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Finance & Development, March 1977
Article

The IFC and the agribusiness sector: The International Finance Corporation’s experience in this field

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
March 1977
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John W. Lowe

A number of issues are reviewed by the International Finance Corporation (IFC) when it appraises an agribusiness venture for investment. Many of these must be considered by any commercial lender. In addition to ordinary lending criteria, however, the IFC also carefully evaluates the developmental impact of projects it finances. Not only the financial rate of return but also the economic rate of return must be satisfactory for projects in which it invests. This article considers some of the issues which have come up frequently among the agribusiness proposals which the IFC has reviewed.

The IFC is the arm of the World Bank which provides debt and equity finance to projects sponsored by the private sector in developing countries. Originally the Corporation was limited to making loans only, and it made no equity investments during its initial years of operation (1956-61). This restriction was removed in 1961, and the IFC began taking equity positions in agribusiness ventures in 1964. To date, the IFC has invested about 10 per cent of the total amount of finance it has provided for agribusiness projects as equity.

For the purposes of this article, agribusiness ventures are considered to be large and generally corporate enterprises which manage the production and/or processing of agricultural goods for domestic consumption or for export. IFC’s investments in such ventures through fiscal year 1976 (ended June 30, 1976) are summarized in Tables 1 and 2. (Original commitment amounts have in some instances been adjusted after the original commitment was made.)

Table 1IFC commitments in the agribusiness sector 1
Fiscal

Year
CountryProjectDescription
1959GuatemalaIndustria Harinera Guatemalteca, S.A.Flour milling
1959ChileFideos y Alimentos Carozzi, S.A.Pasta manufacturing
1960ColombiaIndustrias Alimenticias Noel, S.A.Manufacturing of pasta, crackers
1960TanzaniaKilombero Sugar Company, Ltd.Sugar
1961VenezuelaDiablitos Venezolanos, C. A.Production of deviled ham
1964TanzaniaKilombero Sugar Company, Ltd.Sugar (2nd commitment)
1964ChileFideos y Alimentos Carozzi, S.A.Pasta (2nd commitment)
1965ColombiaIndustrias Alimenticias Noel, S.A.Pasta (2nd commitment)
1965ColombiaAlmacenes Generales de Depósito Santa Fė, S.A. “ALMAVIVA”Grain storage
1966MoroccoCompania Industrial del Lukus,Tomato and pepper cannery
1966ColombiaIndustria Ganadera Colombiana, S.A.Cattle fattening
1968EthiopiaHVA—Metahara, S. C.Sugar estate and mill
1969VenezuelaProtinal, C. A.Animal feed mixing, storage, and distribution
1972SenegalBud Senegal, S. A.Vegetable growing
1973VenezuelaProtinal, C. A.Animal feed mixing (2nd commitment)
1973IranIran California CompanyCommercial farming
1974SenegalBud Senegal, S. A.Vegetables (2nd commitment)
1974NigeriaLafiagi Sugar EstateSugar
1974PhilippinesRFM CorporationManufacturer of various foods
1975GreeceHellenic Food Industries, S. A.Tomato canning
1976PhilippinesPhilagro Edible Oils, Inc.Copra oil processing
1976SenegalBud Senegal, S. A.Vegetables (3rd commitment)
1976RwandaSociété d’lnvestissement Rwandaise du The, S. A. R. L.Tea processing
1976EcuadorSociedad Agicola e Industrial San Carlos, S. A.Sugar
1976NicaraguaPropiedades Azucareras de Nicaragua, LimitadaEstate sugar growing and milling

Investments correspond to those designated under “Food and Food Processing” in the IFC’s Annual Reports. See the Annual Reports for amounts. Projects are listed by commitment; in some cases disbursements have not been made. Fiscal year ends June 30.

Investments correspond to those designated under “Food and Food Processing” in the IFC’s Annual Reports. See the Annual Reports for amounts. Projects are listed by commitment; in some cases disbursements have not been made. Fiscal year ends June 30.

