps replace the subsidized supply with one under market conditions. The structural evolutions underway may enable the clientele to pay market rates for investing in equipment. Whatever the case, the program will have the impact of having increased the clienteleâ&#x20AC;&#x2122;s bank use, thanks to its having established a relationship between the customers and the financial intermediaries. If the program is to help launch a permanent activity for investment credit, the objective of the subsidization phase will be to anticipate the decrease in distribution costs to the financial intermediary and to encourage customers to invest. At the end of the project, the financial intermediary, thanks to the experience it will have gained, should continue distribution of loans for investment in equipment, under conditions whose evolution should be planned from the phase when the loans are set up. Depending on circumstances, the subsidization may be divided in different proportions between the financial intermediary (covering launch costs) and the beneficiaries (reduction of rates to act as an incentive, in a launch phase). This will result in an evolution of exit interest rates according to the share intended for the end beneficiary.

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In both cases, communication on the length of support and the evolution of the supply will have to be clear, as much for the financial intermediary as for its clients and environment. This communication will play an important role in particular for informing the beneficiaries about the real cost of credit; it will thereby enable the cost transparency that is required for a credit supply under market conditions to be able to take over from a subsidized supply.

4.2.2. Targeting: an essential element for effectiveness and cost control Targeting for the subsidization is an essential element for effectiveness and cost control; it concerns both the purpose of the loans and the eligible beneficiaries. In France and in the United States, subsidized loans were initially distributed very broadly, and with a social objective. The high costs of these programs then led the public authorities to refocus them on specific clientele and for specific purposes, in order to increase their effectiveness. As the OECD noted following the lessons it learned from agricultural loan subsidization experiences throughout the world, loans with reduced interest rates thanks to state subsidies can contribute to achieving the objectives of agricultural policy if they are used selectively (OECD, 1970).

Target the purpose of the financing properly Summary The impact of subsidization and its use are maximized in the case of financing investments (equipment, animals, planting), but subsidization can also be used under certain circumstances to finance needs in working capital (inputs). The financing of real estate investments must be considered with much care. Loans to finance short-term economic needs can generally be accepted under market conditions. Interest rates become much heavier for medium- and long-term credit, and their weight can prevent an investment from being profitable. The profitability of an investment may be late in coming , if it is not high enough to cover market interest rates over the medium and long terms. Furthermore, there is greater uncertainty in the long-term (regarding prices and markets), and this weighs on the level of income, which must be secure enough to be able to repay a loan. As confirmed by the Triodos Facet study (2011), which was based on six case studies, it is in reality the medium- and long-term needs that turn out to be practically impossible for farmers to finance, even though their short-term needs are also far from being covered.

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Furthermore, in the context of structural change, investment in equipment has a higher impact than does the purchase of inputs, thereby justifying subsidization of the former. However, while improvement in agricultural performance in developed countries requires investment in equipment, the use of inputs may be a crucial stage for improvement of agriculture in developing countries: for this reason, subsidization of short-term credit should not be totally excluded. Purchase of land is a special case: while clarification of the land tenure situation of farmers is a precondition that has decisive influence on the carrying out of investments on farms, the question of financing land purchase through subsidized credit is a tricky one. Real estate loans are in any event conceivable only in countries where the land tenure issue is sufficiently developed. In these contexts the OECD’s warning must be taken into account: “ a particular difficulty arises when interest rate subsidies are granted for land purchase: their effect risks putting greater price pressure on land, and the long-term advantage for the agricultural community could thus become negligible ” (OECD, 1970). The France case study has shown the mixed results of subsidized real estate loans, especially for smallholder farmers.

