CHAPTER 15
Agricultural Credit System: Institutions and Policies
by N.S. Parthasarathy

15.1 Background

The Government of Syria is sensitive to the need for transforming agriculture from being merely a means of attaining food self-sufficiency into a powerful engine of growth and prosperity, especially in the context of new opportunities of the global market. Comprehensive arrangements for financing a whole gamut of agriculture related activities covering input distribution, crop production, post harvest storage and processing and export marketing would play a crucial role in this transformation. This article assesses the situation of rural finance institutions and policies and their adequacy to meet future growth opportunities.

15.2 Institutional structure for agricultural and credit policy

a) Policy making

The main authority concerned with policy design for all aspects of agriculture is the Supreme Agricultural Council (SAC)^[87], chaired by the Prime Minister and composed of representatives of all concerned Ministries. At the administrative apex of agriculture is the Ministry of Agriculture and Agrarian Reforms (MAAR). The main functions such as statistics and planning, extension, agricultural affairs (in charge of implementation of the crop plan), plant protection, livestock, and animal health are replicated at the province and district levels. The functions finally converge at the service units at the field level.

Agriculture has been a part of the centrally planned economic system with Government organizations and agencies closely involved in all production and distribution activities. Fixed and multiple end-use oriented exchange rates, Government monopolies in procurement of all produce, fixed crop prices with balancing subsidies to neutralize production cost increases, rigidly enforced crop plans down to the individual farm level, strict control on imports through licensing and negligible use of private sector resources and energies to generate competition and efficiency were the main characteristics of the economy till the mid-1980s. Since then, there have been many major changes such as: unification of exchange rates, private sector entry into defined areas of agricultural procurement, imports of certain inputs and export of vegetables and fruits, reduced rigidities in crop planning, removal of explicit subsidies, fixation of prices according to production costs and similar measures.

The Permanent Economic Committee in the Prime Minister’s Office representing Ministries of Economics and Foreign Trade, Finance, the Central Bank of Syria (CeBS) and the Banks is the principal institutional instrument to conduct monetary policy. The annual credit plan provides for the financing requirements of the public sector, which account for the bulk of bank lending. The CeBS is the major source of lending to the Government with additional resources from the Commercial Bank (CoBS) through obligatory subscription to treasury securities. Public sector undertakings borrow mainly from the CoBS.

Till recently, the chief concern of credit policy has been the need of public enterprises and finding the ways and means to meet their requirements. This situation has changed with increasing the role for the private sector in investments. Compulsions to meet the large and growing public sector credit needs and apprehension that prices might get out of control have combined to keep critical monetary determinants unchanged. Borrowing by banks are 1.44 times and 2.66 times the deposits (Demand and Time Liabilities) in the case of Industrial Bank and Commercial Bank respectively, suggesting that banks rely more on borrowings to lend and invest than on deposit mobilization.

b) The financial system

The financial sector in its entirety is government owned and directed. With the Central Bank of Syria as the banker’s bank at the apex, the system consists of five specialized banks, namely, the Commercial Bank of Syria (CoBS), the Agricultural Cooperative Bank (ACB), the Industrial Bank (IB), the People’s Credit Bank (PCB) and Real Estate Bank (REB). The CoBS is the only intermediary for foreign currency dealings and holds foreign currency deposits of companies and individuals. Banks and their allotted segments of activity are summarized in the following table.

The Public Debt Fund is a unit of the Ministry of Finance and is a source of finance for development schemes of public sector institutions, and occasionally provides assistance to overcome difficult cash situations, especially if they had been caused by policy decisions of the Government such as postponement of loans affected by drought etc. Surpluses of public institutions are transferred to PDF. Loans from CoBS and from other specialized banks to public institutions are channeled through PDF. Thus, the PDF acts as the overall pool of surpluses and deficits of public enterprises taking from each according to its capacity and giving back to each according to need.

