Georgia: Microloans in Rural Development

GEORGIA MICROLOANS IN RURAL DEVELOPMENT

Stefan W. Hirche, Projectmanager KfW Development Bank stefan.hirche@kfw.de Tel. (0 69) 7431 4743

Business & Finance Consulting

Michael Kortenbusch, Managing Director Business & Finance Consulting GmbH kortenbusch@bfconsulting.org Tel. (0 25 95) 385 365

Table of Contents Abstract ....................................................................................... 3 I. II.

INTRODUCTION ......................................................................... 4 THE IMPORTANCE OF RURAL AREAS IN DEVELOPMENT POLITICS................

Agriculture: Often the only source of income… ........................................ …yet insufficiently developed .............................................................

Lacking access to funding sources ........................................................

5 5 5 6

III. MICRO-LENDERS DISCOVERING RURAL AREAS ...................................... 8 From specialized to full-range lenders................................................... 8 The logic of the market .................................................................... 9 A challenge to development policy ...................................................... 10 Structural prerequisites ................................................................... 10 IV. PAST EXPERIENCES AND LESSONS FOR THE FUTURE ............................. 11 Institutional capacity ...................................................................... 11 Regional focus............................................................................... 11 Risk management........................................................................... 11 Cost management .......................................................................... 12 V.

SUMMARY AND PROSPECTS........................................................... 13

LITERATURE .................................................................................... 14 Interviews with ............................................................................. 14

Abstract Although the lack of finance for small enterprises has long been identified as one of the main impediments for the development of rural areas in Georgia, most microfinance suppliers have focussed their attention on the urban centres.

However, recently an increasing number of financial institutions seem to be attracted to expand into what has been considered the difficult rural and agricultural lending market. The article sets out to identify the main reasons for this change of policy. In addition to increasing competition and growing saturation in the urban microcredit market, the international donor community gives important impulses in order to expand the outreach of existing programmes.

Furthermore, previous experiences with microlending operations in Georgian rural areas are summarised and suggestions made on how to deal with some of the inherent problems of agricultural lending: a suitable institutional setup, effective risk management and innovative strategies in order to deal with high transaction costs. The article concludes that, although initially neglected, the agricultural microlending market will experience increasing competition in the near future so that micro-entrepreneurs in rural areas can benefit from greatly improved access to external finance.

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I. INTRODUCTION Given its geographic situation and favourable climatic conditions, Georgia was regarded the – agriculturally – wealthiest region among the Soviet republics for a long time. But the demise of the Soviet Union in 1991 triggered a sustained period of economic decline and political crises.

The end of the system of centrally planned economy and the loss of the markets affected the agricultural value chain, formerly state-controlled, more than any of the few industrial firms. The decaying infrastructure, the consequences of armed conflict in Abkhazia and South Ossetia, and the results of a privatization that was not fully thought through have been hampering the recovery of the agricultural sector which used to be of such importance to this very day. As a result, the majority of the rural population now lives below the poverty line.

Poverty reduction is, therefore still seen as the pivotal challenge in development cooperation with Georgia. Among the programs promoting wealth creation, support of small and micro-enterprises (MSME) through loan facilities has proven successful. However, the majority of corporate loan providers remain focused on clients in the few large and medium-sized cities. In spite of the high unsaturated demand for loans in the small towns and villages dominated by agriculture, supply in these regions has improved very little over the last few years.

Only most recently have there been signs that might indicate an imminent trend reversal. Rural microloans1 have the potential of burgeoning into an important cornerstone of the development cooperation with Georgia.

1

For the purpose of this document, the definition of microloans given by the Consultative Group to Assist the Poor will be applied (maximum loan amount USD 10,000).

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II. THE IMPORTANCE OF RURAL AREAS IN DEVELOPMENT POLITICS The importance of rural areas in terms of development politics in Georgia can hardly be overestimated: 48% of the Georgian people live outside of towns with a population of more than 1,000.2 Unemployment and the inflow of refugees from crisis areas has forced many Georgians to support their bare existence with subsistence farming, which lead to a renewed increase in the share of rural population between 1989 and 2002.3 Agriculture: Often the only source of income…

Although the agricultural sector is the only source of income in major parts of the country,4 the productivity is well below international standards. Whereas 55% of the Georgian population are employed in the agricultural sector, agricultural output in 2004 accounted for only 16.2% of GDP.5 In 2003, 56% of the rural population were living below the poverty line – and the tendency is on the increase.6 The regions show a considerable gap in this respect.