Define the target clientele, in order to have sustainable impact Summary In order to encourage sustainable impact, the definition of the target clientele must take into account its risk and profitability profile over the long term (after the end of subsidization). The target clientele of interest rate subsidy programs is clientele with the capacity to make the investment financed profitable, thus making its use sustainable. This in turn leads to change in agricultural modes of production. One of the advantages of the interest rate subsidies approach is that it is financial intermediaries, whose business it is to choose clients with sustainable activities, that are put in charge of selecting the beneficiaries. This aspect must be taken into account when defining the program: it is important to target farmers who not only would not invest in equipment without interest rate subsidies (to avoid windfall effect and generate an additional positive effect), but who also meet the required conditions to make that investment profitable (to ensure the sustainability of impact). Determination of the target can thus be based on several criteria: surface area under cultivation, potential surface area, age, crops cultivated, or farm income (there are several management centers that can check the estimation of this income).

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4.2.3. Financial and non-financial loan conditions whose aim is to establish healthy behavior Limit the proportion of subsidization, with a view to making impact sustainable Summary Setting the level of subsidization is a tricky exercise that must be carried out taking into account the constraints of credit supply and demand. It is better for it to be as low as possible, to avoid attracting persons with influence who could seek to misappropriate the subsidization benefits to their own advantage. When the purpose of subsidization is to launch an investment credit activity via a financial intermediary, the level of subsidization will have to be negotiated with the latter, taking into account the foreseeable long-term evolution of its costs. An interest rate is a price whose purpose is to balance the supply and demand for credit. Subsidization is relevant in a context in which supply and demand are not compatible: the purpose of subsidization is to make them compatible. On the demand side, the acceptable interest rate is determined by the investment’s profitability: theoretically, the interest rate must be positioned below the investment’s internal rate of return (IRR). In addition to this theoretical reasoning, the risk inherent in any change in mode of production as well as in family farming’s aversion to risk, which is more difficult to quantify, are to be taken into consideration. It is thus necessary to plan, at least initially, a margin of incentive for the end beneficiary. This is all the more important when financing green investment, in which the impact of changing techniques leads to positive externalities rather than profitability for the farmer concerned. On the supply side, the interest rate must be superior to the cost of implementation. Here as well the cost of the risk must be taken into account. In a new market lacking statistics, a financial intermediary will tend to make a conscious evaluation of the risk, and thus to over-evaluate. It can later decrease the interest rate based on concrete experience. The interest rates may be different according to the beneficiary. This has been the practice of the PRONAF program in Brazil, which, to support small farms subsidizes interest rates for them at higher rates than for big farms; this goes against the economic logic that would provide less expensive credit to big farms, which thanks to their size can enjoy economies of scale.

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It is better to avoid too much subsidization, which could create the risk of corruption if it attracts elite who seek to misappropriate the subsidy to their own advantage. In this regard, it is preferable for the subsidized rate to be at least higher than inflation. This is because the more attractive the conditions of such support are, the more persons with influence will be tempted to use that influence to misappropriate the support for themselves. They may go so far as to put so much social pressure on the personnel of a financial intermediary that it becomes difficult for it to resist and to apply procedures correctly, especially in terms of the eligibility criteria. The loan thus granted under favorable conditions could then be used to invest in private affairs. If loan disbursements are only in kind, they can be used on the personal farm of such persons with influence (who are not part of the program’s target) or sold to people who are not participating in the program. When subsidization is set up to enable the launch of an investment credit activity that will have to become permanent, the level of subsidization will have to be negotiated with the financial intermediary, taking into account the foreseeable long-term evolution of costs. It is important to take into account costs at different levels: the distribution costs (costs of rural agencies that are growing, costs of rural credit agents with a mature portfolio—continuing education, monitoring, payment of interest, and travel costs) the costs of management, and the cost of risk (which could be lessened in the long-term by setting up a disaster fund, mechanisms for price stabilization, and an insurance mechanism).

