NextBillion - An Initiative of the William Davidson Institute at the University of Michigan

It’s not easy to improve farmers’ livelihoods in any developing country. Add in ongoing violence, feeble institutions, and some of the lowest living standards in the world, and the task can seem nearly impossible.

But in August 2010, a project team from DAI (a global development company based in Bethesda, Maryland) landed in Afghanistan to do just that—by implementing USAID’s Agricultural Credit Enhancement (ACE) program, which aimed to lend $100 million to farmers and agribusinesses to invest in agriculture across the country.

With 80 percent of Afghanistan’s population working in agriculture, the sector is critical to the country’s economy and to the well-being of its people. But while many farmers lack access to the necessary capital to improve their business, Afghan financial institutions have little expertise in agricultural lending, limiting their ability to analyze or underwrite agricultural loans.

The ACE program set out to establish a $100 million loan fund within the Afghan government’s Ministry of Agriculture, Irrigation and Livestock. Called the Agricultural Development Fund (ADF), it would disburse loans through Afghan financial institutions to farmers and agriculture enterprises, improving their productivity, enhancing the country’s agro-processing capacity, and promoting the growth of the sector.

But, as the ACE team soon discovered, there was a catch: Afghan banks wanted no part of the scheme.

“We initially thought that at the right price and with the right incentives, commercial banks and other financial institutions would engage in agricultural lending,” says Juan Estrada-Valle, chief of party for the ACE program. “But several banks were at the verge of closure due to the high level of risk in their portfolios, which made them extremely risk-averse. Meanwhile, solvent financial institutions had excess liquidity and were engaged in safe, short-term lending operations. The ‘right price’ therefore became prohibitively high.”

With a key component of the project design in jeopardy, the ACE staff was forced to scramble for creative alternatives. Eventually, they hit upon a novel idea: forgo traditional lending institutions altogether and create a new lending system, based within agricultural organizations and agribusinesses, such as farmer associations and cooperatives, manufacturers of agricultural machinery, and export firms.

A “credit management unit” (CMU) was set up within each host organization to operate the lending system. Consisting of three to six local finance and administration personnel, the CMUs carry out ADF functions like processing loan applications, administering the loan portfolio, and ensuring timely repayments. A portion of the profits go to the intermediary organization to ensure the sustainability of the CMU after ACE’s involvement ends.

(Above: Mohammad Asif Rahimi, the minister of Agriculture, Irrigation and Livestock, distributes fertilizer on credit to a commercial potato grower in Bamyan province, Afghanistan).

In this way, more than $6 million (roughly 40 percent of total ADF loans disbursed to-date) has been disbursed by CMUs so far to more than 4,800 farmers. The farmers can then use the funds for purchases such as bulk fertilizers or certified seed, allowing them to access high-quality agricultural inputs and apply them at the right time and in the right quantities. These investments result in higher crop yields and a better quality of produce for the borrowers.

Another major challenge for the program was meeting the demand for Islamic-, or Shariah-, compliant loans. Living in a strict Muslim society, many farmers wanted to follow Sharia financing rules, which include a prohibition against charging interest on loans.

Islamic financing models for agriculture are relatively rare, however. So the ACE team reviewed Sharia-compliant products commonly used in other sectors and began adapting them to the ADF loans.

One such model was “Murabahah profit sharing,” where the lender shares in the borrower’s projected profit instead of charging time-based interest on the loan. Murabahah had most often been used in real estate and commodity transactions, but under ACE’s initiative, it now began facilitating a host of novel agricultural deals.

In Balkh province, for example, the ADF lent $2 million to a flour mill, with half the money earmarked for grain purchases, and half to be used for smaller loans to 1,200 local farmers. Under the agreement, the flour mill will keep 90 percent of the profit from these transactions, and the ADF will keep the rest. In interest terms, this would have translated to an annual rate of 6 percent.

Aiming to make the ADF fully Shariah-compliant, ACE has established separate bank accounts, an accounting, portfolio management and reporting system, customized loan contracts, and a Shariah Advisory Board, while also training staff in Islamic finance practices.

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After almost two years, the ADF has lent $37 million to 13,000 farmers in 25 provinces of Afghanistan. Through prudent lending practices and strong borrower relationships, it has also maintained an incredible 100-percent on-time repayment rate.

A recent program survey of potato farmers found that those who had access to ADF loans realized, on average, 22.3 percent higher yields and 39 percent lower production costs, compared with non-borrowers. The ADF borrowers also obtained an eight-percent higher price, on average, for their crops.

One Afghan entrepreneur, Haji Malang, owner of the first agriculture machinery manufacturing operation in the country, used an ADF loan to start manufacturing thresher components he previously needed to import from abroad. The impact of the additional injection of capital was evident immediately; 10 months after receiving the loan, his Javid Thresher Company had increased production by 41 percent and value of sales by 64 percent. The company created an additional 67 full-time jobs, and the machinery—mainly cereal threshers—benefited some 6,500 farm families in six provinces.

“I always dreamed that Afghanistan would one day manufacture its own agricultural machinery,” said Malang. “An ADF loan gave me the opportunity to be part of this process, create new jobs, and help farmers.”

The ACE program has also launched several complementary initiatives to enhance agricultural livelihoods: a financial product exclusively for women agribusiness entrepreneurs and an interactive database that incorporates market data for over 50 agricultural commodities, as well as studies and other information related to Afghan agriculture. ACE also provides technical assistance to its clients, which includes training in financial management, crop production, market development, and other skills.

Of the various challenges that remain, a major priority is ensuring the sustainability of program activities. All aspects of the ACE program—management of the ADF, funding of intermediaries, loans and repayments, technical and value-chain assistance—were designed to transition fully to local control within four years. Knowledge management and capacity-building activities are constantly incorporated into project activities.

Estrada-Valle has another reason to be optimistic. “Afghanistan’s farmers and small businesses are among the most resilient and dedicated in the world,” he says. “Every day, they are proving that progress is possible even in one of the most challenging environments for development. And it is a privilege to help them in that effort.”