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Item Title: A report on smallholder agricultural credit in Malawi - December 1973 - J. D. von Pischke

Item ID: 30197I

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301971 A1898-010 Othertl: N 1400438

A report on smallholder agricultural credit in M a law - December 1973 - J. D. von Pischkt

DECLASSIFIED WBG Archives

A REPOill ON

SMALLHOLDER· AGRIDUJ:JrURAL CREDIT

DECEMBER 1973

BY

J. D. VON PISCHKE

( CONSULTANT)

I.

II.

III.

IV.

v.

VI.

VII.

CONTENTS

LLDP Seasonal Credit Operations, 1968-197~.

LLDP Phase III Seasonal Credit Operations

OtUer LLDP Credit Operations

Proposals for the Selective Use of Credit in the

National Rural Development Program.

Rural Savings

Long Term Aspects of Smallholder Credit Provision

Summary Recommendations

Annex A. Seasonal Credit Operations of the Central Region

Lakeshore Development Project.

Annex B. Hypothetieal Uni-t Credit Aooounting Centre Operating

Data.

Annex c. Credit for Medium and large Scala Agricul:ture.

Annex D. List of Interviews and Disoussions.

~

l

6

8

9

PREFACE

This report contains nw observatio~ . on agricultural credit a.r:rangements in Malawi gathered vvhile participating as a consultant in an IDA mission from the Regional Mission -in Eastern Africa under the leadership of Mr. w. Schaefer-Ke!mert from October 8 to October 26, 1973 .

The terms of reference for my participation specified in a memorandum dated September 27, 1973, covered the following:

1, LLDp1( FHASE III credit arrangements for smallholders.

2. Smallholder Flue-Cured Tobacco Project credit arrange­ments for growers.

3.. National Rural Developm,ent/Modified Input Program credit delivery mechanisms and implications for the future institutional structure for farm credit in Malawi.

Accordingly, in this report the credit performance of LLDP to date is reviewed as are the arrangements specified in the Provisional

-Proposals for LLDP Phase III prepared by the Malawi Government in Sept­ember 1973. The LLDP experience to date and project management's plans for the future are used as a basis for policy recommendations for future smallholder credit arrangements in Malawi.

In order ·to place these recommendations in a broad perspective this report also contains an Annex on the Central Region Lakeshore Devel­opment Project (or Salima Project) which is supported by West German funds and technical assistance, data on domestic private sector savings and a few comments on the m1fortunate consequences of the pricing policies

· of the Agricultural Development and :Marketing Corporation (ADlVIARC), The proposed Smallholder Flue-Cured Tobacco Project is at such an early stage of preparation that no specific proposals for credit arrangements are warranted at present,

Conditions in Malawi appear extremely favorable for testing alter­native smallholder credit delivery systems, These conditions reflect the Government's flexible and pragmatic approach to rural development, the existence of the integrated rural development projects and a broad range of experience in smallholder credit schemes. However1 there appears to be insufficient experience to support the establishment of a viable national farm credit institution at this time, and the advantages of the present structure should be exploited fully before any steps are taken for the creation of a new institution. Establishment of a national institution could easily result in a loss of the valuable flexibility of present arrangements.

l( Lilongwe Land Development Project

I. LLDP SEASONAL CREDIT OPERATIONS 1968-1973

1.01 The Lilongwe Project's seasonal credit operating performance is summarized in Table I. The overall pattern is one of a slow beginning between 1968/69 and 1969/70 1 a rapid increase in disbursements in 1970/71 and 197~72 and moderate expansion between 197~72 and 197z/73. Over the 5 periods since 1968-69 the number of borrowers has increased from 656 to 21,469 and the amount of seasonal credit advanced has like­wise expanded from less than K5,000 to almost K400,000. The largest absolute increase occurred vdth the 197~72 season when the number of borrowers increased by more than 15,000 and the amount of seasonal credit issued expanded by approximately an order of four. The rate of expansion decreased in the 1974/73 season due to (a) management's efforts to con­solidate in response to an increase in a number of defaulters, (b) the barring of these defaulters from receiving further credit, (c) an increase in fertilizer prices which may have reduced credit sales (d) an unreliable rainfall situation which may have decreased fertilizer consumption and (e) farmers use of their own seed from the previous year.

1.02 In spite of the impressive growth in seaso1~ credit operations, three problems have been encountered which remain unresolved and deserve serious consideration in the planning of future arrangements for providing smallholder credit in Malawi. These problems are: defaults on loan re­payment, the level of credit administration costs and the relation between cash sales and credit sales of seasonal inputs.

Defaults on loan repayment

1.03 The Lilongwe Project, when viewed in the context of similar programs operating elsewhere in Africa, has been quite successful in recovering credit extended to smallholders. Cumulative total seasonal loan issues from 1967/68 to 197z/73 exceeded KBOO,OOO by the end of September 1973, at which time approximately lo% of this amount was in arrears. The cumulative repayment record as of 30 September 1973 a~ shown in Table I {Item 8) have reached 10 r the first two years of the project and are above 9o% for the following two years. However, the collection rate as measured by the proportion .of amounts due received each year by the contractual due date, August 31, has deteriorated steadily between 1969/70 and the latest season, 197z/73, declining from 96% to 75% (Item 7). During the last three seasons collections in the 30 days following the due date have increased the collection rate by about 7-8 percentage points and decreased the number of defaulters by a third. Precise interpretation of collection rates before 1972/73 is rendered difficult by the selective (perhaps capricious) application of a K2 surcharge on loans not repaid in fully by 31 August each season and the failure to separate surcharges collected from other collections. The adjusted rates in the Table (Item 9) are based on the assumption that the surcharge was levied on all of the season's loans outstanding at 31 August each year.

- 2 -

TABLE I. LLDP - SEASONAL CREDIT STATISTICS

1968/ 69 1969/70 1970/71 1971/72 1972/73 1973/74 1974/75 1975/76 1976/77 1977/78* 1978/79 Assumptions projected - - - - - - - - -- - - - - - - - - - - - - - - - - - - - - -

l. Number of Units Served 2 5 9 l4 17 21 25 27 30 32 32 Annex 1, p.2l

2. No. of Borrowers 656 561 4408 19802 21469 273.50 - 31350 35350 39300 43200 47200 1973/4 + 4000/Yr

3. % Increase -14% 786% 449% 8%

4. Amount Loaned (K) 4826 7040 83305 328670 392403 481360 559911 640542 722727 805680 892552 No. x Avg. Loan Size

5. % Increase 46% 1183% 395% 19%

6. Average Loan Size (K) 7.36 12.55 18.90 16.60 18.28 17.60 17.86 18.12 18.39 18.65 18.91 197~3 + K0 .26/Yr.

7. Repayment Rate 31 Aug. 66% 96% 86% 79% 75%

8. II II 30 Sept . 73 lOa% lOa% 99% 95% 84%

9. Adjusted Rate 30 Sept . 73 ? ? 95% 90% 84%

10. No . of Defaulters 31/8 354 37 1932 8771 8695

ll. As % of Borrowers (Item 2) 54% 7% 44% 44% 41%

12. Estimated Credit Admini- Annex 1, p.20, Less stration Costs (K) 16468 22191 36398 56398 53662 60030 72439 88418 97039 104168 108363 computerisation, & .excl.

certain vehicle overheads

13. Credit Premium Earned ~e ~e 8302 38182 38250 48136 55991 64054 72273 80646 89255

14. Net Cost of Credit Admini-stration 15985 21487 28096 18216 15412 -- . 11894 16448 24364 24766 23522 19108

l~. Net Cost per borrower 24.37 38.30 6.37 0.92 o. 72

16. As % of Average Loan (Item 6) 331% 305% 34% 6% fi 17. Cash Price of Credit Inputs 4343e 6336e 75002 290488 354153

18: As a % of Credit Admini-379% 35o% 49% 19% 15% station Costs (Item 12)

19. · Credit Administration Costs As % of Amount Loaned 341% 315% 44% 17% 14% 12% 13% 14% 13% 13% 12% (Item 12 + Item 4)

* 1977/78 Data are from Armed 9 of the Provisional Proposals for Phase III. e =Estimated

\

"

3

1.04 The deteriorating trend in collection performance appears to be close~ associated with administrative factors. Project management has used credit as a major tool for the stimulation of production on the assumption that credit encourages farmers to use modern inputs, without which the yields required for the achievement of production targets cannot be realized. Consequently, the program has expanded rapid and les creditworthy strata of borrowers have been included. Table II shows the repayment situation in each of the standard admini­strative units included in LLDP. The statistics of Units 1-5 show clear~ that credit coverage has increased sharp~ with the growth of the program. In Units 3, · 4 and 5, for example, the rep~ent rates realized during the first year of credit operations in these areas were lOa% and the number of borrowers per unit ranged from 68 to 133. By 1974/73 the number of borrowers in these units had increased by more than ten times and the repayment rate had fallen from lOa% to as low as 56%.

1.05 A particularly worrying development is the relatively large number of defaulters among LLDP seasonal borrowers. The number of defaulters as of the contractual due date for the last three seasons has exceeded 4o% of all borrowers as shovvn in Table I (Item 11). At the time of the mission's visit over 2,000 cases referred by project management to the traditional courts in the project area were outstand­ing. Although the courts initially proved quite efficient in enforcing borrowers' repayment obligations, the increase in the number of cases has resulted in substantial delays in securing judgements. It appears that this degree of reliance on these traditional institutions to handle non-traditional problems, such as the repayment of seasonal credit from a non-traditional source, could seriously jeopardize the credibility of the traditional courts and hence deminish their capacity to function efficiently. Project management will no doubt have to alter its tactics or priorities if the courts falter. Management indicated that it now regards a 10-15% default rate at the end of each season as normal.

Administration Costs

1.06 Table I includes estimated credit administration cost data supplied by management (Item 12). (As used in this report, these costs exclude bad debt losses). However, these figures understate the admini­stration costs that would be incurred by ru1 independent credit institution. The estimates include the local costs of the senior agricultural credit officer and his cadre consisting of a chief credit officer, field audit officer, senior credit officer~ credit officers and credit assistants, accountants, accounts assistants, and temporary clerks, plus vehicle running costs, stationery, office machines and small miscellaneous items. The costs exclude overhead burdens relating to project management; certain vehicle overhead costs such as insurance, depreciation7 and driversr salaries; a rent charge for quarters occupied and the cost of capital included in the credit fund~ etc. Offsetting the omission of the cost of capital is the project's lack of authority to employ credit fund balances during the off season. At present it is mandatory for these balances to be left with the Treasury and earn no interest.

U N I '1' S

1968/69 TOTAL LOANED

1. Number of borrowers

z. Repaym ent rate as at 31 Aug._

3. Number of Defaulters

"'• Repa;y111ent rate as at 30 Sept.

5. Number of Defaulters

1969/70 TOTAL LOANED

1. Number of borrowers

2. Repayment rate as at 31 Aug.

3• Number of Defaulters

~. Repayment r ate aa at 30 Sept.

5• Number of Defaulters

1970/71 TOTAL LOANED

Number o! borrowers

2· Repaym ent r at e as at 31 Aug. ,. Number of Defaulters ... Repayment r at e as at 3o Sept.

5· Number of Defaulters

.12.Z1LE TOTAL LO ANED

1. Number of borrowers

Repayment rate as at 31 ~ug. 3• Number of Defaulters

... Repayment rate as at 30 Sept.