Table 15.1 Banks and their customer segments

**PCB’s focus is more on small industries, artisans, producer cooperatives and small merchants.

The credit planning process takes place in two parallel streams. The Agricultural Directorate in each governorate receives from MAAR an indicative plan of expected crop production for the area. Taking local seasonal and other conditions into consideration, the Directorate, in consultation with representatives of the Farmers’ Federation, prepares the plan for MAAR’s approval. ACB is not involved in this process, although credit is an important input. Independently, the ACB branch prepares an annual plan of credit. The plan is largely guided by the previous year’s off-take of loans and is not influenced by the production plan sponsored by the Directorate and the Farmer Federation.

At the head office of the ACB, the branch estimates are consolidated for assessing the fund requirements. The fund plan is submitted for approval of the Supreme Agricultural Council, based upon which CeBS is authorized to discount agricultural loans issued by the branches. Branches directly discount their loan documents from CeBS’s local branch.

Liquidity in the Credit System: Published figures for the latest available year show that, for the banking system as a whole, against capital reserves and demand and time liabilities/deposits (DTL), after allowing for fixed assets and the statutory reserve requirements, there is a balance lendable availability of SP227 319 million, against which claims on economic sectors was SP255 056 million suggesting a strong demand for funds exerted on the system. Of this, the public sector accounted for SP179 817 million, that is, over 70 percent.

Interest rates have remained stationary over several years and financial institutions do not have the freedom to fix deposit and lending rates. As interest rates are neither market-driven nor administratively updated to match macro-economic situations, this critical monetary instrument has remained dormant and, in times of inflation, acted as a serious disincentive to savings with consequent contraction of lendable funds for new investment.

c) Interest rate structure

The cost of various facilities and loans from the central bank of the country are as per schedule given below.

Table 15.2 Central bank rates of interest to specialized banks (%)

*For cooperatives the rate is 0.75 percent lower. ** Rates to IB for rediscounting are lower than those of CoBS by 1.5 percent.

The schedule of interest rates charged by banks is set out in Table 15.3 below.

Table 15.3 Banks’ rates of interest (%)

The additional interest charged to the private sector is 0.5 percent in the case of ACB, 1 percent by PCB and 2 percent by IB. IB’s interest rates are higher across the board by 0.5 to 2 percent for the same borrower category, compared to other banks. It is seen that cooperatives get the benefit of lowest interest and next, the public sector, with private sector subject to the highest rate because of the lower risk that banks attach to lending to public sector agencies guaranteed by the respective Ministries. In refinancing agricultural production loans, CeBS has a discriminatory margin of 25 percent for discounting loans taken by private farmers who are not members of farmer associations.

d) The Agricultural Cooperative Bank

The ACB combines the functions of loan disbursement, input distribution and crop proceeds disbursement, and the last mentioned function is rendered on behalf of Government agencies for procurement of grain, cotton, seed, vegetable and sugar. ACB has a network of 108 branches distributed over all governorates. Branches operate as independent units, each regarded as a separate profit centre. Each branch reports directly to the Director General.

The ACB collects loans and conducts transactions in accordance with the Public Funds Collection Law, the Syrian Law and the Code of Procedures. The funds and rights of ACB are considered as those of the State Treasury. It has priority in claiming fixed and current assets of the debtor and those of the guarantor in respect of recoveries, regardless of whether or not such assets are mortgaged in favour of ACB, subject only to any charge prior to the date of the issuance of the loan. Branch managers are authorized to act as registrars of documents on behalf of the Real Estate Office and mortgage endorsements made by them are legally recognized. ACB also has special powers of confiscation, under law, without having to go through elaborate legal procedures. ACB, as the lending agency, has special powers of endorsing collateral charges on ownership titles, which are legally enforceable. This is a unique feature of the Syrian system, encouraging timely repayments and acting as deterrent on willful defaulters.

All stocks of fertilizers from local production or from imports are taken over by the Bank as and when they are produced or imported. ACB is allowed an administrative charge of 2 percent on imported fertilizers. Stocks are stored in warehouses located in different parts of the country and delivered to cooperatives and farmers at ex-warehouse prices. Seeds are delivered from ACB stores as well as from General Organization for Seed Multiplication’s (GOSM) branches. This again is according to the permitted quantities stipulated in crop licenses. In regard to agricultural chemicals, ACB has an intermediary role of collecting the value of chemicals for control of wheat bugs and herbicides distributed by the Directorate, from the crop proceeds.