Table 2IFC commitments in agribusiness, by subsector
SubsectorAmountPercent
(Number of

commitments)
($ millions)
Sugar (6)24.954
Milling, mixing, storage, and distribution (4)6.314
Pasta (4)3.68
Oils (1)2.86
Tomatoes (2)2.55
Meat and meat products (2)2.15
Commercial farming (4)2.15
Retail food (1)1.22
Tea (1)0.51
Total46.0100
Commitments through FY 1976.
Commitments through FY 1976.

Government involvement

Agricultural development usually has a high priority in developing countries’ planning. As a result, the governments of developing countries often wish to play an important role in any major development in the agricultural sector, such as the setting up of a large agribusiness enterprise. The government may request that it hold, either directly or through a public sector agency, part of the shares of such a company.

The IFC is willing to consider investing in projects in which there is “mixed” ownership between the public and private sectors, provided management of the project is independent and business-oriented. The IFC’s objective, however, is to promote productive enterprise in the private sector that will contribute to the economic growth of its member countries. It does not participate in projects dominated by the public sector or designed solely as part of a public sector program. Such projects may, of course, be eligible for financing by the World Bank, of which the IFC is an affiliate.

A project which is being developed within the private sector may be strongly affected by government action in indirect ways. In agribusiness projects, such important costs as labor and tariffs on imported equipment may be controlled by the government. Prices of agricultural outputs, on the other hand, are often regulated by public marketing boards, which buy these goods at fixed prices for resale. When effectively managed, marketing boards can provide a useful degree of stability to domestic prices for agricultural products. However, they can also affect the viability of a project if the average price they offer is low in relation to world prices. The effect of these various factors has to be taken into consideration in appraising the commercial feasibility of an agribusiness project.

Many governments, through a variety of programs, subsidize the agricultural sector. One way this is frequently done is by making available long-term loans for agricultural enterprises at low fixed interest rates denominated in the local currency. When there is substantial inflation in the local currency, considerable subsidies can result. Subsidies are also frequently provided by means of agricultural support prices, grants of publicly held land for agricultural development, or publicly financed irrigation and other land improvement schemes, the benefits of which are passed on to the producer through low charges.

From the IFC’s point of view, a project in which it is involved must be justified in economic terms—that is, net of any direct or indirect subsidies it may receive. If this criterion is met, the IFC has no objection to stimulating agricultural investment by means of subsidies. The economic criterion is a useful one for investment appraisal, however, because it is a measure of the viability of a project if sub-sidles—which are arbitrary and may change with political priorities—are diminished or removed.

Improving project concept

Agricultural products are grown and sold worldwide and are therefore highly price competitive. Increased costs peculiar to any one project cannot easily be passed on in the form of higher prices. The profitability of an agribusiness project may thus be substantially affected by small but unanticipated changes in input, production, or transportation costs. These risks, in addition to those inherent in any agricultural venture due to weather, disease, spoilage, and so forth, often result in high levels of uncertainty regarding the viability of large agribusiness ventures.

One way in which these risks can be reduced is to process a product further. By further processing, greater value is added to the product, and the profitability of an operation can be increased. Because the final product becomes more differentiated from its previous form, the company producing it can attempt to command a premium for it in the marketplace. In addition, the prices of finished products tend to be less volatile than raw material prices. One tomato cannery with which the IFC is associated, for example, expects to increase its overall return by adding lines for the production of specialty tomato products in retail-sized cans to its current production of basic tomato paste in bulk containers.

For large projects which produce major commodities where further processing is not practical, it is possible to reduce the uncertainty of future profits by selling at a prearranged contractual price, or selling forward. This has the effect of “locking in” profit margins. However, forward sales commitments can also “lock out” profits from sales at future spot prices if prices for the product increase unexpectedly during the production period. In deciding whether and to what extent to sell output forward, management must decide what degree of risk it is willing to accept regarding future prices and profits.