The South and the West of the country, as well as the difficult-to-access Caucasus region are most severely affected, compared to the better-of viticulture and pomiculture regions. …yet insufficiently developed A quick recovery of the Georgian agricultural sector is currently inhibited by a whole range of factors inhibiting. The lack of infrastructure and the insufficient average size of enterprises are only two of the existing structural deficiencies. This is the result of a privatisation scheme for land, which was not fully thought through and where every family ended up with an average of 0.8 hectares of land.7 Estimates say some 400,000 households work on a level of subsistence farming.8 About 88,000 „larger” farms have an average of 4 to 6 hectares of land each.9 The implementation of a land and cadastral register – an effort lead by KfW Development Bank – has provided the basis for necessary consolidation of land and respective ownership titles. In addition, the entire sector suffers from the consequences of a broken value chain and of inadequate product marketing efforts. This is where the USAID-financed project AGVANTA tries to help.

2

For the purpose of this document, the definition of rural population given by the Georgian National Agency of Statistics will be applied.

3 Davis et al. (2004): Rural Non-Farm Economy Poverty and the Rural Non-Farm Economy in Armenia, Georgia and Romania: A Synthesis of Findings, p. 25.

4 Heron et al. (2001), Georgia Agricultural/Agribusiness Sector Assessment, p. 42.

5 GEPLAC (2005), (1), p. 11 .

6 The official poverty line, based on per-capita spending, for 2003 was 48 Georgian Laris (USD 25.

Published by the National Agency of Statistics (2004) in: Social Trends in Georgia; 2004, p. 35.

7 National Agency of Statistics (2004): Households of Georgia 2002-2003.

8 Heron et al. (2001), p. 46 and own estimates. Figures including households for which agricultural business is not the only source of income.

9 BFC/KfW (2003): Georgia Microfinance Feasibility Study, p. 51.

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For an increase in productivity, private investment in agriculture is required. That said the drastic shortage in sources of funding hampers the growth of small farms and, thus, the recovery of this sector so vital for the development of rural areas.

Lacking access to funding sources With his 14 dairy cows, 20 bee hives, and a small grocery store, Zviad Vakhani is a busy farmer. He lives in the village of Varkhani, a thirty minutes drive from the county seat Akhaltsikhe, where the nearest bank has its office.

In January 2004 Zviad was faced with the decision of having to sell three of his cows and to use the proceeds to buy fodder to get his remaining cattle through the winter. It was only a pilot project of the United Georgian Bank, the partner bank of the Small Enterprises Lending Programme (SELP) which is funded by the European Bank for Reconstruction and Development (EBRD), that gave him the chance to take out a loan of USD 1,500 and, thus, to keep his entire livestock.10 In the meantime, Zviad has repaid the loan according to the schedule, and he is making plans now to apply for a larger amount for extending his stable.

10

The Small Enterprise Lending Programme is implemented jointly by Bankakademie and Business & Finance Consulting (BFC) GmbH acting as a subcontractor.

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Chart 1: Development of the microloan sector in Georgia Microloans in the agricultural sector offered

Mainly urban microloans offered

1996 Constanta World Vision (CREDO)

1997

Finca

1998

ProCredit Bank

1999

2000 Bank of Georgia United Georgian Bank TbilUniversal Bank

Credit Union Development Centre (CUDC) ACDI/ VOCA (Georgian Rural Development Fund ,GRDF)

Agro-Business Bank

2001

2002

ProCredit Bank

2003

Finca

2004

Vision Fund CREDO United Georgian Bank Constanta

2005

Bank of Georgia* Bank Republic*

There have not been many cases like this one in Georgia.

In a survey conducted in different regions of Georgia in 2003 on obstacles to growth, 138 farmers ranked “insufficient savings” and “lack of access to credit” second and third behind “lack of modern equipment” out of eight categories. 44% of the respondents stated their request for a loan had been declined, and only 16% had any experience with loans.11 Will Zviad continue to set a lonely example, or does his case herald a trend reversal for the underdeveloped market of agricultural loans?