Define suitable non-financial conditions Summary As with any agricultural credit, the non-financial conditions of loans are as important as the financial conditions and must not be ignored in a subsidization program. These are loan life, grace period, repayment schedules, guarantee demanded, and possibility of advance repayment. The architecture of the credit products must be clearly defined, according to each situation. When doing so, the schedules of the farms’ liquidity flow (not only the income from the production for which the program is intended, but also all the agricultural and non-agricultural income from the target farms; the expenditures of the entire farm, including the schedule of social security contributions, back-to-school costs, etc.) and the possible deferred profitability of the investment (planting, young animals, etc.) must be taken into account to determine the schedules.

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The loan life must be long enough to enable the profit generated by the investment pay for the repayment, with a margin to take into account the risks that weigh on agricultural income. The possibility of paying back the loan in advance and at no charge must be provided for and explained to the beneficiaries. They must be encouraged to use this possibility as a way to reduce their expenses. The guarantees that are demanded must also be adapted to the real means of the farms. Also, to limit the risks of the loan being diverted to purposes other than what was intended, good practices in agricultural credit recommend, whenever possible, disbursing the loan to the lender so that it releases it in kind for the borrower. This nonetheless means that the lender could use the subsidy for other than what was intended or other than for the target, and that the lender’s duties must be included in the auditing process.

Require borrowers to contribute their own resources Summary A practice that is common to subsidy systems and to investment credit, and that thus must be doubly applied in the case of interest rate subsidies, is that borrowers be required to contribute their own resources. This guarantees borrowers’ personal involvement in the project and maximizes the leverage of the subsidization. One of the good practices recommended for subsidizing economic activities is participation by the beneficiaries, according to their capacities in a given context (Meyer 2011). Likewise, for credit, some microfinance methodologies are based on the borrowers contributing their own resources beforehand, which is all the more relevant in the case of medium-term loans for financing investments. This prior contribution must not be confused with the blocked-deposit system practiced by many microfinance institutions; this consists in blocking some of the credit, which may or may not be contributed beforehand by the borrower, in an account in the borrower’s name at the financial institution, thereby acting as a financial guarantee. The financial consequence of this practice is the increase in the real interest rate of the loan, insofar as the borrower cannot freely use some of his or her credit, but pays interest on everything. In the case of both a prior contribution and a blocked deposit, the purpose of this equity is to measure the borrower’s interest in the investment by demanding a personal commitment.

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If personal resources are required, they will be part of the project’s financing plan. This contribution can be built up gradually, as part of a project-savings plan if the financial intermediary offers this product. However, we should remember that this requirement for personal resources must be evaluated flexibly: entrepreneurs who have heavily invested to create their businesses do not necessarily have the means to provide cash for part of the investment to finance with credit. The existing activity should therefore be taken into account in some cases as personal resources, as a way of affirming the borrower’s real investment in the activity.

4.3. Support measures Provide technical and management support for the end beneficiaries Summary As interest rate subsidies often apply to investments, it is essential to provide the end beneficiaries with both technical and management support in the proper use of these investments. Support measures are essential in order to obtain impact from programs designed to introduce new techniques. Whenever possible, it is best that they be entrusted to institutions already existing in the beneficiary’s environment. At the technical level, this will involve introducing new agricultural techniques and their proper use, as well as monitoring the implementation of new skills. In terms of management, support is needed in monitoring accounts (simplified operating account, liquidities forecast) and planning for the development of the farm (farm development plan, investment project). As the U.S. example shows, the advantage of subsidy distribution in the form of interest rate subsidies is that the relationship with the beneficiary is established over the long term, thereby facilitating the establishment of supervision. It is generally advised that support be provided by bodies independent of the financial intermediaries, even though this practice is sometimes put into question.