Data on deposits are shown on table 15.4. It is to be noted that of the total mobilization, term deposits account only for a small proportion weakening the resource base and increasing reliance on borrowings for lending operations.

Table 15.4 ACB deposits

The sum against legal cases, indicative of likely future bad debts, has increased sharply and steadily from 8 percent to 31 percent as seen from table 15.5. Drought conditions in 1998 and 1999 have resulted in large defaults. Prior to this, the situation was reasonably under control. Loans outstanding and to be collected are 2.54 times the annual disbursement.

Table 15.5 ACB loans outstanding

About SP1.8 billion of the receivables are considered doubtful of recovery out of the sum of SP6.8 billion under legal action. It is possible that a significant part of the SP6.8 billion may have to be written off in stages. There being no cash flow from this “asset” there is bound to be considerable liquidity pressure especially because discounting with CeBS involves funding by ACB of 25 percent margin and bridging of the balance 75 percent for a few days - from disbursement to farmers and subsequent realization of discounted proceeds from CeBS. To improve liquidity, it seems necessary to infuse about 50 percent of the debts under legal action equivalent to SP3.4 billion, partly as fresh capital and the remaining as loan.

Available information and data make it difficult to assign the assets and liabilities to the two main operations of ACB, namely, input distribution and banking, to ascertain the efficiency with which they utilize financial resources. The following summary table 15.6 shows that for ACB, as a total entity, profits are declining from year to year. The loss in banking in 1999 could be due to non-recovery of interest on account of waivers/postponements to meet drought conditions in 1998 and 1999. Return on capital (ROC) is poor because of prohibitively high transaction costs at 11.59 percent of loan disbursement.

Table 15.6 ACB profitability

e) The cooperatives

Although cooperatives, in the manner in which they operate in Syria, cannot be considered an intermediary financial institution at the grass root level, they play a vital part in the whole system of input supply, procurement, credit disbursement, crop proceed disbursement, dues collection and in providing farmer groups’ collective guarantee for repayments. But for the cooperatives, the workload and cost per transaction for ACB, which is already high, would be even higher. This kind of intermediation limited to physical intervention, free of fiduciary involvement, has helped in steering clear of the susceptibility to mismanagement and abusive practices that often lead cooperatives to financial failures. The better run cooperatives have the potential to graduate to a more useful role of promoting and mobilizing savings, and acting as mutual help societies. It is critical to promote this concept and reduce the retailing role of credit by ACB, which results in an enormous number of transactions and paper work unduly increasing cost. This would also improve service by avoiding convergence of a large number of farmers, long queues and indefinite waiting during season.

Table 15.7 Cooperatives - Structure 1999

Cooperatives are vertically organized as Peasant Unions at district and governorate levels, further integrated as the Peasants Union Federation (PUF) at the national level. At these levels, they participate in the deliberations of the Agricultural Council. The PUF participates in the Supreme Planning Council and the Supreme Agricultural Council and has a say in matters affecting farming such as pricing, credit and marketing.

15.3 Analysis of credit to rural households

a) Mechanisms and outcomes of the rural credit system

Farm credit accounted for 11.28 percent of total available credit in 1990, and this declined to 9.88 percent in 1999. There is no separate information on credit extended to input and output agencies, both in distribution and in manufacture, and to those engaged in agro-processing and exports. ACB extends assistance to private farmers, cooperative member farmers, cooperatives, Peasant Unions and federations and public sector organizations engaged in agriculture. The private sector has access, if no society is functioning in the same area. In the case of medium- or long-term loans, the access procedure is elaborate and time-consuming. Farmers find it difficult to obtain loans for machinery like harvesters and tractors and have to depend on supplier credit at high interest rates of 20-30 percent. According to them, lesser availability of medium- and long-term loans, affected important activities like land reclamation and fruit tree replanting.

a1) Loans products

Short-term credit is made available for farm expenses such as plowing, harvesting, irrigation and fuel, cost of inputs, for small tools and for animal feeds and veterinary medicines. Short-term loans are for a period of 300 days and are given in cash and in kind as inputs. Medium-term credit for periods not exceeding five years is extended for greenhouses, forest tree planting, purchase of livestock, digging of canals for irrigation, equipment for poultry farms and machinery for grading, waxing and packing.

