Agricultural Credits: What about subsidized interest rates?

Lamon Rutten

The fallacy of subsidizing interest rates for agriculture

When I hear “subsidizing interest rates to promote agricultural lending”, ominous music starts playing in my head. Another instalment of Zombie Revival is about to start. You’d think the evil critters were dispatched for good, but no, someone thinks they should be given a second chance. And before you know it, the living deads are back in your streets, trying to create their particular version of peace and harmony.

Almost everywhere (except in countries that could afford to ignore reality), the most recent incarnation of this dastardly idea was well put to rest in the 1980s. Study after study showed that subsidizing agricultural credit is a bad idea. It leads to rationing of credit, leaving the powerful with cheap money that they often don’t use for farming, and the real farmers excluded from the formal financial system. And commercial lenders are chased out of agriculture.

Most of the institutions that managed the subsidies became hotbeds of inefficiency and corruption, convenient for politicians but a drain on the public purse.  These institutions fell bankrupt in the 1980s, and subsidy schemes collapsed in the face of widespread budget cuts and donor disaffection. Unfortunately, commercial banks were still rankled by what they had seen of agricultural finance, and at least in Africa, little was done to develop new, market-based solutions. The agricultural sector was left a credit orphan. Only a small minority of African farmers gained access to formal sector credit, and that often at ridiculously high interest rates.

The 2008 food crisis put the spotlight on agriculture, and the need to develop agricultural finance was evident. Quick action was needed, any action, and subsidizing interest rates seemed an evident idea.  It was time for a zombie revival. Surely, this time round we would be able to control the zombies, we could make them work for the common good! The US and France did it!  (who cares that heavy bureaucracies absorbed much of the governments’ funds). If developing country farmers are lent too little, it must be because they are unable to pay the interest rates demanded by banks!?

Not really. Indeed, we now know much about agricultural finance and what makes it work, and what hinders financiers in reaching farmers. Rather than supporting a zombie revival and pretend that this time, the new institutions we’ll create will be able to control them, governments and donors should put their funds in de-bottlenecking and de-risking agri-finance, with indirect rather than direct subsidies: improve legal and regulatory systems; develop proper instruments for Central Banks; promote competition in rural lending; build systems that can support agri-finance, from grading laboratories to credit registries and collateral management companies; build awareness of agri-finance techniques among financiers; accompany value chain finance by actions that help farmers improve their productivity and profitability; reduce information gaps; leverage ICTs to reduce financing costs and improve lenders’ reach...  But let the corpse of interest rate subsidies rest in peace, and its ghost stop haunting us. 

The Technical Centre for Agricultural and Rural Cooperation (CTA) is a joint international institution of the African, Caribbean and Pacific (ACP) Group of States and the European Union (EU). CTA operates under the framework of the Cotonou Agreement and is funded by the EU.