S• Number of Defaulters

.!.2.Z.UU TOT AL LO ANr.:D

1. Number of borrowers

2. Repayment r a te aa at 31 Aug.

3. Number of Defaulters

4. Repar-ent rate as at JO Sept.

5• Number of Defaulters

1 2 ' 348 308

69.1 62.6 197 157

77.8 67.1 1.55 139

1'+4 112 1o4 88.1 95·5 100 29 8 -90.4 95-5 -20 8 -

645 650 606 78.9 82.0 81.3 320 310 293

87.2 91.3 92.5 207 201 137

1392 1130 14.56 77.6 85.5 79.6 510 450 495

• 8?.2 91.7 88.9 315 216 290

1569 1166 1239 69.1 ?4.4 ?2.6

929 480 495 77-5 81.4 82.6

6,31 361 3.52

- 4 -

TABLE II. LLDP SEASJ NAL CREDIT REPAn1ENT RATES BY UNITS, 1968 TO 1973

4 .5 6 7 8 9 10 12 13 1.5

68 133 100 100

- -- -- -

351 464 343 395 578 376 89.5 88.1 84.6 8'+.9 93-7 89.7

152 15? 153 132 260 1.55 95.2 92.9 93.0 92.0 97.0 96.7

106 99 110 101 174 100

1357 1851 1492 1644 1534 1356 - 1802 1255 1137 86.4 69.2 70.7 n.o 78.4 80.1 - ?3.2 88.3 73-7

483 850 695 8.22 810 710 - 931 516 485 92.6 8o.o 79.4 83.8 8?.7 89.4 - ?8.6 92.6 81.2

149 689 501 372 517 532 - 659 223 339

1124 1464 1123 1647 11?3 1195 1533 1286 1140 1244 74.9 56.4 73.8 70.3 79.8 74.8 88.4 69.5 79.5 ?4.4 4?3 964 439 673 423 492 33.5 65.5 .296 610

8z.o 76.5 80.9 81.4 88.8 80.9 91~9 79.2 91.:9 8.2.5 ,304 706 363 727 2?4 344 2.56 384 149 371

16 17 29 30

1017 1379 89.0 84.4

374 640 93.4 87.8

160 284

1006 1357 1099 11o4 78.3 70.4 88.4 87.7 332 714 203 182

83.7 80.6 92.5 91.5 . 269 534 122 172

TO

K4, 65

65. 35

72. 29

KZz 56

96. 3

97. 2

K8~ 44o 85. 193 93. 123

K~2

198 ?9 8? 86 52

!:39

214

7.5 86 83 63

TAL

825.?2 6

8

4- 541.

4 4 -451,

039.53 1

0

7 7%

0

8 54

,304.9? 8 8 2 44't

0

5 281.

8, 669.88

02

.2

71 44't

.7 46 26't

2,403.31

69 .4 95 41't

.8 19 29%

REPAY~1E~i AS otr 9/30/13

lOO't

lOO't

99.03't"

94.72't

83.6l't

5

1. 07 Seasonal borrowers do not pay interest as such, but rather pay a "credit premium" included in the price of the goods they obtain on credit. The credit premium earned by the lender is subtracted from the estimated credit administration costs to obtain the net cost of credit administration as shown in the Table (Item 14). Table I demonstrates that net credit administration costs must be spread over a large number of borrowers to be economic. In the 1971/72 and 1972/73 seasons the net costs per borrower were on~y 6% and 4%, respectively, of the average loan size (Item 16). However, during the first two seasons when the number of borrowers was small, the net costs per borrower were more than three times the average loan size. Net credit administrat­ion costs as a percentage of the casl1 price of credit inputs has like\v.ise decelined from more than 300fb in 1968/69 to 15% in 1972/13 (Item 18). The credit premium charge on inputs supplied to borrowers has been kept at between 10-13% of their cash price (i.e., excluding the premium), which has failed to meet credit administration costs in any season to date. The generally increasing trend in average loan size (Item 6) from K7.36 in 1968/69 to Kl8.28 in 1972/73 has increased the absolute amount of the premium and thus has tended to reduce the average loss li~curred in each loan account. Using management's cost figures for the five years 1968/69-1972/73, the estimated total admi~~strative cost of the credit program was Kl85,117. Credit premiums earned approximated K85,921. Thus, the credit administration costs not covered by credit premiums earned approximates Kl00 9 000, or about K2.10 for every loan issued.

Cash sales versus credit sales

l.Q8 Phase II appraisal projections showed cash sales and credit sales to project farmers in a proportion of roughly 3:4. However, cash sales have failed to materialize and sales of inputs in the project areas have been almost entirely finru~ced by project credit. Cash sales of fertilizer, for example, the major input L""l program packages in terms of volume and value, have amounted to less than K3,500 in each of the seasons since 1970/71 when credit was first issued on a significant scale:

Season Value of Fertilizer Volume of Fertilizer Volume of Fertilizer Cash Sales Cash Sales Credit Sales

metric tons metric tons

1970/71 ? 10.0 817.9 1971/72 K3,169 58.6 3818.0 1972/73 K2,972 43.8 3854.3

The reasoP~ for the low level of cash sales in relation to credit issues appear to include:

1. The absence of special promotional activities aimed at cash sales.

6

2. The absence of price tags on inputs in markets, which makes it difficult for the farmer to ascertain or compare cash prices and credit prices.

3. The probability that farmers are willing to discount the credit price by a much higher factor than the rate of interest embodied in the credit premium.

4. The possibility that the credit scheme includes virtually all farmers who do not face a cash con­straint1 excluding only those who are not in a position to pay cash for seasonal inputs.

The relation between cash sales and credit sales is a problem only in so far as project funds might be more usefully employed in alternative activities ru~d in so far as the credit premium has failed to cover credit costs during the life of the program to date1 providing no precedent for the formation of self-sustaining credit arrangements following the phasing out of the LLDP.

1.09 It may well be tr~t cash sales could be increased if inputs for the next season were available at the time farmers market their produce and receive their cash payments for it.

II. LLDP PHASE III SEASONAL QREDIT OPERATIONS

2.01 Projections of LLDP Phase III credit operations are also included in Table I. These projections are based on estimates of the number of accounts and total credit issued in 1977/78 found in Annex 9 of the Provisional Proposals prepared in September 1973 7 and on cost data foUl~d in A~~ex 1, pages 20-21~ of the same document. The cost figures in the Table have been adjusted downwards 1 however 1 to maintain consistency with the estimated operating cost data used by project management to date as reported in the Table (Item 12)o The adjustments consist of restrictillg vehicle costs to runni1~ costs onl~ (excluding insurance, overhead, depreciation and drivers 1 salaries) and by omitting the costs of computer­ization included in the Provisional Proposals estimates. The need for computerization is not established, no immediate steps to investigate alternative systems or to acquire a computer are envisaged (although this situation may change with the appointment of a financial and accounting expert for integrated rtu~al development projects later this year), and the bookkeeping workload may be decreased significantly if group credit replaces individual loans. The mission was informed that spare computer time is available on public sector facilities in Malawi and if computer­ization is required the economics of buying time rather than investing in a system for the project should be explored.

7

2.02 The projections of the number of borrowers and the total amounts of credit issued contained in the Table show a growth of both elements slightly in excess of 14% compounded annually between 1972/73 and 1978/ 79. The average loan size is expected to increase slightly over the period, although it may be argued that Malawi's position as a price taker in the world fertilizer market vdll result in considerable variat­ion around the projected trend. The projected gross costs of credit ad­ministration as a proportion of projected loan volume (Item 19) remain fairly constant over the period at between 1~ and 14%, although this figure is reaised to between 14% and 16% if the estimated full costs of vehicle operation are included.

2.03 The Phase III cost projections may be too high if group credit proves workable from the point of view of diminishing supervision requirements (as discussed later in this report). Group credit is being attempted on a pilot basis in the 1973/74 season. It is worth noting, however, that previous efforts with group credit failed to reduce administrative costs because of project involvement in helping groups keep records.

2.04 Projections may also be upset by economies in administration achieved by new systems introduced by the finance and accounting expert for integrated rural development projects who is expected to take up his position late in 1973. However~ there appears to be no immediate prospects for substantial savings in costs~ new systems often involve costly running-in periods, and the expert will probably have to spend considerable time initially in designing account structures to give management useful cost data rather than in concentrating on credit accounting and the technology which might do .the job most conveniently. Thus~ there is little basis for altering the projections at present to include the expectation that administrative costs will be substantially reduced by computerization or other new systems.

2.05 The projections assume that the project will expand to cover 32 standard units and 3 modified input areas by 1978/79 (Item 1). The projections assume that no units will be phased out of the credit scheme and that any units which are phased into tra.nsi tional arrangements (yet to be drawn up) will not be subjected to any de.crease in credit usage or supervision.

2.05 It is argued later in this report that in the long run credit should be provided on a self-sustaining basis in Malawi. The integrated rural development projects appear to incorporate sufficient flexibility to experiment with alternative arrangements designed to achieve a self­sustaining level of credit operations. Hence, during Phase III strenuous efforts should be made to ensure that the credit premium cover the "full11

administrative costs of the lender as well as losses from loan defaults. Credit premia of 30-35% on top of the cash costs of credit inputs may be required, assl.k"1ing that the 1972/73 situation is perpetuated, i.e., "full" administrative costs of about 20% of the amount loaned (cash cost of inputs plus the credit premium) and a 5-10% reserve for bad debts. The mathematics of these costs may be illustrated by the following hypothetical example:

8

Cash price of credit inputs Credit premium @ 34% Amoilllt loaned

100 34

134 Administrative costs (134 x 2o%) 27 Bad debt losses (134 x 5%) 7 __. __ _

34 Amount loaned less credit costs 100 Cash price of credit inputs 100

Net income of credit program -0-

IIIo OTHER LLDP CREDIT OPERATIONS

3.01 The preceding commentaries are biased a little by their ex-clusion of the other credit operations of LLDP 9 which consist of medium term and non-seasonal credit. Medium term facilities are extended for the purchase of ox carts and teams 9 maize mills 9 etc. Non-seasonal credit is short-tern credit which is devoted largely to financing farmers who obtain steers for stall feeding for a period of about six months. The rate of interest on both types of credit is si% on outstanding balances, and repayment rates for both facilities have been maintained at 100%. Their exclusion from the previous sections is based on their size in portfolio terms 9 their limited coverage in terms of numbers of borrowers~ and the relative absence of operational problems as ex­emplified by the virtually perfect recovery record. The extent to which these loans contribute to the net costs of credit administration reported in Table I provides a conservative bias to tl1e conclusions regarding seasonal credit which are based on these statistics. This bias results from viewing total credit administration costs as relatir~ only to seasonal credito Given the emphasis on seasonal credit, other facilities may in fact add only margin~lly to overheads.

3.02 The scope of mediurr1 term and non-seasonal lending has been as follows:

Medi urn Term Loans

Loans issued (K 1 000) No. of borrowers No . of units served

Non-Seasonal Loans

Loans issued (K'OOO) No. of borrowers No. of units served

1968/69 1969/70

0.1 5 2

1970/71 1971/72

31.1 83

8

13.2 130 14

1972/73

47.6 90 14

58.3 168 14

The financial years listed above end on March 31. The estimated volume of these loans to be issued from April to December 1973 are K20 7 700 and K9,000 in medium term and in non-seasonal facilities, respectively.

9

3.03 The cumulative total of credit issued under these programs by the end of March 1973 approximated Kl50,000 9 compared to a cumulative total of more than K815,000 in seasonal credit. The Provisional Proposals for Phase III indicate that this proportion 1 roughly 15-2o% in other than seasonal credit~ vall be maintained, and that in 1978/79, for example~ total advru1ces vdll exceed Kl.O million1 of which seasonal credit will exceed K800 1 000. These projections may be altered somewhat by the inclusion of poultry and dairy elements in Phase III 1 and also by changes in the projected availability of animals for stall feeding.