Long-term credit for periods of ten years or less is aimed at financing construction of stores, land improvement, forestry projects, fruit tree planting programs and cold storage facilities. It is generally restricted to state farms.

Working capital is provided to agriculture graduates who are in contract with the agriculture engineers’ syndicate or with the Peasant Union. No private sector dealers in inputs or output without a contract are eligible for assistance. These joint ventures, in return for the guarantee extended by the syndicate/union to ACB for the working capital loan, should give away to the syndicate/union 40 percent of the profits. Working capital is given as a lump sum cash loan and not as a drawing facility subject to a limit and subject to availability of security in the form of stocks. The maximum loan under this scheme is SP300 000 against the syndicate’s/union’s guarantee, and is returnable in six months. As working capital is required continuously, the loan needs renewal every time it is repaid, considerably reducing its usefulness in terms of convenience, continuity and cost.

Loans for land reclamation are subject to a standard ceiling whereas the actual fund needed may be higher depending on the nature of the terrain and the soil structure. The ceilings of SP5 900 per dunnum for mountainous terrain and SP4 400 for flat land appear to have not been revised after they were fixed over ten years ago. The actual costs are estimated by farmers at SP15 000 for mountainous terrain and SP6 000 to SP10 000 for other land types; allowing for some exaggeration by complaining farmers, it seems that there is scope for review and greater flexibility. As regards finance for fruit tree planting programs, the term of five years is clearly insufficient, as most fruit trees take longer (six-seven years for seedlings for apples, for example) to attain a commercially viable level of yields. Replanting cost for apples is about SP195 000 for irrigated farms and SP96 000 for rain-fed farms, whereas loan sizes do not often match this need.

A significant feature is the low proportion of medium- and long-term loans, and the declining percentage from year to year - from 17 percent in 1997, to 15 percent in 1998 and further down to 14 percent in 1999. Medium- and long-term loans carry a margin of 25 percent for discounting with the CeBS and it is possible that ACB’s ability to enlarge the quantum of medium- and long-term loans is constricted by fund availability. Medium- and long-term loans are important for increasing productivity, improving quality and value addition and raising farmers’ debt capacity

a2) Loans disbursement, security and recovery

Loan amounts are determined strictly on the basis of input eligibilities determined in the crop license. Loan sums and inputs in kind are given to the cooperative for disbursement to individual members according to their eligibility. Private farmers who are not members of farmer associations, apply individually and make individual arrangements for drawing the cash part and taking delivery of inputs. The following tables show the sums lent by ACB according to term and sector.

Table 15.8 Loans by term (SP million)

Table 15.9 Loans by sector (SP million)

Lending has been steadily declining. Private farmers accounted for more than 50 percent and cooperative members about 45 percent, the remaining going to the state farms. Many non-member farmers prefer to stay out of the association, as they do not wish to be penalized for other members’ defaults. Many wished that they could buy inputs from nearby sources for cash.

The loans recovery enforcement mechanism is effective and as such, repayments are generally satisfactory except in times of poor rainfall and drought, as for the last few years.

Table 15.10 Recovery situation

*Receivables are total of loans due and overdue during year under review.

In times of natural calamities like drought, a committee, appointed by the Governor, consisting of representatives of ACB, administrative authority of the affected area, the MAAR and the Peasant Union assesses the extent of damage based upon which ACB Board is authorized to grant full or partial deferment. If damage is not more than 30 percent of the debtors’ average annual yield, 50 percent of the sum due is deferred, and 100 percent is deferred if the damage is more than 60 percent. Deferment applies only to principal and interest must continue to be paid. The repayment in instalments is allowed over not longer than three years. It was noted, however, that rescheduling is not allowed for medium-and long-term loans when repayment capacity is affected by drought.