*envisaged

Providers focused on urban clients Providers focused on agricultural clients

11

BFC/ KfW (2003), ibid, p. 51.

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III. MICRO-LENDERS DISCOVERING RURAL AREAS From specialized to full-range lenders From their beginnings in the middle of the 1990s, the vast majority of microloan providers had been specializing either on urban areas or on rural areas.

International donors’ largely considered that “urban” and “rural” target clients were very different in terms of product and processing needs or risk and cost management, and, hence, efficiently serving both of them in the same institutions was deemed impossible. Since all institutes offering microloans – except for Georgian commercial banks – are of recent origin, initially most of them deliberately focused on the – economically speaking – “easier” urban market.

A trend reversal can be seen only since 2002/2003, which seems to indicate that specialisation on institutional level is coming to an end.

Table 1: Providers of microloans for the agricultural sector in Georgia12 Institution/ Programme Agro-Business Bank of Georgia Georgian Rural Development Fund14 Credit Union Development Center Vision Fund CREDO

Status

Donor

Specialisation

Agricultural portfolio Dec. 2004 (USD)

Estimated growth (Agricultural portfolio)13

Market Share Dec. 2004

741,685

50 %

16.4 %

2,075,000

3%

45.9 %

Up to now EU/TACIS USDA, USAID

Agricultural

Credit cooperative

WB, IFAD

Agricultural

635,447

15 %

14.0 %

NGO

USAID, UNDP, OSI

Urban

167,117

180 %

3.7 %

Bank NGO

Finca

NGO

Constanta

NGO

ProCredit Bank

Bank

United Georgian Bank – SELP

Bank

Agricultural

USDA BP/Care, Mercy Corps IFC, KfW, EBRD

Urban

70,588

50 %

1.5 %

Urban

31,031

100 %

0.7 %

Urban

686,641

200 %

15.2 %

EU/ EBRD

Urban

117,685

250 %

2.6 %

4,525,194

56 %

100 %

TOTAL

Even though the supply of credit in the rural space is still limited, compared to cities, an increasing number of providers show evident interest in this previously underdeveloped market – tickled by a number of factors.15 12

Only microloans (USD 10,000 or less) granted to agribusinesses Data for mid-2006, based on providers’ estimates.

14 Former 2003 ACDI/VOCA 15 Over the past two years, the share of loans to the agricultural sector in the total portfolio has been on the decline at all three lending institutions specialising in agricultural clients.

13

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The logic of the market With Georgian commercial banks actively entering the market for microloans, the supply structure improved substantially (see figures 1 and 2). The total portfolio of microloans increased from USD 28 million in 2002 to USD 47 million in 2004. Even in smaller towns, the sellers’ market has turned into a buyers’ market.

Chart 2: Microloans offered in Georgia, urban

Dec 2002

Dec 2004

0

5.000

10.000

15.000

20.000

NRO/Credit Unions

25.000

30.000

ProCredit Bank

35.000

40.000

45.000

Other Banks

Figures 2 and 3 illustrate the development in the market and the market share of different providers. Along with the considerable growth of the urban market, we can see a shift towards universal commercial banks on the supply side.

Conservative estimates put the saturation of the urban markets at between 60% and 80%, whereas in rural areas less than 30% of the effective demand can be met.

Chart 3: Microloans offered in Georgia, agricultural Dec 2002

Dec 2004

0

1.000

2.000

3.000

4.000

5.000

USD 1000 Agro-Business Bank

GRDF

CUDC

ProCredit Bank

United Georgian Bank (SELP)

Other NRO

Lenders are forced by increasing market saturation and declining margins in the urban markets to look out for new groups of target clients. As a consequence, the number of offices in rural areas is on the increase, as is the number of branch offices providing agricultural loans. (See figure 4)

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A challenge to development policy Along with commercial interests, development policy plays a crucial role as well.