3.04 The high recovery rates reported by project management 7 the status of many of the borrowers as indicated by the ARDS draft Volume Two on LLDP, and the relatively large average loan size (above KlOO) suggest that the provision of this type of finance may be attractive to commercial lenders but probably not at the present preferential interest rate of si%. Profit margins on ox carts, maize mills, and stall feeders are reportedly substantial 9 and consequently there would seem to be no reason why a preferential interest rate should be accorded these borrowers. During Phase III, if not before, project management should inform the commercial banks of the extent and nature of these lending operations vdth a view to involving them to a greater extent in commercial opportunities such as these developed by the project.

IV. PROPOSALS FOR THE SELECTIVE USE OF CREDIT IN THE NATIONAL RURAJ.~ DEVELOPMENT PROGRA1{1

4.01 One of the mission's tasks was to consider proposals for a national rural development program (NRDP) which would use the experience

_and expertise accumulated under the four on-going projects as a basis for mounting similar but less intensive programs in other parts of the country. The structure and operations of the propoGed national program have yet to be agreed~ but there is little doubt that the final format will include credit to farmers in program areas. Accordingly, this section uses LLDP credit performance as a basis for the formulation of guidelines for national rural development program credit. (The question of institutional arrangements for credit operations is treated in the next section of this report).

4.02 Experience to date witr1 the use of seasonal input credit in LLDP suggests that:

1. the goals of rural development schemes specified in terms of input usage levels or output/yield criteria may appear to conflict with the requirement in the long run that credit prograrrLS must be self -sustaining 7

and

10

2. the role of credit changes as program goals are progressively realized with respect to individual farmers in program areas 7 as explained below.

4.03 Tr1e Rationale for including Credit in Integrated Rural Develop-ment Prograw~ or Paclmges. Credit is used in LLDP initially to encourage farmers to use purchased inputs and to do so in accordance with extension advice. Credit is offered to induce innovation and as one of several links between farmers and the program. This approach assumes that:

i) farmers in the program area would not otherwise use the recommended inputs either at all or in the prescribed manner~ or

ii) that credit will enable a larger group of farmers to participate in the program than would otherwise be the case.

These assumptions are based on the belief that farmers or at least a significant number of farmers do not have or would not use cash to obtain program inputs.

4.04 The use of credit on the cutting edge of development involves a large number of sn~ll accounts. In 1972/73 the average size of the 21,469 LLDP seasonal loans was Kl8.28. The costs of centrally admini­stering these accounts and the costs of loan supervision by project staff are high in relation to the interest charge or credit premium levied on borrowers, as discussed above. The operating loss sustained is a type of development cost 1 however, and is a logocal component of project overhead if credit is used to induce innovation.

4.05 The Changing Role of Credit as Development Occurs. Once the farmer has become an adopter, the rationale for credit as a "loss leader" service 7 to induce farmers to participate in the rural develop­ment program by providing facilities at less than cost, disappears. Development has brought the farmer higher net returns, and the argument that the farmer has no cash or vdll not use cash for the purchase or program inputs requires recasting. This alternative possibility, that farmers are perfectly willing to use their seemingly meager cash resources for on-farm innovations or investments which yield an attractive return7 also applies from the outset to those farmers in program areas who used purchased inputs prior to the introduction of ) the rural development program. To carry what has become a normal farming practice under the guise of a developmental overhead cost may represent a questionable use of scarce resources 1 especially in view of the selective nature of credit scl1emes.

ll

4.06 It may be argued that, given the fungibility of money, credit for inputs enables a farmer to use funds not spent on inputs for other purposes which contribute to development; and that in any event the farmer's need for input credit grows as he develops by using ever more inputs. The indirect financing argument has certain merits, but none explain why subsidized credit is required to achieve the benefits which are claimed to accrue. Little data is available on how expenditure patterns change with increasing prosperity in LLDP communities -­indirect financing may be goin~ into beer, health services and school fees~ or farm assets. The growth in the "need11 for credit as levels of input usage increase is in harmony with normal commercial practice. ) Larger operators borrow more than small ones, other things being equal.~ However, in view of the broadly based focus of LLDP there would seem to be little case for subsidizing credit to the most progressive elements in the community w~ile providing no credit to the least developed. The average loan size projections contained in Table I increase only modestly over Phase III~ suggesting that project management may not believe in allowing credit to grow with the farmer. (T'v ~

4.07 Credit Cost Considerations. The costs of smallholder credit administration are inevitably substantial, as already noted. Credit for LLDP farmers is disbursed in small amounts, reflecting the relatively small average fa~~ size. Most LLDP borrowers repay in two or three instalments, necessitating as many bookkeeping entries. Loans are super­vised by credit assistants at the unit level in the field, one assistant to approximately 250-350 borrowers.

4.08 The cost of credit administration may be reduced by devices which reduce the number of accom~ts or the number of accounting entries. Group credit reduces the number of accounts maintained by the lender by decentralizing record keeping. Group credit may likewise reduce the nunilier of entries if members aggregate their repayments. Group credit may also reduce field staff costs in two ways . The first is that the lender's security is no longer mainly a function of supervision of individual borrowers, but rather a function of the collective pressure brought to bear by the group on its members. Secondly, group credit provides a basis for group extension approaches, although of course group extension approaches llk~Y exist independently of group credit arrangements. Group extension may have little direct impact on credit administration costs, but does pe~~t economies in extension adninistration and nmy enable extension staff to increase the number of contacts with farmers at whom they are directing their efforts or to enlarge the n~~ber of farmers with whom they are in communication.

4.09 Economies of group credit may be offset by rising bad debt losses as the size of the group increases, diminishing group cohesiveness, weakening the sanctions which can be brought to bear on individual members, and thus increasing the probability of group disintegration and default. It is also possible that groups may result i 11 the aggregation of individual

12

defaulters. Dr. Kinsey~ the ARDS consultant concerned with LLDP 9

informed the mission that his latest data (not yet written up at the tLme of the mission's visit) suggests that default presently tends to be concentrated geographically in villages where headmen do not provide an-eiample of rompt repayment or in which headmen are not enthusiastic ~ut exhorting villagers to repay their loans. There is at least a probability that entire groups may default 1 although project management intends to diminish this probability by ensuring that groups do not initially contain defaulters with arrears outstru1ding.

4.10 Groups of borrowers will be required to place a lo% security deposit with LLDP management as a condition for receiving loans. The purpose of the deposit is to safeguard all members' interests by providing a cushion against defaults by some members 9 thus helping to ensure the group's continued access to credit. The deposits will also reduce the project's loss if an entire group defaults 7 in much the same manner that requiring a down-payment for credit inputs diminishes the lender's maximum loss on a transaction. It remains to be seen whether groups will in fact treat their deposits as a down-payment 9

defaulting to the extent of the deposit 9 or whether the deposit will be treated by borrowers as a security fund to be left intact from season to season.

4.11 Even if groups are used as vehicles for loan disbursement and collection, it is probable that the administrative and bad debt costs to the lender may still be at a level which cannot be covered by the low rates of interest which are sometimes considered most suitable for the stimulation of rural development. This possibility raises the question of the proper role of subsidized credit once the initial thrust of rural development progranlli has run its course.

4.12 Any ongoing credit schemes must be commercially viable over the long run (for reasons outlined later in this report) and the LLDP system shows little promise of attaining this level of performance. LLDP 1 s relatively high collection rates have declined as the number of accounts and the penetration of credit use have increased to include C) less creditworthy borrowers. It may appear attractive to weigh the ~, marginal cost of credit loss through default against marginal gains from credit use by a larger number of farmers 9 and to n~ke credit decisions or program design decisions on this basis. As attractive as this approach may ,be in the initial stages of project implement-a tion9 there are strong institutional reasor1s why a commercial approach should be applied to collection performance very clearly, although not necessarily from tho outset, in the course of a development scheme. Poor loan discipline is very difficult to correct. The existence of a large number of defaulters may creat a political climate in which I'021i enforcement at a commercial level is not possible. When this occurs, as it has in cour1try after country 9 the future of production credit is jeopardized 9 development of capital markets is hindered 9 and the cost of establishing viable credit arrangements to serve large numbers of rural people is greatly increased.

13

4.13 The Need for Long Term Planning of the Role of Credit. Accordingly, subsidized credit schemes oriented towards smallholders in general (i. e .~ rather than at specialized cash crop scheme parti­cipants) should specify carefully the clientele they are designed to serve and also the manner in which subsidy may be eliminated as program goals are achieved. Subsidy elimination may be approached in two alter­native ways 9 as outlined below:

1. Graduation consists of phasing the borrower out of the credit scheme by enabling the borrower either (a) to finance himself from resources accumulated by progran1 participation, or (b) to obtain credit from commercial lenders by reaching a certain level of husbandry and commercial practice. Graduation is appropriate when the costs of credit cannot be recovered from borrowers at ru~y given point in the long run.

2. Progressio11 consists of phasing the subsidy element out of the credit scheme by passing along to the. borrower a progressively larger portion of the costs of credit until the scheme is self-sustaining. During the course of progression t~e borrower becomes increasingly capable of satisfying commercial standards of credit­worthiness. It is likely th~t the amount of credit which the borrower can service rill also increase~ providing a more economical basis for program operation by spreading overheads over a larger port­folio.

4.14 LLDP appears to lack direction with regard to either graduation or progression, probably largely because project management fears that a hardening of loan terms or the removal of credit facilities would result in a substantial decline in the use of inputs. Management's fears in this regard remain largely unsubstantiated. However 9 it would be m~­realistic to embark on a graduation policy which did not include some consideration of savings facilities available to project farmers.

4.15 The national rural development program should experiment w~ith both alternatives, graduation and progression, if sufficient experience is not accumulated by thG present projects. Although the LLDP project appeared not to be moving systematically in either direction as of 1973, the West German supported project v~s using grades of farmers based on farm development levels which provides a basis for a strategy of progression. (In fact, the Lakeshore project management claims that their non-settlement credit operations are already self-supporting. See Annex l to this report)o

14

V o RURAL SAVINGS

Savings Balances in the Economy

5.01 Formal sector savings institutions serving rural areas include co~nercial banks and the Post Office Savings Bank (POSB) , wr~ch are discussed separately in this section. Table III contains data on the levels of deposits within each system between 1965 and 1972~ a period during which their savings and time deposit balances grew at a rate of 16% compounded annually. Post Office Savings Bank deposits, although accounting for less tl~ one third of the total balances of both systems, expanded at a slightly faster rate than the savings and time deposit business of the commercial banks over the period. The relationship between the growth of savings and time deposits and monetary GDP has not changed significantly over the period from 1966 to 1972. Savings balances have remained at between 9% and 11% of monetary GDP, while increments to these deposits have not exceeded 3% of monetary GDP over the period.

5.02 Unfortunately, published data do not distinguish between rural deposits and urban deposits. However, some indication of the dynamics of rural savin~s behavior may be found in the expansior1 of the Post Office Savings Baril{ from 159 branches in 1969 to more than 200 in 1973. Most of the branches which have been added to the system are located in rural areas. Commercial bailks have probably .not expanded their facilities in rural areas at the same rate, given the "high" cost of this business as reported to the mission by bank managers in Lilongwe ru~d by Reserve Bank officials in BlaDtyre. The marginally higher rate of growth of Post Office Savings Bank deposits than of commercial bank time and savings deposits may therefore indicate that rural savings on deposit with t~ese two types of institutions are expandir~ at a relatively more rapid rate than urban savings.

5o03 Non-bank financial institutions appear to compete with banks for private deposits to only a limited extent. Building society deposits increased from K290 ,000 to K628?000 between 1965 and 1972, while deposits with Mercentile Credit expanded from Kl9 9 000 to Kl42,000 between September 1968 and the end of 1972. Vfhile this grov~h is impressive, these balances equalled less than 5% of private domestic time and savings deposits in the co~~ercial bru~ng system at the close of 1972. The total assets of insurance companies in Malawi at the end of March 1973 approximated K5.5 million, of which approximately K800 7000 consisted of deposits with commercial bruiks. The Conmercial B~~~ nmnager in Lilongwe reported that a surprising number or rural people have life insurance policies and that many of the potential borrowers from the pilot bank branches to be established in the project area (disucssed later in this report) would no doubt be able to offer insurru~ce policies to collateralize their loans.