In the case of crops sold in the open market such as citrus, growers may at times be financially disabled by bumper crops and precipitous fall in prices due to weak post-harvest supports. Farmers’ ability to keep to the schedule of repayment is affected in such circumstances and there is no special provision to extend relief on repayment of loans to meet such market situations beyond the growers’ control.

Table 15.11 Summary of collateral requirements for agricultural loans

Real estate collateral is the most widely accepted form of security and value cover for loans ranging between 80-100 percent.

a3) The real cost of credit

The general structure of interest rates has been shown above (table 15.2). In addition to interest, association members have to pay the association 1 percent of the loan for their services. Although the term is 300 days, farmers do not find any advantage in delaying the sale of the harvest, as the official prices for the crop are the same for all months. Farmers who are in debt sell the crop the very day of harvest, particularly cereals. Sometimes lack of proper storage at village level also compels immediate disposal. Consequently, the duration of the loan is only about 180 days. As such, the commission of 1 percent is equivalent to 2 percent annualized. It is estimated that other incidental expenses incurred in getting through the formalities and visiting the bank to submit the application and to collect the cash/input would be about SP200. If the average loan is reckoned as SP20 000, this is equal to 1 percent and again annualizes as 2 percent. However, this expense is incurred by private farmers and not by association members. The commission, on the other hand, is incurred by association members and not by private members. Thus, it can be said that the effective cost is about 2 percent more than the official rate. To this must be added 0.1 percent administration charge, 0.15 percent stamp duty and 0.25 percent on each bag of fertilizer - totalling 0.5 percent which, again, annualizes as 1 percent. The total effective rate is 3 percent more than the apparent rate.

Fruit growing farmers mentioned that they had to bear “quite a lot of expenses” in getting the loan. Fees for the inspection team, collection agent’s fee and fee for registering collateral, besides the incidental expenses for completion of formalities constitute the additional charges. However, because of the extended term of the loan, these may not annualize at more than 1 percent even if the total expenses are 5 percent of the loan value. The real cost may lie in the additional penal charges of 1 percent per month or 12 percent per annum, payable if the loan is not discharged in five years. In situations where a waiting of, two years beyond the official loan term is involved to discharge the loan, the additional 12 percent per year for the two years is 24 percent. Spread over a seven-year term, this additional incidence is, arithmetically, about 3.5 percent per annum. Thus, the effective additional cost would be about 4.5 percent (inclusive of 1 percent mentioned earlier) per year on medium-term loans.

b) Alternative sources of finance for rural households

Fruit growers take medium- and long-term loans from friends or relatives living outside the country, mostly Arab countries and Lebanon. Machinery suppliers are also a common source of finance for purchase of equipment. The procedures are short and simple although interest rates are high. For production expenses, the alternative sources are the input supplier and the output dealers, exporters’ agents and cold storage units. Input dealers are generally small traders and do not have the capacity to extend credit covering the whole crop duration. In the case of agro-chemicals, however, profit margins being good, because of the cost-plus pricing system and withdrawal of control, large agro-chemical marketing firms are able to extend prolonged credit to their wholesalers enabling the latter, in turn, to sell on credit to farmers. Output dealers, exporters’ agents and cold storage units are active in fruit and vegetable growing areas. Financing by them takes several forms. Direct advances ahead of the season are given with, and sometimes without, an agreement on the unit price at which the harvest would be sold. The farmer is thus under obligation to sell the crop to the dealer at a price to be negotiated after the money has been taken and finds himself under pressure to accept any price offered by the lender. Another form of financing by the output buyer is to agree on a lump sum to be paid to the grower for the entire output. The lump sum is paid in suitable instalments to enable the grower to meet production expenses. The expected yield is estimated by the contractor in such a way that he recovers interest at a high rate. Sometimes to meet production expenses farmers liquidate their assets. When the need is large they are forced to sell the house and equipment. Smaller farmers sell their animals.