After years of successful operation, mainly in the urban market, many lenders are looking for new challenges – not least due to the fact that, in contrast to other countries, Georgia is yet to see the big breakthrough of a program specializing in rural credit, despite the many attempts launched already in the past.16 The prospect for access to financial and technical support is an important additional incentive. The EBRD, for example, is set to launch a module for microloans to farmers under their Small Enterprise Lending Program (SELP). The World Bank plans to continue their recent attempts for setting up credit cooperatives under a modified framework in 2005.

Chart 4: Outlets of microloan providers in Georgia 60 50 40 30 20 10 0 1999

2000

2001

2002

2003

2004

In cities with a population of more than 500,000

Forecast until mid-

2006

In towns with a population of less than 50,000 Agricultural loans offered

Structural prerequisites Last but not least, the structural settings for lending operations in rural areas have improved significantly in recent years. Thanks to the implementation of a modern land and real estate register, the procedures for providing and registering property as collateral have become relatively simple.17 The creation of a market for arable land was an important prerequisite for consolidation in land ownership.

Whether or not the trend reversal that is beginning to show will improve access to loans to the formerly omitted rural population will depend on whether the intrinsic challenges of a sustainable credit business can be mastered even in structurally weak regions.

16

Projects that are considered to set an example on a nationwide scale are, i.e., the agricultural Cooperative Bank of Armenia (ACBA) established by CrĂŠdit Agricole under the TACIS framework, and the credit cooperatives initiated in Moldova with financial support by the World Bank.

17 Interview with Giorgii Chonishvili, [May 4, 2005].

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IV. PAST EXPERIENCES AND LESSONS FOR THE FUTURE The experience of numerous institutions in micro-lending in rural Georgia to date has shown that, though it may not be an easy trade to deal with, this segment is promising well, with institutional capacities, regional focus, adequate risk and cost management being the key factors for success.

Institutional capacity First of all, qualified managers and strengthened technical support by long-term consultants are required to ensure a professional approach and operation. Engaging short-term consultants, in particular at initial project stages, comes with a risk that too little attention will be paid to implementing efficient and effective structures for management and organization, which may turn out very labourintensive and require tremendous efforts; this is what happened with the donorfunded program for implementing credit cooperative in Georgia. With regard to existing institutions, such as the Georgian commercial banks supported under the SELP, setting up a respective focus group at the Head Office to coordinate the manifold actions has proven successful.18 The local and sector-specific know-how of the loan officers engaged is essential as well. Experience shows that, for people having a track record in the respective fields, it is most likely that they will convert the training received under a project into a high-quality microloan portfolio.

Regional focus The aforementioned regional disparities build a strong case for a deliberate geographic focus. The first offices should be opened in regions with more favourable parameters for agribusiness. This will enable lending institutions to offer a specialized range of products. This cluster approach has worked well particularly for newcomers to agricultural lending business, as loan officers can focus on one product and, thus, achieve a higher productivity.

Risk management As numerous lenders have shown (for example, Agro-Business Bank with a default rate of 2% as per December 2004) agricultural lending and a good portfolio quality do not necessarily exclude each other. But, of course, the risk inherent to agricultural loans is higher and contains a number of variables: regional crop failures that tend to affect all farms in a given area, lead to an increased covariance risk. A case in point, in 2004 all apple farmers in the main growing area of Gori were hit by a crop failure destroying 80% of their early apple crop after late frost. The redemption rate at the end of the pilot project was 98%; nevertheless many borrowers were faced with liquidity problems. Given the lack of insurance against weather risks, e.g. hail, lenders and debtors will have to live with said risks for the time being.

18

Interview with Natia Jorjikia, [May 5, 2005].

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Mainly, repayment schedules are being adapted to the respective production cycle and usually do not allow for monthly instalments, which makes monitoring of repayments a difficult task for lending institutions. Sporadic site visits have proven successful in these cases. The absence of fixed instalments, as common for most farm businesses, is a challenge for institutions focusing on agricultural lending in terms of liquidity management forcing them to operate in urban markets as well.

The lack of adequate collateral has frequently been cited as a risk factor for agricultural lending. The crucial point here is, though, that lending institutions would insist on repayment and, in fact, sell the collateral provided in case of a default. Otherwise, they might re-live the experience of an American NGO that lost USD 500,000 in agricultural loans in the South Georgian region of SamtskheJavakheti as a consequence of lax controls.