- 15 -T.:"..BLE III .. BANK .AND po sr.r OFFIC E SAVINGS BALANCES -- 1265-1972 {K•ooo2

I I

1965 1966 1967 1968 1969 1970 1971 1972 Compound Annual ! Growth Rate

Commeroial Banks Private Domestic Time And Savings Deposits 6250 7798 8570 10376 12216 14442 15293 18130

% INCREASE 25% lo% 21% ls% ls% 6% 19% 17%

Post Office S3vings Bank

Deposit Balances (Net of :Migrant Labour Scheme) 2083 2549 3058 3555 4407 5178 6374 7123

% INCREASE 22% 2o% 16% 5(f/ p 7% 25% Is% 19%

Total 8333 10347 11808 13931 15966 18457 20298 24030 16% Annual Increment 2014 1461 2123 2035 2491 1841 3732

Monetary G.D.P . at Market 14% Prices 114100 123800 132900 152400 171900 214500 244900

Savings Balances as % 9% lo% 10'/o lo% 11% 9% la';b

Incremental Savings as % 2% 1% 2% 1% 1% 1% 2%

w; J

Source: Reserve Bank of Malawi, Post Office Savings Bank.

16

Savings in the Corarnercic..l Banking System

5.04 The banking sector includes the Natior~l Bank (owned by Standard Baruc7 25.5%; Barclays? 25.5%; Malawi Government 49%) and the CoLIDlercial Bank (Portuguese and Malawian interests). Total liabilities of the commercial ballits a t the end of march 1973 amounted to K59.4 million, of which K50 . 9 million consisted of deposits. Of these, Kl8.4 million were time and savings deposits from the private sector. Interest at 4% on minimum monthly balances is paid by both banks on sav]:Dgs deposits . Minimum balances of KlO are required by the National Banl\: 7 while the Commercial Ba.."lk: minimwn is only K4. The prime lending rate is s%, and rates arc as high as 16% on certain types of credit facilities. The spread of between 4 and 12% appears generous compared to the narrower margins found in Kenya and Tanzania, and helps to carry the relatively high cost of providing bruiking services in rural areas through an extensive networh: of sub-branches, agencies and mobile services .

Post Office Savings Bank

5. 05 The Post Office Savings Bank operates through about 200 post offices throughout ~/[alawi . Financial services available at post offices are limited to money transfer and savings accounts. The rate of interest paid on savings accounts is 4% credited annually . The minimum trans­action and balance is 50 t and the maximum withdrawal is K20 vv.ithin any 3 day period, except by special arrangements or at the head office branch. Depositors have complete freedom to make deposits and withdrawals at any brru1.ch~ subject to these limitations.

5.06 Data on POSB operations between 1969 and 1972 are given in Table IV. The system has experienced a rapid growth in deposits and in georgraphical coverage (measured in terms of branches) since 1969. However, the average balance per account has remained static over the period, at between K28 ru1d K30 9 perhaps reflecting the limited useful­ness of Post Office facilities compared to those offered by commercial ba1Ucs 7 vvhich in most cased do not limit withdrawals made on de1ruand and which have a range of other services to offer depositors . The static average balm1ce may also reflect low balances belonging to the numerous new account holders, or simply a large nULJ.ber of static accounts. In 1972 9 for example 9 the number of withdrawals was 370 7 036 9 while the number of accounts was 248 9 454 9 giving an average of only 1 . 5 debit transactions per account. Tl1e POSB has engaged in publicity campaigns (directed at Post Office box holders as well as at a wider public) and its interest rates are competitive ~dth those offered by commercial banks while its minimum balance and transaction limits are lower than those of the banks. However, its growth may be hampered to some extent by the colonial Post Office siting syndrome which frequently placed post offices in government administrative compounds located on the fringes of towns rather than the market areas which constitute the hub of the rural economy.

17

TABL E IV. POST OFFICE SAVINGS BANK OPE RATI ONS 1969-1972

1969 1970 1971 K million

Amount Deposited (including interest) 2.7 3.5 4.3

Amount Withdrawn 1.9 2.7 3.1

Excess deposits and accrued interest over withdrawals .8 .8 1.2

Bslance due to depositors as at 31st December 4.4 5.2 6.4

Kwacha

Average amount of each deposit 17.76 13.34 14.29

Average amount of each withdrawal 8.42 10.22 10.57

Average Balance per Account 29.86 29.34 30~36

Number of deposits 251' 342 287,066

Number of withdrawals 267,938 296,360

Number of Accounts remaining open 147' 579 176,498 209,932

Number of Branches at year-end 159 164 171

Source: Annual Reports of the Post Office Savings Bank.

1972

4.6

3.9

.7

7.0

13.82

10.50

28.67

317,309

370,036

248,545

187

18

5.07 Table V provides a summary of Post Office savings transactions for the first eight months of 1973 at the departmental post offices which are located in large centers and postal agencies which are generally operated by District Councils in rural areas. At the end of 1972 there were 59 departmental post offices and 128 agencies providing POSB services. Balances appear to accumulate at a faster rater at the agency branches than in the departmental branches, although interpretation of the statistics is complicated by the excess of withdrav~ls over deposits at the head office branch and by withdrawals of migrant labor scheme savings at postal agencies and departmental offices.

5.08 Balances on migrant labour scheme accounts consist of deductions from the monthly wages of Malawian laborers in South Africa and Rhodesia recruited under the Governn1ent 1 s migrant labor scheme (MGLRSA). Labor contracts are for a period of 24 months and 60% of each worker's net monthly salary is deducted in months 4-21. Laborers frequently have a forced savings balance of K300 awaiting them upon their retun1 to Malawio Tl1e passbooks for these accounts are available for collection by returning workers in their home districts" which is designed to promote spending in these areas. In most cases practically the entire balance is with­dravm in a single transaction. Bicycles, blarucets" beer and trru1sistor radios are traditionally purchased vath the proceeds of mine employment. The Post Office Savings Bank would like to secure the same arrangement with WEIJELA (a private mine labor recruiting organisation)" which currently pays out K500 9 000 monthly in cash in Bla.ntyre to returning laborers.

5.09 The POSB is limited to investment in Government securities 9

which contributes directly to the Government's capital budget 9 providing an indirect link between private rural savings and rural investment tmdet·­taken by the Government. As of the end of 1972 POSB holdings of Malavvi Government stock had a market value of K7.2 million (nominal value K7o5 million) compared to total POSB liabilities of K7.4 million. The POSB operated on a profitable basis in 1971 and 1972.

Savings Facilities in the LLDP Area

5 .10 Savings have not been a major focus of any of the integrated rural development projects. However" an increasing amount of attention is being devoted to rural savings potential" as manifested by the P,ilot effort to provide Post Office Savings Bank deposit facilities at two marke s in the Shire Project during peak payout periods" by the Salima project management's participation in the construction of several Post Office brancl1es" and by the pilot scheme to be undertaken in 1974 in Lilongwe involving the establishment of 17 static" agencies of the Commercial Baru~ in two units. Project officials interviewed during the mission had widely differing views regarding the role of savings in rural development. The senior credit officer at Salima thought that savings had very little role to play and that it would be preferable if project farmers used their incremental income entirely for consumption" which would promote the development of rural trade and infrastructure. In Lilongwe" on the

19

TABLE V. SUMM ARY OF TRANSACTIONS AT POST OFFICE SAVI NGS BANK BRANCHE S

TRANSACTION AT

Post Offices

(a) Northern Region (b) Central Region (c) Southern Region

Postal A9encies

(a) Northern Region (b) Central Region (c) Southern Region

Savings Bank Head Office

Migrant Labour Scheme

Total

JANUARY - AUGUST 1973 ( K '000 )

DEPOSITS

313.2 588.2 80/.7

1(?09.1

77.5 188.0 159.3

424.8

{~05.1 --1,182.3

3' 721.3

Source: Post Office Savings Bank.

IJJITHDRAWALS

207.0 421.0

1,038.2

1,666.2

63.3 131.6

88.6

283.5

649.6 --

2,599.3

NET DEPOSIT

42.9

141.3

(244.5)

1,182.3

1,122.0

20

other hand, project officials felt that savings facilities should play a significant role in Phase III, and that the Commercial Bank's experimental activities in 1974 should be monitored closely. The POSB has since early 1973 prepared special returns for the Salima project management on deposit behavior at the eight branches in the project area 7 and the Lilongwe project management could no doubt profit from similar data from the POSB and commercial banks operating in their project area.

5.11 Bank managers in Lilongwe and project management and evaluation personnel indicated to the mission that informal sector savings and credit institutions do not exist on any significant scale. Project management in Salima1 however, reported the existence of several local money-lenders. In both areas shopkeepers are reported to extend credit in kind (salt, sugar, oil, matches, etc.) to established clients, but the individual amounts involved are probably quite small, say a maximum balance outstanding of Kl-2 per borrower. Nine markets vdthin or on the immediate fringe of the LLDP program area (as defined by proposed 1976/77 coverage) are served by commercial banks and the Post Office Savings Bank. Seven of these markets have Post Office Savings Bank branches and four are visited by mobile banking units operated b~;the National Bank of Malavli and the Commercial Bank in Lilongwe town7' Saving facilities are also available in Lilongwe town, in two other markets in Lilongwe District, and in Lumbadzi, just over the District boundary on the road to Kasungu.

5.12 No data on the performance of these facilities was readily available -- the Post Office was unable to provide returns at short notice of its branches in the area and commercial bank data failed to distinguish between urban and rural deposits. However, the Commercial Bank's manager reported that considerable savings are being accumulated in rural areas and the potential for tapping these savings through the banldng system is attractive.:?/ The National Bank's manager did not share this view, and it remains to be seen which school of thot~h better approximates reality. The differences in their opinions may to a large

1( Lilongwe is the site of regional headquarters for both banks, and mobile services based there serve areas as far north as Karonga and also the Lakeshore area. The National Bank has nine mobile units at Lilongwe and the Commercial Bank has one.

1/ The fact that a few LLDP project loans are repaid by borrowers before they market tl1eir produce and that a significant portion are repaid at unit centers rather than at produce markets suggests the existence of savings capacity.

21

degree reflect the fact that the National Bank and its predecessors have been doing business in the country for many years and has a market shnrcexceeding 80% 1 while the Commercial Bank was formed in 1970 and needs funds to expand its operations. Consequently, the Commercial Bank plans to establish two "static" (i.e. permanent) agencies in the project area in 1974. The two branches will be in adjacent units, one of which has an established trading area while the other has none. Each agency will be manned by a teller and a messenger, with routine services by the b~-k's mobile unit for transporting cash, supplies9 etc. The bank expects to develop savings business initially and perhaps after one year diversify into lending. The buildings to house the branches are being built by the LLDP unit management committees, composed largely of local residents in the units concerned, with finance provided by project management in the form of loans. The Commercial Bank expects to lease the quarters from the management committees, although their m1certain legal status may necessitate alternative arrangements. The cost of each building is estimated at Kl 7 600 and fittings will cost an additional K400 per branch. Staff costs will approximate K75 per month. Bank management expects average balances per accom~t of K20, turning over once a year. Each branch is expected to break even on direct costs in the fourth month after opening and to be operating profitably within a year.

ADMAIW and Rural Savings

5.13 The operations of the Agricultural Development and Marketing Corporation (ADMARC), Mala\vi's principal statutory marketing baord 7 are commented on in severl IBRD documents and sumciarized in the Provisional Proposals for LLDP Phase III prepared by the Governmento The functions of ADMARC fall into three categories: (a) price stabilization and implementing Government's pricing policies relating to agricultural produce, (b) input supply and produce marketing, and (c) accumulation of surpluses and their investment. The last function is the one which is most directly related to rural savings and the development of capital markets, and deserves consideration in arzy discussion of these subjects.