c) Assessment of ACB

There is little flexibility in loan structures to suit different crop and cash flow situations. There is no distinction between a good borrower and a bad one, between a borrower who keeps his value addition in the bank and one who either does not produce the value addition or squanders it. The author hardly heard from any of the farmer group reports of high interest rates. On the other hand, their readiness to resort to more convenient and costlier alternative sources is indicative of the higher value they place upon better service and easy access than on cost. The low percentage of medium- and long-term loans is not conducive to promote long-term investment to improve farm productivity.

c1) Subsidy dependence

The subsidy dependence of the rural financial institution is the percentage by which its average on-lending rate would have to increase to make it sustainable (Jacob Yaron and Others, Rural Finance, The World Bank, 1997). In the present case, the present average lending rate of 7.44 percent needs to be increased, according to the mission’s estimate, by 3.26 percent points towards interest, plus 9.59 percent points toward additional transaction cost incurred by ACB - that is, by a total of 12.85 percent. This gives a subsidy dependence index of 1.73 (12.85/7.44), which is extremely high and untenable. Of this 1.73, untenably low interest rates account for 0.44 and the very high transaction cost for the balance 1.29. This stresses the urgency of restructuring ACB and lowering its transaction cost per loan.

c2) Effectiveness

ACB has partially succeeded in meeting the needs of the farm sector for cash and in-kind loans. Loan volumes have been declining year after year. An important objective of ACB is to encourage cooperative societies. While cooperatives have been supported through concessional terms, not much effort has been made to promote them as second tier institutions for savings mobilization and retail lending. This would have shifted ACB’s focus from retail lending to wholesale lending, leaving to grassroot financial institutions the responsibility of credit rating of borrowers and ensuring timely collections. Encouragement of mechanization, micro-irrigation and similar activities are part of ACB’s objectives, but these have not made satisfactory progress as indicated by the low ratio of medium-long term loans.

Outreach is normally measured by several indicators, such as number of borrowers, average loan size as proxy for income level, percentage lent to zones with less rainfall, percentage of women borrowers and number of branches. From available figures, it is observed that the number of beneficiaries in 1999 was only 54 percent of the number in 1994. Even allowing for the poor rainfall in 1999 and 1998, it is seen that contraction had already set in from 1995. The number of borrowers was 749 703 in 1989, nearly three times the client base in 1999. This trend is indeed cause for concern. The possible reason could be either that those loans are not reaching farmers or that farmers are unwilling to utilize the facility from the Bank resorting to alternative avenues, or that farmers are becoming self-sufficient for financing production activity. The last mentioned possibility seems most unlikely, going by the impression one gains from meeting farmer groups in different parts of the country. Loans advanced have also been going down - in 2000 to 61 percent of the 1994 level despite increase of area during the same period. Not surprisingly, therefore, the average size of loans has been increasing and is presently 1.32 times the size of six years ago. The higher average size is suggestive of a movement toward larger farmers and/or toward better-endowed zones. Statistical information is not available on lending by zones or lending to women farmers, to ascertain the proportion of credit extended to disadvantaged segments.

There has been no major expansion of ACB’s branch network in recent years. It is recognized that each branch has to be self-sustaining in terms of earnings as far as possible. When overall profitability is satisfactory, there is room to cross-subsidize branches in remote areas. Another possibility is providing skeleton service or weekly rotating branch with the same staff, taking turns over two or three small branches in nearby locations. No innovative work of this nature is in evidence.

The very low ratio of medium- and long-term lending is hardly conducive to farm productivity and enhancement of its debt capacity. ACB is unfortunately under constant liquidity stress and is not able to act beyond the role of a passive credit conduit.

c3) Delegation of powers

The Credit Committee at the branch, consisting of the branch manager and heads of credit, collection and information divisions, is authorized to sanction to a maximum of SP50 000 per farmer for short-term loans, SP200 000 for medium- term loans and SP100 000 for long-term loans. For societies, federations, governorate unions and state farms the corresponding limits are SP2.5 million, 1.5 million and 1.5 million respectively. Sums in excess are sent to the Board of Directors, consisting of the Director General and Directors of divisions. The Board has authority to sanction short-term loans without any ceiling on their authority, but medium- and long-term loans subject to limits of SP500 000 and 250 000 respectively.