The risks from adverse developments for any one agribusiness product can be mitigated by product diversification or by adjusting the balance among various product lines. However, effective agribusiness management requires close day-to-day supervision and quality control. By trying to manage too many product lines, management may be stretched too thinly. Careful management is the sine qua non of a successful agribusiness venture.

Many projects where a new crop is being produced on formerly unused land (so-called greenfields projects) can often be improved by including other products as well. Besides lowering the overall risk, the inclusion of other products lessens the impact of unforeseen developments relating to any one particular crop. Large crop projects are often based on the production of the same crop elsewhere in the same region. Sometimes such projects may be more profitable on the basis of an entirely different crop. These questions should be reviewed at the feasibility stage of project preparation.

Losses from spoilage in the processing and distribution of agricultural products in developing countries are often great. As a result, the returns to projects incorporating facilities for storage (either on the production site or at an appropriate distribution terminal) are frequently quite high. Many agribusiness ventures can be improved by incorporating provisions for adequate storage facilities with the project.

Appropriate finance

Finance for agricultural projects in the form of crop financing is available in many developing countries from local commercial banking or agricultural credit sources. Generally it is short term, corresponding to the duration of a crop cycle, self-liquidating, and usually secured by the crop itself. Because of the risk of crop failure, a mortgage on the land or other collateral is often taken in addition to claims on the crop itself.

Recent changes in the nature of agricultural projects have, however, had the effect of requiring substantially different kinds of finance from traditional crop finance. First, the growth of the technology of agricultural production has dramatically increased the amount of capital equipment employed, financing for which must be amortized over several years. New irrigation and planting techniques, recent developments in the use of fertilizers, pesticides, and herbicides, and modern breeding and feeding facilities all require higher capital outlays. The production of many new high-yield hybrid plant varieties requires the use of these capital-intensive farming procedures. Second, economies of scale from the use of these procedures have resulted in an increase in the size of the average agricultural project. Financing must, accordingly, both be greater in amount and have longer repayment terms than has traditionally been required.

Local commercial banks and agricultural credit institutions are generally able to offer some medium-term finance for certain kinds of agricultural projects. However, the length of the term of such loans may be less than the period which many agribusiness projects require. In addition, relatively high security is often required for credits from such sources. Often much of the debt must be personally guaranteed by the venture’s sponsors. Excessive dependence on short-term loans lessens the ability of a company to suffer short-term losses because high cash generation is required for debt service.

In these circumstances, longer-term loan finance and equity finance are needed, tailored to match the cash flows a project is projected to generate and the risks it faces. Such finance is frequently termed “project finance,” and the IFC is in a unique position to provide it. The under lying security for project finance is the projected profitability of the project rather than the collateral offered.

Project finance is fashionable in financial circles these days, but there is little new to it. It requires the financing institution to review the intrinsics of a project thoroughly. For large and complex agribusiness ventures dependent on both local circumstances and world markets, this can be a difficult task. Here the IFC is in a special position to assist on the basis of its growing experience in the agribusiness field.

“during the fiscal year ended June 3O, 1976, [the IFC] committed a record $15.2 million for agribusiness…”

Frequently a question arises regarding the extent to which land should be financed as part of an agribusiness project. Land is a capital input in agricultural production for which long-term, project-oriented financing is needed and appropriate.

A problem arises, however, when land comprises a great proportion of the expected cost of a project. Often this is the case in large-scale greenfields ventures, particularly if land is made available to the project sponsors on very attractive terms. In these instances there are several reasons why financing of the land component of the venture should be carefully reviewed.

The financing of large land acquisitions, conceptually speaking, involves the refinancing of the holding of an asset (land) by one group as opposed to another. The basic question is which owners, in terms of general policy, are the more desirable ones. The answer should be: those that will develop the land most effectively. The assemblage of large tracts of land for agribusiness projects can greatly increase agricultural productivity and allow large economies of scale in agricultural production. On the other hand, such acquisitions may be contrary to the government’s long-run objectives regarding the equitable distribution of land.