5.14 The effect of ADMARC 1 s operations on rural savings appears to be repressive 9 and may be traced to substantial differences between AD~UURC buying and selling prices which results in high net profits on turnover of major crops handled by ADMARC o Groundnuts are the most outstanding example. Between 1969/70 and 197~72 net profits on groundnut sales approximated 20-3o% of the net sales values of the groundnuts purchased. The extent to which ADMARC has accumulated sur­pluses is reflected in the increase in its investments, which amounted to Kl.5 million in 1969 and to K3.7 million in 1972 7 and in the increase in its year-end liquidity position. Working capital grew from K2 million to Kl4 million between 1969 and 1972 while sales increased from ICL9 million to K28 million.

22

5. 15 Surpluses are accumulated for two purposes. One is to provide assets for price stabilization purposes and the second is to "tax" agricultural production in order to generate funds for investment in large scale agriculture and in agro-industry. It llk'?.Y be noted in passing that ADr~C 1 s approach to accumulating price stabilization reserves appears not to have been at all systematic until 1972 with the result that a substantial portion of assets ostensibly accumulated for price stabilization purposes are invested in securities which would probably not be liquidated easily. AD~ruuRC also appears to have no idea of how the optimal reserve level should be determined, and in any event efforts to stabilize price rr~y destabilize farmers' incomes as demon­strated by CoP. Brown, "The Malawi Farmers Marketing Board", Eastern Africa Economic Review, Vol. 2, Noo 1, June 1970 7 pp. 37-52 1 which discusses the policies and operations of ADMARC 1 s predecessor.

5.16 There are se·v-eral reasons wby an alternative policy 9 based on paying the farmer a price for his crop which realistically reflects its market value, would in many cases be in the best long run interests of the country. An exceptio11 9 for which this alternative is not appropriate, would be cases in which quotas, as for tobacco, are distributed in such a v~y that the grower could comnmnd a monopoly profit~ For most crops, however, passing to the growers a substantial portion of the surpluses now being accumulated by ADrruuiC is preferable because it would:

a) en~ourage agricultural production,

b) provide producers vrith a broader range of choice,

c) raise consumption levels in the smallholder sector, stimulating trade and monetization of the rural economy, and

d) promote and utilize the development of financial expertise by specialized institutions.

5.17 These assertions assume that farmers are responsive to price levels and changes. Evidence that this is the case in Malawi includes LLDP management's belief that unimpres sive groundnut yield trends and the relationship between groundnut production and maize production in the project area are to some extent the result of relatively unfavorable price/labor input relationships for groundnuts. Management also has used price responsiveness to help to explain the decrease in input tonnage purchased in 1972/73 9 when the prices of fertilizers increased significantly .

5.18 If farmers are responsive to price levels and changes, it is reasonable -to assume that higher farmgate prices would stimulate production and employment and that since a significant volume of cash crops are exported that this would increase the country's ability to earn foreign exchange. idore cash in the hands of smallholders would stimulate rural trade and induce merchants to stock a greater variety of items, giving the bulk of the population an expanded range of choice.

23

5.19 Greater rural trade should make it attractive for the bruiks to expand their services in rural areas. Greater access to banldng services by people in rural areas would encourage rural savings and bring into the system balances which are now hoarded. Likewise 9 more financial services, such as credit, in rural areas should also stimulate rural economic activity.

5.20 Most importantly, those enterprises which are now looking to AD1~C for funds would have instead to look to the mainstream financial institutions. It may be surmised, in view of ADiviARC' s ad.ministrative difficulties which are reflected in its inability to provide inputs in a timely manner, its accom1ting problems which are reflected in the inconsistencies in its financial statements9and its policy-making and strategic problems manifested in its approach to the accumulation of price stabilization reserves, that ADMARC is not so highly skilled in the field of finance as are the country's specialized financial institutions. These institutions are more likely to ensure that investments are made on a prudent basis, that borrowers or sellers of securities are subjected to financial discipline and that firms which seek funds in the capital market have access to financial expertise provided by lenders or buyers of securities. Greater reliance on the capital market would provide an incentive for institutional diversi­fication which would expand the presently rather narrow scope of that :market.

VI. LONG TERM ASPECTS OF SMALLHOLDER CREDIT PROVISION

Principles

6o01 Three ~2jor concerns underlie the proposals contained in this section. One is the need for experimentation with alternative methods of credit issue, disbursement and collection; the second is the as yet nnsubstantiB.tud contention that credit is an essential component in rural development programs; and the third is that agricultural credit in a predominantly agricultural economy should 9 in the long run, operate on a self-sustaining basis.

6.02 Self-sustaining Credit Operations. Administrative arguments against subsidiziP~ agriculture through credit programs are summarized below. Subsidies to agriculture through credit occur when interest rates ru1d other charges fail to cover lenders' costs, which include admini­strative expenses, the cost of the capital employed and bad debt losses.

1. Credit schemes usually benefit only a relatively small proportion of farmerso Furthermore, credit worthiness is usually the attribute of a relatively well-off group. Thus, subsidies in the form of low interest rates or written off or lli~collected loans are inconsistent with a broadly--based approach to rural development aimed at the average grower or at large groups of rural people.

24

2. Credit schemes which founder may create a tradition of poor loan morality which makes it more difficult and costly to establish successful credit arrangements at a later date.

3. Credit schemes which fail to recover amounts due and which are associated with public sector initiatives in rural areas may weaken the ability of the Government to govern. Rural people may discover that their Govern­ment is unwilling or unable to enforce contracts. The impact on the traditional courts of LLDP credit defa1ilts may prove to be a classic case of this type.

4. Credit is an indirect input, and a costly service. Direct stimulants of development, such as fertilizers, markets and prices, may be more efficient vehicles for subsidy. If subsidies are required in order to stimulate rural development, these are probably best aimed at the removal of constraints which will benefit broad numbers of people or which are selective in benefitting critical and well-defined groups of people in a marmer consistent with considerations of equity.

5. Many arrangements for subsidizing farm credit institutions inhibit the growth of the 1~tional capital market. The usual pattern in the Tllird World countries which suffer from the affliction consists of q public sector institution which is unable, on the basis of its financial performance, to attract private funds locally and which operates on or1e side of the market only, as a lender. Soft flh~ds are solicited from external donors and the exchequer to prop up its operations. The question of providing a range of financial services to rural people is not considered, as administrators are pre-occupied vrith keeping the national fa1;m credit institution afloat. Policy makers (many of whom have loans from the national farm credit institution) are wary of abandoning the subsidized interest tradition and of adopting a pragmatic policy which would make it financially worthwhile for financial institutions to take intermediation to rural areas. Without intermediation rural savings are not tapped or stimulated. Credit remains a service for the few~restricted by the perverse dynamics of the subsidized market which stifles growth by its inability to attract private local capital, including the savings of the rural people themselves.

25

6.03 Given these arguments, it is important that development programs have as a long run goal the attainment of self-sufficiency in terms of their credit operations. Administrative costs and bad debt losses should not have to be carried by outside sources, and should not erode the capital of the lender.

6.04 Credit as an Essential Component of Rural Development. The integrated rural development projects have failed to produce any evidence that credit is an essential element in tl1eir operations or that credit has enabled a large number of farmers to do what otherwise 1night have been impossible. That many creditworthy farmers are capable of financing the adoption of improved inputs themselves is demonstrated by:

1. the use of fertilizers by many farmers in project areas prior to the commencement of the projects;

2. the levels of fertilizer usage in areas such as Dowa where credit for input supplies is not readily available; and

3. the relatively widespread practice of farmers' grouping themselves spontaneously or with some extension assistance for the cash purchase of inputs in bulk to be transported to their villages by ADlV1AH.C o

6.05 However, it appears reasonable to assume that credit may have enabled a certain group of farmers to use modern inputs and hence parti­cipate in rural development projects who might not othervv.ise have done so. But this group remains to be identified in tern1s of its characteristics, numerical weight and catalytic importance. At best, credit may encourage input adoption by some farmers who had not previously availed themselves of fertilizers 9 etc.; at worst it may allow farmers who would be using inputs in any case simply to defer payrnent by using finance provided at less than its accounting costo

6.06 Credit schemes may also involve certain disadvantages to borrowers and to the community. For example 9 credit schemes in many countries are linked with monopsonistic produce rnarketing channels. The moneylender in India and numerous modern sector lenders in many countries are alike in tying the borrower to a specific buyer for his crop. This type of arrange­ment may place the borrower at a disadvantage by limiti11g his freedom to trade with the buyer offering the best price or conditions. In rural Malawi 9 the practice of tying borrowers to ADMARC buying points may retard the development of competitive local buyers who could serve the entire community 9 not simply those who borrow to obtain cash inputs.

26

6.07 Credit may encourage some farL~ers to take risks which they would not otherwise accept 1 and when these risks move against the borrower his welfare is compromised. One of the risks of credit is that its provision may not be matched by the acclli~ulation of management skills by the borrower. Tractor purchase credit in may parts of Africa provides sad demonstrations of how to lend a man into a hole. Seasonal credit for farm inputs in Malawi presently poses a relatively minor· threat of this type 1 but one which should nevertheless be considered. In some cases incremental inputs which a farmer takes because he has access to credit may not produce a return large enough to recover their costs. This situation may arise due to a poor crop year. It may also occur from the sub-optimal use of inputs by new adopters who have not been well advised in improved practices by extension agents or other sources of information~ or who fail to follow advice which is readily available and to which they have been exposed. Failure to recover the cost of incremental inputs may also occur when recommended practices are in fact inappropriate. Although no cases of inappropriate recommendations were brought to the attention of the mission with respect to rural development in Mala\v.i, the probability of errors of this type with respect to new and thus inevitably relatively untried practices cam~ot be entirely discounted in any rural development activity.

6.08 When credit encourages a farmer to use incremental inputs which fail to yield a return at least equal to their costs, the farmer may be unable to clear his debt at the end of the season or as installments fall due. In this situation the farmer may become increasingly encumbered by debt~ and in certain countries relatively easy -access to credit has led to widespread rural indebtedness and the creation of a class of indebted rural people. The limited amounts and types of credit, balanced against the supply of profitable innovations currently available to small farmers in Malawi poses no threat of this rr~nitude, but the provision of credit to the majority of farmers in many LLDP units~ for example, does appear to have Permitted some to have become indebted who may be unable to repay at the close of eacl1 season, as suggested by the substantial nwnber of cases before the traditional courts. In the LLDP situation the problems con­fronting the courts no doubt involve a cost to the community as a whole~ including delays in obtaining judgements on lru~d questions, cattle thefts and other routine matters, and quite possibly the weakening of the courts' authority, as suggested earlier.

6.09 Not all farmers who fail to recover the costs of incremental credit inputs will default, of course. Some sadder and vdser men will repay from other sources of income or from the liquidation of assets.

27

Delivery Systems

6.10 Annex l of the agricultural sector review conducted by RMEA earlier in 1973 examines the case for establishing a national credit authority. The annex reviews proposals made by the B8nk1 s Mr. Stoneham in 1970 that an agricultural bank be established~ and comments on proposals put forward by the Malawi Government for the issue of seasonal credit through a proposed ADMARC subsidiary (ASCOM) and for the establishment of an Agricultural Bank of Malawi to serve a portion of the large farm sector initially with medium fu~d long term credit. The agricultural sector review report proposes the establishment of a Rural Development Bank of Malavd (RDBM) supported by a specialised Farm Management Service.