The Bank management does not have the authority to design and introduce new loan or savings products suited to different crops, clientele and conditions. Insufficient delegation is not conducive to placing upon bank managements the responsibility for mobilizing savings, operating within prudence norms, controlling costs, designing products and finally, producing an acceptable return. There are no goals to score and no competitor to outplay.

15.4 Credit to services providers

a) Food industry

Figures show that food industry’s share of borrowing from the banking system is steadily on the increase, from 20 percent in 1990 to 39 percent in 1999. In absolute terms it has grown from SP298 million to SP976 million, by well over three times. Significantly, while sums borrowed have increased, the number of borrowers has declined from 1 129 to 976 suggesting that average size of loans has increased. This might imply a use of better technology, or higher degree of automation or scale increase, or a combination of any of these. CoBS does not have figures classified according to industry and nature of activity.

Against a theoretical potential of SP73 252 million, calculated on the basis of approved projects under Law 10, IB has met cumulatively SP5 844 million from 1990 to 1999 - less than 10 percent of the potential. To the extent of working capital funding from CoBS, the gap would narrow. The low percentage is also due to a poor rate of maturation of approved investments, as well as to low participation by the private sector in bank credit.

b) Input distribution

With regard to fertilizer, ACB is the sole distributor for the whole country. ACB finances its purchases from the GFC and from GEZA, with original Government capital and additional infusions, if any, of monies from depositors on which an interest of 8 percent is payable and by rediscounting its sale bills with the Central Bank of Syria at rates ranging from 2-3 percent. The rediscounting rate is dependent upon the term of loans under rediscount and whether the loans are to cooperative or to other sectors, the former getting a preferential rate. Liquidity gaps arising out of defaults are covered by commercial borrowings from other banks or from the public debt fund. Whenever loans are rescheduled at the behest of the Government, under drought and similar natural calamities, the Government funds the delayed cash inflow.

GOSM, the seed producing organization, meets its working capital requirements through commercial borrowing from CoBS.

The CoBS provides working capital to private traders, importers, exporters and agro-processing companies. Working capital is extended as a drawing facility and not as a loan in the sense of a cash disbursement. Private importers and distributors of seeds and agricultural chemicals met by the mission were not found to be overly enthusiastic about the facilities available from the CoBS. Many of them rely on owners’ funds and borrowings or capital contributions. The reason given is that borrowing from the Commercial Bank of Syria is fraught with time-involving procedural hurdles eventually resulting in credit limits that are too small for the scale of operation. The interest on borrowings from the Commercial Bank is 9 percent for private sector and 7.5 percent for the public sector, and thus places a handicap on the private sector.

c) Input retail

ACB gives working capital loans to joint ventures (JV) at 7.5 percent. The JV, however, has to pay a 4 percent commission to the syndicate or farmer union guaranteeing the loan, this represents 40 percent of the profit share. At a distribution margin of 10 percent on inputs, the JV has to give 4 percent toward this share. As this is an absolute sum and not an annual rate, the 4 percent translates to 8 percent on an annual basis on the six-month duration allowed for the loan.

While the CoBS finances medium and large agricultural trading companies, the PCB focuses on small traders, professionals and vocational categories. Both long-term and short-term credit are available depending on the purpose. Ceiling for credit granted by PCB has been increased to SP500 000 for short-term loans and to SP one million for medium-term loans. In respect of medium and long-term loans, invariably a fee of 2.5 to 3 percent is charged from the principal at the time of disbursement, which has the effect of increasing the effective rate by 1 percent. PCB deducts the interest in advance in the case of loans of less than SP1 million and borrowers of higher values have the option of paying interest in advance or along with each instalment. Security for long-term loans is as high as five times the value of the loan, and it is surprising that such stringent terms should be imposed upon those whose resources are limited and whose economic status the PCB is aiming to improve.

