According to ISF Advisors, an industry strategy group, small and medium agricultural enterprises (SMEs) in developing countries face a financing gap of $106 billion.
In its recent report published in partnership with Commercial Agriculture for Smallholders & Agribusiness (CASA) – with support from the UK Foreign, Commonwealth & Development Office and USAID – ISF estimates that around 220,000 “agri-SMEs” in sub-Saharan Africa and in Southeast Asia need a total financing of 160 billion dollars; but only $54 billion of that is covered through formal channels.
The financing needs of these companies are all the more urgent as developing countries seek to adapt their food supplies and economies to climate change. Moreover, taken together, these countries are now the biggest emitters of greenhouse gases, according to the Center for Global Development – which puts their contribution at more than 60%.
Adding to this seemingly dire picture is another data point from the Climate Policy Initiative, which indicates that small-scale agriculture received just 1.7% of the total $530 billion in global climate finance tracked between the years 2017 and 2018.
The private investment gap is the largest
Given this, investing in the development of market innovations that can reduce the footprint of the agricultural industry seems crucial. But the ISF report highlights a particular gap when it comes to the funding category typically tapped by startups: venture capital.
According to the ISF, private equity and venture capital financing for agricultural SMEs in developing countries totals only $1-2 billion per year. This suggests that the misalignment of expectations between companies, investors and financiers plays an important role here. For example, “investor expectations for risk-adjusted returns, ticket size, and investment horizon often do not match the investment readiness, scale, and capital strategies of agricultural SMEs. “, says the report.
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The main sources of finance for agricultural SMEs are local commercial banks which contribute $40 billion in short and medium term loans with strong collateral bonds. They particularly prefer to invest in larger and more mature companies within the SME sphere, such as established aggregators and local processors that control regional or national markets.
Then there are public development banks and social lenders that typically provide short-term finance and working capital loans to low-growth, less mature, and less profitable agricultural SMEs; these contribute between 3 and 4 billion dollars.
Closing the agricultural financing gap
The ISF report suggests four long-term changes that could systematically close the gap over time:
- Donors must find ways to build infrastructure around climate finance. This specifically means establishing a taxonomy defining what constitutes environmentally sustainable investments in agriculture, integrating climate expertise into agricultural SME financing, and making greater investments.
- Better enable the growth of large numbers of commercially investable agri-SMEs, which could anchor local banking markets for financing.
- Develop the infrastructure, incentives and capacity of local banks and donors that are needed to serve smaller, less commercially viable agricultural SMEs.
- Make blended finance more efficient and effective.