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Provide technical assistance to the financial intermediaries in order to set up the distribution of the subsidized credit Summary Technical assistance for the financial intermediary, which implies a need for subsidies, will often be necessary to ensure that the subsidized credit is distributed under the right conditions. This is especially true if the financial intermediary has no experience in financing agriculture, and in particular when the purpose of the subsidization is to launch an in-house activity to provide loans for investments. For the program to be carried out properly, the donor must make sure that the partner financial intermediaries have the means to implement it under the right conditions. Above and beyond this first objective, the program will seek to establish the right conditions for the financial intermediary to be able to continue offering credit to farmers after the program’s intervention period. This ties in with the priority to be given to financial intermediaries working in the local market, in accordance with the principle of subsidiarity stated in the AFD strategy for a mix of loans and donations. Assistance provided to the financial intermediary will differ greatly depending on its experience in agricultural financing, its existing system, and its network. The idea is to accompany the financial intermediary so that it sets up all the elements needed for proper distribution of the subsidized loans. This may require a support grant that will have to be worked out based on sharing of costs for the launch of a new activity or for the development of an existing activity. The purpose of this grant will be to support the financial intermediary in setting up effective operations during the launch phase, by financing aspects such as knowledge of the market and development of suitable tools and procedures (evaluation of demand, monitoring loans, loan management system, etc.). AFD sometimes finances such changes based on calculation of the comparative financial advantage included in the subsidization of a credit line for a financial intermediary (AFD, 2009 and 2011). This type of mechanism does not come within the scope of this review, but it could be used to provide the extra subsidy needed that comes in addition to the share of subsidization allocated directly to the interest rate. It would nevertheless seem simpler and more transparent to use a separate grant. If this is not the case, it is important to separate—in both the initial negotiation and in the implementation follow-up—the subsidy intended for transfer to the end beneficiary from that intended to provide support for change within the financial intermediary.

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This also has an effect on reports on the use of the subsidy, as it is important to identify the subsidies going to the end beneficiary (and thus to the agricultural sector) and those going to the financial intermediary (and thus to the financial sector).

Communicate information to the financial intermediaries and the end beneficiaries Summary Communication measures must accompany the program, targeting both the financial intermediaries and the end clients, in order to guarantee the sustainability of both supply and demand after the subsidization program. The goal of communication targeting the financial intermediaries is to make sure that all those wishing to develop an activity in agricultural financing be aware of the conditions for participating in the program and be able to apply for partnership. Communication targeting the beneficiaries must be done in close coordination with the partner financial intermediaries. It must focus on the conditions of the credit supply (purpose, eligibility criteria, conditions), the length of the program, and the importance of developing savings in order to implement the investment projects.

Improve the borrower’s environment, according to needs Summary Support measures may also be needed to improve the farmer’s environment, e.g. for land tenure, infrastructures, or agricultural insurance. For coherent implementation of a country’s agricultural policy, measures to improve the environment surrounding the agricultural activity are also needed. Some concern the agricultural financing directly, such as the land-tenure issue and mechanisms for risk reduction. The land-tenure issue is of particular significance, as a clear tenure situation is often a prerequisite for improvement of the farm, soil preservation, the planting of trees, and thus for the implementation of conditions favorable to the use of the investment. Furthermore, a clear tenure situation, with a land registry and the possibility of taking out mortgages, facilitates guarantees for agricultural credit. Poor quality of infrastructures in rural areas has an impact on farmers. For this reason, when setting up interest rate subsidization, providing states with support for infrastructure development at the same time as providing them with grants is crucial for obtaining long-term impact.

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4.4. Conclusions Interest rate subsidies can be a worthwhile tool for supporting agriculture, as long as conditions are favorable and the tool well designed and implemented Summary Subsidization continues to seem like a worthwhile tool for supporting agriculture, as long as conditions are favorable or made favorable by support measures, and as long as the system, targets, and loan conditions are thought out properly. Rigorous monitoring and management are required to avoid straying from the objectives, and this often leads to high costs for the system. The main recommendations about the implementation of programs that include subsidized credit concern the context of the intervention, the subsidization system, the targeting of the support, the loan conditions, and the support measures, as detailed below. Context of the intervention Interest rate subsidies must first and foremost be part of a coherent, global, and longterm system of public support for the development of family farming. Furthermore, like any intervention based on credit, interest rate subsidies for agricultural loans can only be created in countries with a functional financial system and a positive and stable economic situation. A local financial intermediary capable of distributing subsidized credit must exist before implementation of such a program can be considered. If none exists, government intervention will be needed to help one or more financial intermediaries that wish to branch into this sector, and subsidy-type support will be required. Subsidization system A crucial element behind a successful program is the selection of the financial intermediaries that will become the partners in charge of distributing the subsidized credit. Any financial intermediary (public or private) that meets certain criteria should be eligible to participate in the program. New partners should be able to join in the program if the occasion arises. The system must be designed in such a way that lenders can make their loan attribution decisions independently. They must thus be free to select their customers, within the identified target population.