6.11 Government officials indicated to the mission that the ASCOM proposal has been reconsidered and scrapped. Government also appears sensitive to the costs of establishing a centralized farm credit institu­tion and the overheads which it would inevitably involve 9 and to the uncertainty that a new national institution could improve upon the per­formance of the present decentralized, specialized and fragmented structure. Officials of the Reserve Bank said that their organization has no proposals for the development of any specific institutional arrru1gements for providing farm credit and that a flexible and pragmatic approach appears preferable at the moment. Given these views (with which the mission is basically in accord) and the prospects for the generation of significant new data through the operation of group credit schemes in LLDP and from experimentation in project and NRDP areas~ it would appear that tl1ere is no urgency in according a high priority to the implementation of the Rural Development Bank proposal.

6.12 Rather 9 the country is in a position ~o benefit greatly from the experience which has been gained by the present pluralistic structure and by exploiting its inherent advantages of flexibilityo The follovdng proposals for the long term development of institutional arrangements for the provision of smalll1older credit in Malawi incorporate the possibility for th~ formation of regional institutions or a national institution in the wake of the credit operations of the integrated rural development projects. If experience over the next five years suggests that this type of institu­tion would be useful~ renewed attention should be given to its formation. Its scope and coverage could be expanded as warranted, and could in effect result in the realization of the RDBM proposal in due course.

6.13 The possibility t hat banking s ervices could be provided profitably to smallholders on the basis projected by the Commercial Bank in Lilongwe has 1nany administrative and economic attractions. The administrative advantages lie in the broad range of services available to commercial bank customers in comparison vrith those offered by the Post Office Savings Ballir. The barnes link savings directly with credit, providing a number of financial services at a single office. Reserve Bank officials cited these advantages to the mission when justifying their according higher priority to the role of commercial banks in rural development than to the role of the Post Office Savings Banko

28-

6.14 The economic attractions of the commercial banks lie in their relative flexibility in employing funds 9 as compared to the portfolio limitations imposed on the POSBo A deposit with a commercial b~~ probably contributes much more to the development of the capital market than does a deposit with the POSB. Of course, the POSB may be able to provide services to the smallest depositors who would not be seriously solicited by commercial banks. As the services of the two institutions are not perfect substitutes, a case can be made for the voluntary expar1sion of both systems in rural areas. The normal pattern is that depositors tend to move out of the post office savings system and into the commercial banking system when they reach a certain level of liquidity and sophistication.

6.15 Long term institutional arrangements for the prov1s1on of farm credit in Malavd can conveniently be considered under a classification including: (a) present rural development project areas, (b) future national rural development program areas?(c) special cash crop schemes, (d) $ettle­ment schemes and (e) other areas. "Long term11 refers to the period follow­ing LLDP Phase III 9 ioe. 1979/80 and beyond.

6.16 Present integrated rural development project areas. In areas presently covered by project services, credit should continue to be issued in order to give farmers an incentive to participate in these projects throt~h the use of puchased inputs and in order to provide project manage­ment with more experience in credit administration. As noted with reference to LLDP Phase II, however, alternative delivery ~echanisms and loan terms should be tested in ongoir~ project areas.

6.17 The long term continuation of credit . arrangements in present project areas should be based on the experience and operational expertise accumulated over the course of the projects, but should be conditional upon the achievement of a self-sustaining level of operations. It is proposed to test the feasibility of continuing credit arrangements on a permanent basis beyond the life of a project in any given area by having project credit machinery maintained following the phasing out of other project operations. Credit operations will be carried on in phased out units by project management, but as a separate accounting center (or "profit center" in accounting terminology) carrying its own direct costs and a proportionate share of project credit administration overhead.

6.18 In order to permit the accumulation of data useful for determining whether the operation could be self-sustainir~ 9 man~ement should have full discretion over the funds and functions under its control, which would include the power to specificy loan terms and conditions and to add addit­ional services to stretch overheads. If the prohibition against investing credit funds in Government securities or placing them with commercial baclU3 or other financial institutions during the slack season cannot be waived, management should be allowed to undertake this investment on paper (but not on a retrospective basis) and the dummy income figure generated by these shadow transctions included in the data used to determine whether the credit operations in the phased out areas are self-sustaining. (Hypothetical operating data are given in Am1ex B) 0

29

6.19 If after the course of three or more years it is demonstrated that viability on this basis cannot be obtained 9 credit provision should be discontinued abruptly. (If at this point ADMARC is rurming efficiently 9

the possibility of its handling seasonal credit may be reconsidered in view of economies of administration which may be available from combining input supply and credit, as in developed countries and in cooperatives)e If viability is achieved on paper two alternatives appear ;plausible. One is the transfer of credit activity to commercial banks. As most of the credit is seasonal~ it could well be that the banks would be interested i n this type of lending. The second alternative consists of establishing a separate regional or national credit institution to take over credit operations in ;post-project areas. The capital of this institution would be the credit fund for the areas concerned, which might be ;provided by the Government on a dividend-free basis. (Should dividends be required 1 the shadow revenues of tl1e prototype organization sho~ld be adjusted accordingly.) Any additional capital required should be raised on market terms in the interest of financial responsibility. After the issue of post-project viability is explored in a sufficient number of cases, the need for a trar1sitional ;period between the ;phasing out of ;project coverage (excepting credit) and the continuatio~discontinuation decision may be eliminated, with the credit operations being either discontinued entirely or taken over by commercial barilrn or a 1~tional or regional organization directly from ;project management as ;project coverage is phased out in any area.

6. 20 Future national rural develonment program areas. As suggested above~ credit should be included in the NRDP in a selective and clearly defined manner. If NRDF areas are organized on a leos intensive basis than the present integrated rural development project 9 groups are probably the most appropriate ur1i ts for credit administration because of the economies which they should permit. However, given the lack of hard evidence that credit is an essential service 9 it is proposed to experiment in at least one l{RDP area by excluding credit from the services offered. This experiment might be conducted by comparing ;project performance in t wo sirr~lar areas 1

one se1~ed by project credit 9 the other not so served; or tl1e experiment might be attempted on a temporal basis by introducing credit two or three seasons after a project has started up in an area 7 and perhaps in not all project areas at the same time. Experimentation should continue with group schemes and with other alternatives which may be developed to reduce costs and/or improve repayment ;performance.

6.21 Special Cash Crop Schemes. Cash crops schemes administered by special authorities frequently include credit elements for growers. Credit arrangements are easily handled by project management because of the ;projectrs role as a marketing channel through which loan recoveries can be made, and because of management's supervision of growers in the scheme.

6.22 Flue-cured tobacco is grown on special schemes in Malawi. The mission was concerned ~nth pre-eppraisal of the ;proposed Malawi Smallholder Tobacco Project which will become effective by 1976 at the earliest. It is ;premature to attempt to outline in detail tl1e credit needs or credit delivery system before thB size and location of the project are agreed upon 1

30

and no attempt is made hereo However, the type of credit appropriate for a flue-cured tobacco scheme is outlined in ~ recent Commonwealth Develop­ment Corporation (CDC) document 1 Beport on Smallholder Flue-cured Tobacco Project - Malavri, by Sandys, Collinson and Paynec Details are cited briefly to deonstrate how a cash crop settlement scheme can p:ovide an array of credit services to settlers with relatively little administrative in­convenience, encompassing a broad range of operations vdth a very small probability of default. The project proposed in the CDC document extends a pilot smallholder scheme which has been administered by the Kasungu Flue­cured Tobacco Authority (KFCTA) since 1970, and vall involve 600 growers by 1977/78. Each grower will have a plot of 20 acres nnder a renewable f'ive year licence? on v1hich 1! acres of tobacco~ one acre of maize and on-half ­acre of gronndnuts will be grown each year on a rotating land use pattern with a five year cycle. Credit to growers is tied to production and investment cycles.

6. 23 The typES of credit supplied include:

(i) medium-term loans to individual growers for the construction of two tobacco barns on their plots at the time of settle­ment;

(ii) credit in kind in the form of central services (project management 9 roads, water supplies, grading sheds 9

nUl~~eriesy etc.);

(iii) a subsistence allowance of K4 monthly paid in cash and Kl7 of subsistence crop inputs supplied at pl~~ting time for the first two seasons.

(iv) credit in kind for direct cash crop input costs.

6.24 Credit advanced, plus interest 9 will be recovered from annual payouts for cash crop deliveris to the authority, anc will reduce the projected gross margin of approximately K500 per farm at maturity to a net profit of approximately K200., Arrangements for the replacement of the two initial barns after 10 years are not firmly spelled out 7 although it is noted by CDC that growers might be encouraged or forced to place anticipatory interest bearing capital equipment replacement deposits with KPCTA ..

6.25 The administrative efficiency of these arrangements 9 including the bulk purchase of inputs and close supervision of their use 7 is a strong argQment for keeping them under the control of the cash crop project aut!rroties involvedo The mission visited no other cash crop schemes 9 ~~d arrangements slightly different from those described above would be required for projects introducing a cash crop in &~ already settled area.

31

6.26 Non-cash Crop S£ecial Schemes. [Ettlement schemes are linked to the Mala\v.i Young Pioneers organization and also include other farmers. At present there are more than 3 9 000 settlers outside and about 600 within major project areas. Credit is provided to virtually all settlers for the purchase of seasonal inputs and also on a selective basis for medi~m term investments such as oxen and tobacco barns. Standard cost data developed by the Ministry of Agriculture include a credit fund of K98 per settler on a dry land scheme for the purchase of inputs for five acres of crops at full development. The standard credit fund for irrigated rice schemes amounts to Kl3 per a cre of rice . Young Pioneer settlers also receive an initial K96 allowance in the form of uniforms, tools, etc., which is recovered over a five year period. The Settlement Credit Fund is administered by the Ministry of Agriculture . As noted in the Stoneham report and reiterated in the s ector review report, repasment is a problem. Although 94% of the seasonal credit issued to settlers from the Settlement Credit Fund in 1974/73 had been recovered as of the end of September 1973 7 the cumulative collection rate for the Fund sL~c e its inception in 1970/71 was 72% as of the same date . The Fund ' s credit issues have not exceeded K75 9 000 annually . The r epayment rates achieved by Salima Proj ect management on its settlement loans at the close of each season, have varied from 21% to 847;; -- a sharp contrast with the as% to 95;s obtained in non-settlement project areas.

6.27 The general poor performance of the settlement loan portfolio in Malawi reflects problems outside the realms of finance, such as settler selection and the politics of enforcing loan agreements. As suggested by the Salima case where the same management has a good record with non­settlement credit and a medi ocre record with s ettlement credit, it is unlikely that better financial administration alone could rr.ake the settlement portfolio viable . Hence, it would appear unwise to incorporate settlement credit in a national agricultural credit insti tution. If the settlement portfolio were taken over by such an institution there might also be pressure to use resources earmarked for or generated by other progran1s to bolster t he weak performance of the s ettlement loan scheme . In view of the small size anu t he political nature of the settlement program, and the mission's superficial review of its credit component, further suggestions are not vvarranted here.

6. 28 Other areas . Host parts of rural lialavvi are not included i~a

project areas, special cash crop s chemes or settlement schemes. Small­holders in these areas have virtually no access to institutional credit. The comr1ercial banks rarely lend to t he bona f i de small farmer~ and the Government Loans Board (GLE ) is not a vigorous lender . The Board is the only s~ecialized agricultUl~al credit institution which does not have a specif ic geographical responsibility, and hence warrants description .

32

6.29 The travails of the Board and its predecessor, the Central Farmers Loans Board, are outlined in the Stoneham report and in the sector review report wr1ich indicates that of the K20l,OOO loan portfolio, Kl53,000 is outstanding in s everal large loans 9 that 60% of the port­folio is in arrears 9 and that 40% of arrears are deemed uncollectablc. I11_fon 1ation obtained by the ruission indicates that the situation has not altered significantly since the sector r eview was undertaken. Loans to agricult1u~e have been resumed by the Board, follovv.ing a period of suspension, and lending to business and industry has now been sus­pended. Disbursements between April and the nuddle of October 1973 amounted to Kl2 ?600. The interest rate remains at 7i%.