Cost management The transaction costs are higher than in micro-lending business in cities and, thus, make great demands on the lenders. Potential clients are often scattered over a wide area and live far from the nearest office, which makes it difficult to keep close contact to lenders and to run branch offices with profit or even to cover all expenses. For example, the clients of the Georgian Rural Development Fund live up to 100 km from their nearest branch office.19 Allowing for a two-hour drive for one way, a credit analysis may well take a whole day – while you could have served three urban clients in the same time.

Further, the revenue is often lower than in the case of MSME. In contrast to retailers with high stock turnover, farmers usually can not afford to pay high interest. While for MSME loans a monthly interest rate of 3% is common, even a monthly rate as little as 2% is perceived a heavy burden by farm businesses.20 To withstand this increasing cost pressure, various approaches can be used, such as "bundled" credit analysis of multiple clients. At present, FINCA is the only provider in Georgia lending to groups of farmers, so far with good success. Another opportunity is through implementing mobile branches, which is currently being considered by some of the lenders.

In addition to new approaches on the process side, alternatives in terms of institutional setup should be examined. Credit cooperatives seem an appropriate way to transfer part of the high transaction costs to the borrowers. A respective project, so far has had little success in Georgia, but the weaknesses, first of all lacking control by management, have been recognized in the meantime.21 A similar project is being promoted by the EU, envisaging the creation of a refinancing fund administered by Agro-Business Bank for refinancing credit cooperatives and collaborating with manufacturers’ associations.22 It is expected that the project will lay the basis for a sustainable institutional framework.23 19 20 21 22 23

Interview with Giorgii Chonishvili, [May 4, 2005].

Ibid Interview with Natia Jorjikia, [May 5, 2005].

A similar model has been successfully implemented by ACBA in Armenia.

Interview with Christophe Cordonnier, [May 13, 2005].

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V. SUMMARY AND PROSPECTS Providing access to funds for small entrepreneurs can play an important role in the development of rural areas. But while, at present, the market saturation for micro loans in urban area has reached 60%, micro loans remain unattainable for large parts of the rural population.

For little more than two years, we have been seeing a change in lenders’ market bias in the microloan segment - away from former specialization to a broad range of services for both urban MSME and farmers. This process is driven by economic factors as well as development policy. Forced by increasing competition in the urban markets, major lending institutions – previously focused on urban clients – try to enter new customer segments. The few lenders focusing on rural areas so far attempt to diversify their customer base to improve their risk and liquidity position. Support by international donors is an important factor for improving access to credit in rural areas.

Recent forecasts for a number of leading providers indicate that their agri-lending segment has potential for growth well above the average in the near term. By mid-2006, the number of branches disbursing loans to agricultural business is expected to triple, coming from 46 in 2003, while available funds should increase by 56% and reach a volume of USD 7 million. Improved access to external funding sources will be of increasing importance for the development of rural areas in Georgia in the coming years. If, in addition, the present structural deficiencies will be successfully mitigated, the agricultural sector in Georgia can look into the future with confidence.

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LITERATURE Business & Finance Consulting (2003): Georgia Microfinance Feasibility Study, Study for KfW. Davis, J.R., Bezemer, D.J., Janowski, M., Wandschneider, T. (2004): Rural NonFarm Economy Poverty and the Rural Non-Farm Economy in Armenia, Georgia and Romania: A Synthesis of Findings, Natural Resources Institute Report No. 2773.

GEPLAC (Georgian-European and Legal Advice Centre, 2005): Georgian Economic Trends, No. 1 (2005).

Heron, L., Lee, R., Winter, M. (2001): Georgia Agricultural/Agribusiness Sector Assessment, Study for USAID, Georgia Office of Economic Reform.

Interviews with Chonishvili, Giorgii, General Manger, Georgian Rural Development Fund, [May 4, 2005].

Cordonnier, Christophe, Project Team Leader, Tacis Strengthening the capacity of Agro-Business Bank of Georgia, [May 13, 2005].

Jorjikia, Natia, Head of the Credit Unions Development Centre, [May 5, 2005].

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