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4. Recommendations

The risks associated with the subsidized loans must be assumed by the lender, at least partially. The total volume of the intervention must be large enough to avoid excessive distortion of competition among farmers. At the same time, it is important to make sure that the partner lenders have the capacity to participate in the program so as to avoid creating unbalances in their activities. The systemâ&#x20AC;&#x2122;s relevance must be evaluated regularly to allow for adjustments. Performance objectives must be defined and be one of the bases of evaluation. These can include objectives for developing savings in order to encourage greater bank use. An audit system is essential to avoid the perverse effects of subsidy systems wherein certain categories of the population or the financial intermediaries take advantage of the benefits. Keeping the audit system lightweight for cost reasons is one of the obstacles to achieving effectiveness in such programs The exit strategy must be progressive and planned as early as the implementation phase. A communication plan about the subsidization of the rates will be needed to prepare customers to use commercial credit after the end of the program. Targeting of support Targeting of the interest rate subsidy is essential for both effectiveness and cost control, both in terms of what the loans are used for and with regard to the borrower. The impact and usefulness of subsidization are maximized when the loan is used for investments (in equipment, animals, planting, etc.). But the subsidization can also be used under certain circumstances, to finance working capital (for inputs). Financing real-estate investments must be considered with great care. Targeting of the borrowers is also important for achieving sustainable impacts: indeed, the target clientele must be defined taking into account its risk profile and potential for long-term profitability (after subsidization ends). Loan conditions Determining the loan conditions is crucial for obtaining sustainable impacts from a subsidization program. Setting the level of subsidization is quite complex, and must take into account the constraints of existing credit supply and demand. The level should be as low as possible in order to avoid attracting persons with influence who might seek to misappropriate the subsidization benefits to their own advantage.

July 2015 / Agricultural Credit: Assessing the Use of Interest Rate Subsidies / ÂŠ AFD

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4. Recommendations

A SAVOIR

When the purpose of the subsidization is to launch an investment credit activity within a financial intermediary, the level of subsidization will have to be negotiated with the latter, taking into account the foreseeable changes in its costs over the long term. The non-financial conditions of loans are as important as the financial conditions and must not be ignored in a subsidization program: loan life, grace period, repayment schedules, guarantee demanded, and possibility of paying back the loan in advance. In the case of financing and investment, a contribution from the borrower should be required so as to guarantee his or her personal involvement in the project and to maximize the leverage of the subsidization. Support measures Support at various levels of the intervention is essential for a successful subsidized loan program. It is important to provide technical and management support to guide the final beneficiaries in using their investments wisely. Technical assistance for the financial intermediary, which involves a need for subsidies, will often be necessary to ensure that the subsidized credit is distributed under the right conditions. Communication measures targeting both the financial intermediaries and the end customers must be included in the program in order to ensure sustainability of both supply and demand at the end of the subsidization program. Support measures may also be necessary for background issues such as land tenure, infrastructure, and agricultural insurance.