6.30 Loans to far~ers are generated and vetted by Ministry of Agri-culture extension staff on the basis of the farruer 1s character, experience and vv.illingness to follo w their advice. Applications are submitted to the GLB by t he Director of Extension. More than half of these applications are rejected by the GLB reportedly because of the lack of available fQ~ds or because the applicant appears capable of financing himself. (Recent balance sheets &~d trial balances show a substantial cash position approx­imating Kl50 1 000. These bank deposit balances appear to earn no interest, and may suggest preparations for more large scale commitments). The minimum loan issued is K40 1 and loans in excess of Kl,OOO require the approval of the Minister concerned. Loans in default may be referred to the State Advocate for collection. The GLB's procedUl~es are quite cumber­some , and it appeared to the mission that the Government Loans Board is not presently equipped administratively to ru1dertake any significant viable expansion of its flli~ctions, in spite of its relatively liquid position.

G.31 An interesting but minor aspect of GLB operations is its loans to groups of farmers for seasonal inputs beginning in 1972~ and on which 100% of amounts due reportedly have been recovered. About ten groups have been involved to date. The groups are formed with extension assistance for the purchase of seeds and fertilizer and i nclude from 30 to more tha~ 100 menbers. The only security behind these group lo&~s is the signatures of tho group chaiTIMU11 secretary and treast~cr. (Loans to individuals are s ecured by bills of sale over chattels.) Payments for supplies are made directly by the GLB to ADMJJRC, and recoveries are made from the proceeds of deliveries to ADNffiRC organized on a group basis. The GLB loan decision­making procedure has been simplified vvith regard to s easonal input loans so that approvals may be nade in a timely Elannero The Chairman of the GLB~ who is r eportedly a r etj_red businessman, is empowered to approve these loans on a provi sional basis between the roughly bi-monthly regular meetir~s on the Board.

6.32 In view of the Government Loans Board's discontinuation of non-farm lending and its cumbersome procedures and poor performance , there would appear to be advantages fron1 the standpoint of control, organization and responsiveness if the Board 's operations were transferred to the Ministry of Agriculture. The Ministry has a Credit Section which hru1dles about 10 funds (most of which are simply trade credit operations of public sector agro-industrial ru1d service organizations) and which could handle the credit accounting of Board activities. Economies could no doubt be realized in credit decision-making, as loan applications are vetted by Ministry staff in any case; and in administration, as defaults would become the responsi­bility of the Ministry . However, the fund should be kept small if it cannot be operated on a viable basis. Dramatic expansion could again present temptations to finance questionable medium and large scale operat­ions7 and could place Ministry staff in the undesirable position of being too frequently identified with debt collection activities and actions against defaulters, which could jeopardize the Ministry's image among smallholders. Present arrangements in the field are handled by special credit officials in the extension service, which may at least partially offset the public relations disadvantages of grafting credit onto extension functions within the Ministry.

6.33 As noted above, the smalll1olders outside the various projects and schemes have virtually no access to institutional credit. This situat­ion vall be altered for some of these farmers as integrated projects and the ~lillP moves into more parts of Malawi and as new canh crop schemes are developed, but for the majority tl1ere will be little change in the status quo. For the reasons discussed above, including credit administration cost considerations and reservations about the contribution of credit to rliTal development, it is proposed that the status quo in these unserved zones be regarded as an acceptable situation until more experience is gained from the provision of credit in other rural areas in Malava . The problems encountered by the Gover112ent Lo8lls Board and its prdecessor7 the Central Farmers Loans Board 1 indicate all too well the course which would probably be followed by efforts to provide smallholder credit on a relatively ~ill­

controlled or uncoordinated basis in these parts of the com1try.

VII. SUJVIMARY RECOMi\:IENDATIONS

7.01 The advantages of control and flexibility contained in Malawl 1s present farm. credit delivery mechanism outweigh any benefits which might be gained from the centralization of credit policy and operations in a national agricultural credit institution at the present time. The system also appears conducive to experimentation. Precedents have yet to be developed in Malawi for the responsible operation of a national farm credit organization. Opportunities to establinh these precedents exist in the present structure.

34

7.02 Credit should be considered in its proper context, i.e. as one form of capital. Alternative forms of cnpi-tal provision and accumulation to support rural development should be considered whenever anyone proposes credit as a tool for helping to achieve some developmental goal. The alter11atives include input subsidies, pricing policies, investments in infrastructure~ savings facilities and related :measures which improve far~ers 1 ability to accumulate capital and/or enlarge their debt capacities.

7.03 Credit services of integrated rural development projects should be 1naintained on an experimental basis for up to three years in areas in which other project services are phased out. During this period the operations in question should achieve a fully viable commercial level of operations. If viability is achieved, a basis is provided for co~~ercial baril~ involvement or for the fo~~tion of regional rural banks or of a national farm credit institution. If viability is not achieved~ credit services should be discontinued in the areas in question.

7.04 The 1lliDP should be designed to obtain operating experience \~th ro1d vd thout credit elements in rural develop~nent projects and to test alternative delivery mechanisms .

7.05 Special cash crop credit schemes should continue to be managed by the authorities rwming the schemes.

7.06 Settlement credit and the ngricul~~a+ loans of the Government Loans Boards appear to be minor infections which can be tolerated, but which should be kept small and largely within the Ministry of Agriculture.

Al'ilf.EX A Page l

SEASONAL CREDIT OPERATIONS OF THE CENTRAL REGION LAKESHORE DEVELOPMENT PROJECT

l. The credit operations of the Lakeshore or Salima Project in many ways resemble those of LLDP~ The emphasis is on seasonal cr8dit for the purchase of inputs 9 credit field staff are used for supervision at the local (unit) level 9 recoveries are made to a substantial degree through project staff stationed at AD~~C buying centers, the interest charge of approximately lo% is embodieJ in a credit premitm incorporated in the price of inputs obtained by borrowers, and repayment rates are relatively high. Performru1ce Data is given in Table A.

2. The differences between the two projects are worth noting 9

especially in view of the importance this report attaches to flexi­bility in administration and experimentation with alternative delivery mechanisms . Ten are listed belowo

1. The Salima Project was initially oriented towards cotton and later was reoriented towards integrated rural development . Accordingly, credit facilities, first offered in 1968/69 9 were not expanded to include inputs other than cotton sprayers and insecticides until 197~72. Major crops in the project area are cotton, maize 9 tobacco and ground­nuts. Input usage r~s increased dramatically in the project area since the project began9 as shown by ADMARC sales data expressed in short tons:

67/68 68L69 6Q/70 70/71 71/72 72/73 .

SA 25.1 35.1 73.2 123.7 129.0 294.0 . 20-20-0 56.9 150.4 234.1 595.0 DDT 7.9 11.4 20.2 23.8 25.8 22.5 SEVIN 4.2 6.,8 15.5 13.0 11.5 9.4

2. Extension density is about one-half that in the LLDP area and credit coverage is also lower. The .ntunber of borrowers in the 1972/73 season approximated 69 700 out of m1 estimated 48 9 000 families in the 1 9 380 square mile project area. The figuTes are not comparable to those for LLDP 9 however, because only about 12 1000 farmers are classifi ed as full time 9 and only farmers within or moving into this group have access to project credit. There are approximately 8 9 000 "true sub­sistencen farms 9 consisting only of women, .... children and old people carrying on while the able bodied mal~s are at work in South Africa or Rhodesia.

ANNEX A Page 2

3. The program's standards of credit-worthiness involve the ranking of farmers into six broad classes, beginning with subsistence or part time farmers (Class I) and con­tinuing through farm planning farmers (Class V) and farm planning farmers with cattle (Class VI). These broad classes are broken down for certain administrative pur­poses into as many as 11 models by level of farming sophistication and by cropping patterns. The purpose of these classes is to provide a focus for project activities aimed at increasing farm incomes by the improvement of existing enterprises and the addition of new enterprises in a step-by-step manner, from one class to the next. The overwhelming majority of farmers are in the lower classifi­cation grades.

Credit plays an important role in the progression envisaged by the project administration. The subsistence or part time farmer who desires to progress out of this category is eligible for credit for cotton insecticides and sprayer (to be paid for over two seasons) provided in kind. The proper use of these inputs will enable the borrower to increase his yields by an amount which is more than sufficient to repay his loan. If the farmer handles his loan properly during the first year, in the following year he becomes eligible for a larger loan which includes cotton insecticides again plus fertilizer and improved seed for his maize enterprise. If this loan is handled properly the farmer qualifies for a larger package the following season including improved inputs for groundnut production7 for example 7 and so on through the ranking system. If at any point the farmer does not handle his credit facility properly he is either declared ineligible for any further credit if the default is large and until such time as repayment is received; or in the majority of cases, in which a substantial proportion of the amount due is received 1 the farmer is down-graded and hence eligible only for a smaller amount of credit the next season.

4. The loan decision making procedure does not involve local committees, but is restricted to the recommendation of extension staff and a search of project credit records to ensure that the applicant is eligible for the package for which he has been recommended.

5. Borrowers (excluding settlement scheme borrowers) are accorded. moratoria on loan repayments by the credit administration only if they report difficulties beyond their control duripg the growing season.

6. Project management does not loo~ to be traditional courts as a reliable ultimate sanction against defaulters. Rather~

credit and extension supervision and the classification system for project farmers are considered the only realistic safeguards against poor payers. Cases are referred to the courts, but this course is not regarded as so strategically important as in LLDP.

ANNEX A Page 3

7. Credit administration costs (excluding the salary of the expatriate senior credit officer) are about equal to the income from the credit premium. Administration costs are low relative to LLDP because most credit assistants are engaged for three months only during thE period when crop deliveries are made 7 motorcycles rather than cars are extensively used for staff trans­port, and perhaps because accounts are kept entirely by hand. The field staff consists of four inspectors and four full-time credit assistants supplemented by about 25 collectors durir~ the marketing season.

8. Several groups of rice farmers receive group credit under special arrangements and these ~~d certain other classes of farmers are receiving contract cultivation services partially financed by credit.

9. The Salirna Project includes a settlement scheme and project management administers credit issued to these farmers. The collection performance of settlement loans has been inferior to that experienced under other project credit facilities, due largely to problems specific to the settlement program. The turnover of settlers is high 7 denoting faulty selection procedures; the loans tend to be relatively large; and the politics of settlement loan recovery complicate credit administration. Settlement port­folio data is also shown in Table A.

lOo Project management pays ADMARC weekly for inputs supplied to fanners on credit. The clearing exercise involves a weekly meeting between the project credit section and an ADWillRC official at which copies of farmers' loan authorization forms against which supplies are issued are tallied. Within several days of these meetings the project accounts section sends a check to ADr~Co (LLDP is billed by ADMARC after the close of each season. ADW~C accounting procedures are such that the statement is usually received in April 7 indicating that it takes AD1~C almost as long to process its records as it takes the farmer to grow his crop).

4. In summary 1 the Salima model, in comparison with the LLDP system, is more selective in its use of credit, subjects its borrowers to the discipline of demonstrating their credit worthiness in a progressive mEU1ller over several seasons, operates at a relatively lower cost which is a

ANNEX A Page 4

function of i ts selective coverage and economies in staff and transport, achieves collection rates (excluding settlement credit) marginally s~.lper­ior to thos0 obtained by LLDP~ and relies less on local participation (loan ·applicant screening committees and traditional courts) to achieve its goals.

5• Given its perfo~nce in terms of credit n~gement~ certain aspects of the Salillk~ experience deserve serious consideration in the formulation of NRDP credit operations. The ranking of farmers according to their husbcn~J practices ru~d former credit performance is one example of a precedent which could be useful if the NRDP credit format includes loans to individuals.