Often all of the land included in very large schemes is not developed at the initial stage. Much of it may be held primarily for capital appreciation. Landholders can benefit from an increase in the value of land as a result of economic activity with which they have little to do (for example, the growth and expansion of a nearby urban center). Financing the acquisition of land can lead to the transfer of an expected increase in value from current landholders to prospective ones. If much land in an agribusiness project remains undeveloped, the economic rate of return on the project, allowing for the opportunity cost of invested funds, is usually low, and can even be negative.

Large land ventures are often proposed in the form of cattle-raising projects. However, the value added from grazing cattle on large tracts of land may be low in relation to the value of the land itself. In such projects, the cash generated from the sale of cattle (as well as from the sale of timber which may be cleared) is usually applied to the debt service of the mortgage on the land. The real financial return in these instances is in the prospective capital gain on increases in the land’s value.

For these reasons, when large quantities of land are involved in a venture, the IFC usually prefers to confine its financing to a well-defined, commercially oriented part of the overall project. In a cattle project, for example, financing might be limited to the ownership, feeding, and slaughter of cattle and the storage and distribution of meat. If one aspect of an agribusiness operation is set up as financially distinct from another, however, care must be taken to ensure that goods are transferred from one entity to the other at realistic prices in order that the earnings of each part of the project are reasonably allocated.

Appropriate technology

Large, modern, integrated agribusiness projects are being proposed with increasing frequency in developing countries by experienced agricultural consulting and engineering groups operating in developed countries. For such projects the latest technology is often proposed, based on the economies of scale which the size of the project appears to permit. However, such projects, when founded on cost experiences in developed countries, may fail to allow adequately for actual infrastructure and overhead costs in developing countries.

Much infrastructure, such as water, electricity, land grading, soil enrichment and improvement, and disease control, is already available in developed countries. Provision of this infrastructure in a developing country can be very costly. In addition, overhead costs such as those for foreign exports, equipment repair and downtime, and expenses associated with the remoteness or inaccessibility of a project site can be very great in developing countries. These costs can outweigh potential benefits arising from the use of modern mechanized techniques. Further, the higher quality goods resulting from the use of advanced growing techniques often do not sell for prices that are sufficiently higher, particularly in local markets, to justify the higher cost of their production.

Essentially, the question of the extent to which these factors balance each other is at issue in projects of this type. The fact that sponsors of the project are often agricultural equipment manufacturers accounts at least in part for the bias toward capital intensiveness often seen in such proposals.

Expanding activities

It is difficult to evaluate exactly what the return on the IFC’s investments in agribusiness projects has been to date, because regular market quotations on such projects are not readily available for many current IFC investments. When the IFC’s equity investments are valued at cost (and allowing for the write-off of one pilot investment which has not recovered expenses), the IFC’s return on equity in agribusiness ventures has been low compared with the return on its overall equity portfolio.

While the return on agribusiness ventures should improve as the IFC’s experience in the area increases and as existing holdings which have increased in value are sold, these results are one indication of the difficulties involved in identifying sound and profitable ventures in the agribusiness sector.

The IFC has recently been increasing its investment commitments for agribusiness projects. During the fiscal year ended June 30, 1976, it committed a record $15.2 million for agribusiness in five ventures: coconut oil processing in the Philippines (Philagro Edible Oils); vegetable growing in Senegal (Bud Senegal, second commitment); tea growing in Rwanda; and two sugar projects, one in Ecuador (San Carlos) and the other in Nicaragua.

A large number of additional projects in the agribusiness sector are currently under review by the IFC. Some of the issues which it confronts most often in its review of agribusiness projects have been highlighted in this article in the hope that they may be of interest both to potential project sponsors and to other financial institutions active in this field.

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