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ÂŠ AFD / Agricultural Credit: Assessing the Use of Interest Rate Subsidies / July 2015

Appendix List of persons contacted Aurélie CHEVRILLON Agriculture, Rural Development and Biodiversity Division, Sustainable Development Department – AFD Camille SÉVERAC

Financial Institutions and Private Sector Division, Private Sector, Banks and Local Authorities Department – AFD

Didier SIMON

Economist, Agricultural, Rural Development and Biodiversity Division, Sustainable Development Department – AFD

Jean-Luc FRANÇOIS Head of the Agriculture, Rural Development and Biodiversity Division, Sustainable Development Department – AFD Agriculture, Rural Development and Biodiversity Division, Sustainable Development Department – AFD

José TISSIER

Marie-Cécile THIRION Research and Development Division, Studies, Research and Knowledge Department – AFD Mathilde GASPERI

Agriculture, Rural Development and Biodiversity Division, Sustainable Development Department – AFD

Mustapha KLEICHE

Financial Institutions and Private Sector Division, Private Sector, Banks and Local Authorities Department – AFD, Energy–environment sector

Naomi NOËL

Agriculture, Rural Development and Biodiversity Division, Sustainable Development Department – AFD

Philippe SERRES

Financial Institutions and Private Sector Division, Private Sector, Banks and Local Authorities Department – AFD, Microfinance sector

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Appendix

A SAVOIR

Vatche PAPAZIAN

Agriculture, Rural Development and Biodiversity Division, Sustainable Development Department – AFD

Claude TORRE

Agriculture, Rural Development and Biodiversity Division, Sustainable Development Department – AFD

Aphichart ASSAKUL

Agriculture, Rural Development and Biodiversity Division, Sustainable Development Department – AFD

Renate KLOEPPINGER ex Rural Finance Advisor, World Bank Philippe BOULLET

Director of the Conseil National of CERFRANCE

Alain FOURNIER

Director of Ambre Conseil, part of CERFRANCE Lot-et-Garonne

Gilles THIERRY

Responsable Agriculture at Crédit Agricole

André BAUDELET

Statistician at Crédit Agricole

Benoît THIERRY

Country Program Manager Nepal and Thailand, Asia and the Pacific Region Division (APR), Department for Operations – IFAD

Francesco RISPOLI

Technical Adviser, Rural Finance, Technical Advisory Division, Programme Management Department – IFAD

Michael HAMP

Senior Advisor, Rural Finance – IFAD

François DOLIGEZ

Iram, Université de Rennes 1

Patrick MUNDLER

Directeur département études rurales – ISARA Lyon

Christoph KESSLER

Head of Agriculture & Natural Resources Division, Africa – KfW

Claudia SCHMERLER Senior Officer in charge of Agriculture Finance, Financial Sector – KfW

[144 ]

Eva TERBERGER

Direktorin, Evaluation Department – KfW

Matthias ADLER

Principal Financial Sector Economist – KfW

Appendix

Ron WEBER

Evaluation Department – KfW

Maurice DESRIERS

Service Statistique & Prospective – French Ministry of Agriculture

Sylvie JOURNO

Bureau du crédit et de l’assurance, gestionnaire des prêts bonifiés – French Ministry of Agriculture

Kofi OWUSU-BOAKYE Office of Development Credit – U.S. Agency for International Development (USAID)

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Acronyms and abbreviations AATIF

Africa Agriculture Trade and Investment Fund

ACIF

Agricultural Credit Insurance Fund (USA)

AFD

Agence Française de Développement

AfDB

African Development Bank

AGF

Government Commodity Acquisition Program (Brazil)

ASP

Agency for Services and Payment (France)

BAAC

Bank for Agriculture and Agricultural Cooperatives (Thailand)

BMZ

Bundesministerium für Zusammenarbeit

BNDES

Brazilian National Economic and Social Development Bank

BRI

Bank Rakyat Indonesia

BRL

Brazilian real

CABFIN

Improved Capacity Building in Rural Finance

CAP

Common Agricultural Policy

CCC

Commodity Credit Corporation (USA)

CER

Agricultural Management Center (France)

CGAH

Accredited and Authorized Management Centers (France)

CNASEA

National Center for the Management of Farm Structures (France)

CNCA

Caisse Nationale de Crédit Agricole

CONAB

National Food Supply Agency (Brazil)