TABLE A: CENTRAL REGION LAKESHORE DEVELOPMENT PROJECT SEASONAL CREDIT OPERATIONS (INCL. COTTON SPRAYERS)

------------------------------Projected--------------------------------------1968/69 1969/70 1970/71 1971/72 1972/73 1973/74 1974/75 1975/76 1976/77 1977/78 1978/79 1979/80 Assumptions

Seasonal Credit Excluding Settlement Credita

No. of Borrowers 917

% Increase

Amount Loaned (K) 38,870

% Increase

Av~rage Loan Size (K) 42.39

Repayment Rate -Sept.30

As of Sept.30, 1973

Estimated No. of Defaulters as of Sept.30

92%

99%

100

2,181 4,030

238% 185%

59,412 71,000

53% 20'/o

27.24 17.82

88% 93%

99%

240 443

5,030 6,600e

40% 17%

84,400 134, oooe

19% 59'/o

14.99 20.30

92% 95%

96% 95%

619

As % of Borrowers (--------Between 10-12%e-- --- ---·)

396

6%

Estimated Credit Administration Costs(K) N.A.

As % of Amount Loanede

Settlement Credit

No. of Borrowers 120

Amount Loaned (K) 1,039

Average Loan Size (K) 866

Repayment Rate as of Sept.30 84%

N.A.

190

3,500

1,842

76%

5,680

8%

298

14,000

4,698

21%

6,752

8%

9,380

7%

213 130

7,600 • 6,000

3,568 4,615

62% 84%

7,800 9,000 10,200 11,400

18% 15% 13% 12%

193,429 252,857 312,286 37.1,714

44% 31% 24% 19%

24.80 28.90 30.62 32.61

a = Seasonal Credit includes credit for cotton sprayers to be repaid over t~o seasons.

12' 600

11%

431,143

16%

34.22

e = Estimated by project management or derived from estimates provided by project management.

N.A. =Not Available.

13,800

10%

490,571

14%

35.55

15,000

9"1..

550,000

12%

36.67

Growth by equal increments to estimated 1980 position stated by Chief Credit Officer. Slightly less ambitious targets are given in an official publication.

TABLE Bo HYPOTHETICAI, UNIT CREDIT ACCOUNTING CEl'TTER OPERATING DATA

Credit premia earned

Commission earned

Interest earned

Surcharges earned.

Gross revenue

INCOME STATEMENT

(KWACHA)

20 9 000 X 25%

209000 X Oo5%

350 X K 2

General Administrative expenses

Staff costs:

3 Credit assistants @ 375 + lo% Non Civil Service Pre:niu..'1l 1 9 238

t Credit Acctso Asst.@ 275 140

i Credit Officer@ 1150

Vehicle Costs:

2 Motorcyles @ 10 9000 mi x 4 t

2 Bicyclos

i R4 @ 3 9 120

Office rental

Supplies and communication

Central Services:

3~ Credit management@ 14 9 790

3~ Stationery and accom~ting@ 39500

Overheads (Financial. controller 9 training, evaluntion9 etc.)

Net Income

Allowance for bad debts:5% of principle and interest

5o% of &urcharges

Net profit (loss) before tax

230

800

15

780

250

50

500

120

520

1,250

350

K 5~000

100

200

700

69000

4~643

19357

12600

(I~ 243)

HYPOTHETICAL U}TIT CREDIT ACCOUNTING CENTER OPERATING DATA

ANIJEX B Page 1

1. This Annex provides some hypothetical data which attempts to portray the financial aspects of an LLDP unit credit operation in the transitional period following the phasing out of other project services, as proposed in headi~~ VI of this report. The operating data are based on cost assumptions contained in the LLDP Phase III Provisional Proposals, Annex 1~ with modifications, and on proposals made in this report. The assumptions not specified clearly in the attached statements are as follows:

1. The unit credit fund share amounts to K23,500 (roughly the average per unit projected for 1978/79) and this constitutes the capital of the center. A principal amount of K20~000 is loaned in the first season.

2. The credit premium equals 25% of the cash price of credit inputs.

3. The unit credit operation has access to project manage-ment time, vehiclesand services in the proportions shovvn in operating expense calculations in the income statement.

During the transitional period it is proposed that seasonal credit operations are continued under project management~ but on a basis designed to achieve commercial viability, defined as break even :._:>erformance or better, so that credit fund capital is retained intact. The unit credit operation is to be organized as an accounting center, or profit center in accounting terminology, simulating the situation which would face a separate institution engaged in providing ~&allholder credit in the unit on roughly the same basis as project management .

4. Loans are made to individuals, not groups, for seasonal inputs.

5. A surcharge of K2 per loan is applied to all loans out­standing after the due date~ 31 August.

6. Eight months after 31 August due date a collection ratio of 95% is realized on each season's loans, the remaining 5% and half of the surcharges being written off.

ANNEX B Page 2

7. The credit operation receives a i of 1% commission from ADMARC on the cash price of credit inputs in recognition of the increased volume of ADMARC sales and produce pUl~chases induced by the availability of credit for seasonal inputs.

8 . Management invests its surplus cash at 5% per armwn net of transaction costs. Surplus cash is defined as 90% of cash not required in anticipation of the following month1 s loan disbursements and operating expenses. This assumption is incorporated in the figures by reducing interest earned by 10%.. Invest­ments or liquidations of investments aro made on the first day of each month. Overdrafts at 10% are available when the credit fund is depleted at peak periods.

9. The cost of credit fU11d capital is zero.

10. Figures are rounded off for convenience.

2. The data indicate that with a credit premium of 25% plus commissions, interest and surcharges, the center would fail to break even if expenses of roughly the magnitude incurred by project management (including rent and and senior management overheads) had to be carried. The net profit before tax is negative, and the size of the month end cash balance declines slightly over 12-rnonth intervals after the first season's disbursements are completed.

3. The calculations assume prompt billing for inputs issued by ADTh~C . If the present lag in billing LLDP were ITk~intained , a much larger portion of the fU11d would be available for investment.

4. It is quite possible that the level of overheads could be reduced by using temporary staff at peak seasons? which is the practice of the Salima Project, thus reducing the permanent staff requireL1.ent. The use of groups rather than individuals as borrowing units could also diminish loan supervision overheads.

5. In any ovent, the r esults suggest that it could be worthwhile to diversify the activities of the unit credit center in order to spread overheads . Possibilities might include the operation of savings accounts on an agency basis for the Post Office Savi11gs Bank or a commercial ballir (although the addition of savings facilities would probably require a more qualified staff and consequently a larger payroll), sale of insurru1ce 7 medium term and non-seasonal loans etc.

MONTrffiY CASH POSITION FORECAST

Operating Loan Loan Cum.ulati ve Surcharges Investment Month Available Interest Opening Expense Disbur- Collec- Collection Collected Interest & End for Invest- @ 5% p.a. Balance (4643+12) sements tions Ratio Commission Balance ment at 1st

of month

Year 1

October 23,500 390 3~000 20,110 20~110 November 20,110 390 12~000 7,720 7~720 December 7~720 390 3~000 4,330 4~330 Ja.'l1.uary 4,330 390 2,000 1,940 1,940 February 1,940 390 1~550 1,550 March 1~550 390 1,160 1,160 April 1,160 .390 770 770 May 770 390 380 380 June 380 390 1,250 5% 1~240 . (10) July 1;240 390 2~500 15% 3,350 1,240 Augu.st 3,350 390 13~750 7if/o 16~710 3,350 September 16,710 390 2,500 so% 320 19,140 16,710 247x.9=220

Year II October 19~140 390 3~000 1~250 85% 17~000 17~000 November 17~000 390 12~000 1,250 9CI-/v 100 5~960 5~960 December 5~960 390 3~000 625 ~)'2 .5% 100 3~295 3~295 January 3~295 390 2,000 300 93.7% 50 1~255 1~255 February 1~255 390 200 94.5% 50 1,115 1,115 March 1,1}5 390 100 94.9% 25 850 850 April 850 390 25 95% 25 510 510 May 510 390 120 120 June 120 390 1~250 5% 980 120 July 980 390 2~500 15% 3~090 980 August 3~090 390 13~750 7Cf/o 16~450 3,090 September 16,450 390 2,500 safo 290 18,850 16,450 21lx..9=190

- 2 -

Available Opening Operating Loan Loan Cumulative Surcharges Investruent Month for Invest- Interest Balance Expense Diebur- Collec- Collection Collected Interest & End ment at 1st @ 5% p.a .. (4643+12) sement tions Ratio Commission Balance of month

Year III

October 18~850 390 3,000 1~250 85% 16,710 16,710 November 1 6 ~ 710 390 12~000 1,250 90% 100 5,670 5,670 December 5~670 390 3~000 625 92.5% 100 37005 3,005 January 2,005 390 2,000 300 93.7% 50 965 965 :E'ebruary 965 390 200 94.5% 50 825 825 March 825 390 100 94. g;~ 25 560 560 April 560 390 25 95% 25 220 220 May 220 390 (170) (170)

ANNEX c

CREDIT FOR MEDIUlVI AND LARGE SCALE AGRICULTURE

1. This report does not consider credit for large scale agri-culture because, as noted in the Stoncllc·:.. report and in the sec.tor. rcvicn~ existing institutional arrangements appear to serve the large farm and esta te sector adequately. If the country's capital market is devel?ped through the types of policies suggested in this report, the large scale sector would presumably share in the benefits envisaged.

2. The present proposals also do not address themselves to the alleged plight of the 200-odd civil servants who a r e the owners of medium ar1d large scale farms and who are reportedly in debt to the commercial banks under short term facilities which were granted by the banks to meet medium and long term financial requirements. If the commercial banking industry (in which the Government has a large share of ownership) is distressed by the arrears accumulating on these loans, it may for the sake of appearances wish to consider the establishment of a paper sub­sidiary to handle the refinancing required (mainly a matter of book entries reflecting the r evrriting of short term loans on a medium and long t erm basis). However ? a s noted in the s ector r eview report 9 the problem appears to be as much one of management as of finance 9 and the Government may wish to give further considera tion to the Farm Management Servic e proposal mooted in the sector review.

3. A farm mortgage institution backed initially by the commercial barurs could be useful to the medium and large scale sectors in several ways. Some of the present borrowers will do so well tha t they w{ll be able to make good use of further financ e supplied on coiDQercial terms, and hence constitute a market f or further lending. Some borrowers will do so poorly that their farming opera tions will r equire further finance to obtain viability. A f arm mortgage institution might be in a better position than the banJrn 9 several years hence, to make the necessary r epossessions or to use lender's leverage to install good management.

4. In any event 9 the use of public funds or external funds provided on "soft" terms simply to refinance bad loans made by commercial barucers would be a most m1fortunate precedent. If the banking industry is to mruce a useful contribution to the development of financial expertise and responsibility in the economy 9 it should be made to live with its own bad decisions and allowed to enjoy the fruits of its good decisions.

ANNEX D

LIST OF INTERVIEWS AliD · DISCUSSIONS

Officials of the following institutions were met during the mission:

Agriculture Development and Marketing Corporation (AD~~c)

Central Region Lakeshore Development Project

Commercial Bank of Malawi

Kasungu Flue-Cured Tobacco Authority

Lilongwe Land Development Project

1linistry of Finance

National Bank of Malawi

Post Office Savings Bank

Reserve Bank of Malawi

Blantyre & LLDP Markets

Salima and Senga Bay

Lilongwe

Kasungu

Lilongwe 9 Zomba and Blantyre

Zomba and Blantyre

Lilongwe

Lilongwe and Blantyre

Blantyre

Also of assistance to the mission WdS Dr. Bill Kinsey, an IBRD consultant involved in evaluation of the LLDP for the Bank's African Rural Development Survey.