CPR

Rural Product Certificate (Brazil)

DACS-AGRI Specific Support Plan for Farmers in Difficulty (France)

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Acronyms and abbreviations A SAVOIR

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DCA

Development Credit Authority (USAID)

DDAF

Departmental Agriculture and Forestry Directorate (France)

EAFRD

European Agricultural Fund for Rural Development

EEC

European Economic Community

EGF

Government Commodity Loan Program (Brazil)

Emergency Disaster (USA)

ERS

Economic Research Service

FAC

Fund to Ease Financial Burden (France)

FAT

Workers Support Fund (Brazil)

FCS

Farm Credit System (USA)

FmHA

Farmers’ Home Administration (predecessor of the FSA)

Farm ownership (USA)

FSA

Farm Service Agency (USA)

GAO

United States General Accounting Office

GDP

Gross domestic product

GEF

Global Environment Facility

GIZ

Deutsche Gesellschaft für Internationale Zusammenarbeit

GSE

Government-sponsored enterprise (USA)

IBGE

Instituto Brasileiro de Geografia e Estatistica

IDA

International Development Association (World Bank fund for the poorest)

IFAD

International Fund for Agricultural Development

Incra

National Institute of Colonization and Agrarian Reform (Brazil)

IRR

Internal rate of return

Acronyms and abbreviations

KfW

Kreditanstalt fĂźr Wiederaufbau (Credit institution for reconstruction)

MAPA

Ministry of Agriculture, Livestock, and Food Supply (Brazil)

MDA

Ministry of Agrarian Development (Brazil)

MFW4A

Making Finance Work for Africa

NGO

Non-governmental organization

NPR

Rural Promissory Note system (Brazil)

OECD

Organization for Economic Co-operation and Development

Operating loans (USA)

PAR Portfolio-at-risk PEP

Subsidy Auction Program (Brazil)

PNRA

National Agrarian Reform Plan (Brazil)

PROAGRO Federal Guarantee Program of Agricultural Activities (Brazil) PRONAF

National Program to Strengthen Family Farming (Brazil)

PSEA

Special Agricultural Support Plan (France)

RFP

Rural Finance Policy

RNEA

Net farm income

SEAF

Seguro da Agricultura Familiar (Brazil)

SME

Small and medium enterprises

SNCR

National Rural Credit System (Brazil)

UNCDF

United Nations Capital Development Fund

USAID

United States Agency for International Development

USDA

United States Department of Agriculture

WTO

World Trade Organization

July 2015 / Agricultural Credit: Assessing the Use of Interest Rate Subsidies / ÂŠ AFD

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Presentation of the authors Christine WESTERCAMP, is a senior consultant at HORUS Development Finance and has been working in microfinance since 1987. A specialist of rural and agricultural finance, she provides sector and microfinance program support for financial institutions, governments, and regulatory bodies. Miryam NOURI, Miryam Nouri is a consultant at HORUS Development Finance. She is specialized in strategy and mobile banking, especially for projects to implement mobile financial services to increase bank use in the rural world. André OERTEL, André Oertel is a senior consultant at HORUS Development Finance. He has been a specialist in microfinance and SME financing since 1991. He supervises SME finance projects and advises banks, microfinance institutions, and institutions in charge of financial sector regulation.

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Already published in the collection À S avoir N O. 1: La régulation des services d’eau et d’assainissement dans les PED The Regulation of Water and Sanitation Services in DCs À Savoir N O. 2: Gestion des dépenses publiques dans les pays en développement À Savoir N O. 3: Vers une gestion concertée des systèmes aquifères transfrontaliers Toward a Joint Management of Transboundary Aquifer Systems À Savoir N O. 4: Les enjeux du développement en Amérique latine Los desafíos del desarrollo en América Latina À Savoir N O. 5: Transition démographique et emploi en Afrique subsaharienne À Savoir N O. 6: Les cultures vivrières pluviales en Afrique de l’Ouest et du Centre Rainfed Food Crops in West and Central Africa À Savoir N O. 7: Les paiements pour services environnementaux Payments For Ecosystem Services À Savoir N O. 8: Les accords de libre-échange impliquant des pays en développement ou des pays moins avancés À Savoir N O. 9: Comment bénéficier du dividende démographique ? How Can We Capitalize on the Demographic Dividend? À Savoir N O. 10: Le risque prix sur les produits alimentaires importés – Outils de couverture pour l’ Afrique À Savoir N O. 11: La situation foncière en Afrique à l’horizon 2050 À Savoir N O. 12: L’agriculture contractuelle dans les pays en développement – une revue de littérature Contract Farming in Developing Countries – A Review À Savoir N O. 13: Méthodologies d’évaluation économique du patrimoine urbain : une approche par la soutenabilité À Savoir N O. 14: Assurer l’accès à la finance agricole Creating Access to Agricultural Finance À Savoir N O. 15: The Governance of Climate Change in Developing Countries À Savoir N O. 16: Renforcer la mesure sur la qualité de l’éducation À Savoir N O. 17: Gérer l’instabilité des prix alimentaires dans les pays en développement Managing food price instability in developing countries

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Already published in the collection

À Savoir N O. 18: La gestion durable des forêts tropicales – De l’analyse critique du concept à l’évaluation environnementale des dispositifs de gestion À Savoir NO. 19: L’Afrique et les grands émergents À Savoir N O. 20: Abolishing user fees for patients in West Africa: lessons for public policy À Savoir N O. 21: Coopérations Sud-Sud et nouveaux acteurs de l’aide au développement agricole en Afrique de l’Ouest et australe – Le cas de la Chine et du Brésil À Savoir N O. 22: L’enseignement privé en Afrique subsaharienne : enjeux, situations et perspectives de partenariats public-privé À Savoir N O. 23 : Les stocks alimentaires et la régulation de la volatilité des prix en Afrique À Savoir N O. 24: Les enjeux du développement en Amérique latine (Deuxième édition) Los desafíos del desarrollo en América Latina (Segunda edición) Os desafios do desenvolvimento na América Latina (Segunda edição) À Savoir N O. 25: Tools for what trade? – Analysing the Utilisation of Economic Instruments and Valuations in Biodiversity Management À Savoir N O. 26: Gestion du patrimoine urbain et revitalisation des quartiers anciens : l’éclairage de l’expérience française À Savoir N O. 27: Les évaluations d’impact dans le domaine du développement Development Impact Evaluations À Savoir N O. 28: Les agricultures familiales du monde Family Farming Around the World À Savoir N O. 29: Crédits agricoles : que penser de la bonification des taux d’intérêt ?

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What is AFD? Agence Française de Développement (AFD), a public financial institution that implements the policy defined by the French Government, works to combat poverty and promote sustainable development. AFD operates on four continents via a network of 72 offices and finances and supports projects that improve living conditions for populations, boost economic growth and protect the planet. In 2014, AFD earmarked EUR 8.1 bn to finance projects in developing countries and for overseas France.

www.afd.fr

Agence Française de Développement 5, rue Roland Barthes – 75598 Paris cedex 12 Tel: 33 (1) 53 44 31 31 – www.afd.fr Copyright: 3 rd quarter 2015 ISSN: 2105-553X

July 2015

Agricultural Credit: Assessing the Use of Interest Rate Subsidies

CONSULTANTS

COORDINATION

Christine WESTERCAMP Miryam NOURI André OERTEL

Aurélie CHEVRILLON and Mathilde GASPERI chevrillona @ afd.fr gasperim @ afd.fr AFD Sustainable Development Department

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29 Agricultural Credit: Assessing the Use of Interest Rate Subsidies / July 2015

Agricultural Credit: Assessing the Use of Interest Rate Subsidies A SAVOIR

Christine WESTERCAMP Miryam NOURI André OERTEL

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