d) Post-harvest activities

For agro-processing companies, fixed capital for acquiring plant and machinery, land and buildings as well as working capital are available from IB. It finances all activities except requirements of foreign currency, including the opening of Letters of Credit in favour of foreign parties. For these, the borrower has to go to the CoBS. IB also extends working capital in local currency. Generally, IB contributes 30 percent of the project cost with the promoters contributing the balance. Olive processing, cold storage, manufacture of veterinary and agricultural chemicals, fabrication of agricultural machinery, and export oriented activities are classified as of higher priority eligible for 50 percent contribution from IB toward fixed capital for initial establishment and for expansion, the promoter group contributing the balance of 50 percent. Security for the long-term loan is in the form of property collateral in addition to the assets of the establishment. For short-term loans, two guarantors are needed, each of them with property to cover 100 percent of the loan, the valuation taken at 75 percent of market value. Availability of working capital seems a major problem for many agro-processing units.

e) Low participation by private sector

The reluctance of the private sector to avail itself of bank credit, assuming that it is available without much procedure and red tape is due to several reasons. Religious considerations preclude lending and borrowing against interest. The private sector is still unfamiliar with legitimate procedural and security requirements of the banking industry. Many promoters do not appreciate the criticality of working capital and do not tie up working capital along with financial arrangements for capital for plant and machinery. They look for working capital after commencement of production, and quite often find themselves having to grapple with an acute cash crunch. Slow progress in lending to the private sector is also due to the fact that banks still look upon the public sector as their chief customer. Public sector lending is the softer part of the market, needing less effort in evaluation, securitizing, monitoring and recovery. The preferential treatment to public sector borrowers (example: lower interest) not only places private sector at a competitive handicap, but sends out a wrong signal from the government to banks that the private sector is lower priority.

f) Alternative sources for service providers

Inadequate support from the banking system leads private entrepreneurs to resort to many ways of funding new projects and expansion of existing ones. Many invest their own savings and those of close relations and friends, forming the promoter group. Promoter exposure is necessary up to 50 or 60 percent of project cost when a lending institution extends financial assistance. However, in the current situation in Syria, the promoter group is obliged to “own” 100 percent of the capital to meet the project cost instead of 50-60 percent. In the absence of any leverage through borrowing, the cost of capital is very high and many projects that are worthwhile with partial financing by the bank may not be attractive for investment entirely with owners’ capital.

Private funding is apparently taking place on a fairly large scale outside the banking system. Return expectations in the informal market are anywhere from 24 to 36 percent, and sometimes even higher. Private flow of funds between lenders and borrowers is not the most efficient way of establishing a fair equilibrium price for capital, as it is determined very often by the mutual bargaining strength of the two parties without either of them having any information on alternative availability and terms. The same funds flowing through the banking system would result in time and demand deposits, greater lending ability with banks, more quasi money, multiplier effect of deposits creating loans and loans creating deposits and a generally higher liquidity. Viewed from this angle, private flow of funds only infuses money into the market, and that too inefficiently. The informal flow denies the economic system the benefits of the multiplier effect and market efficiency.

An important source of funding is from external commercial borrowing. Although this is illegal, some promoters do resort to this source where interest is low but exposure to adverse changes in the exchange rate is high. Allowing for the exchange rate change, the cost is still attractive because of the high interest charges in the informal market.

The informal funding of projects leads to a situation where only projects with very high returns would pass the test. As a result, many projects with attractive returns, by normal standards, would get neglected, arresting economic growth. It also affects expansion and modernization necessary to acquire global competitiveness. Lack of competitiveness forces manufacturers to confine themselves to the domestic market and exerts pressure on the Government to protect local industry for its low efficiency and poor product design and quality.

15.5 Agricultural policies and the rural financial system

a) Savings

Savings has been appropriately called the “forgotten half of rural finance”, as provision of financial services often focuses more on extending credit, neglecting other services like savings, family budgeting and insurance. Earning rates on savings having remained constant for over ten years now. The attractiveness of the rate has varied depending on the inflation rate and opportunity cost of capital. The following picture emerges deflating the retail price index change from the interest rate of 8 percent. Savings increased when “real” interest rate improved and more so when it turned positive. Savings in 1990 were a bare SP66 291 million. Since then, it has increased more than four-fold. This also goes to show that opportunity cost of capital in the informal market is not such a heavy counter-force as to dampen the effect of improvement in positive rates of return in the formal system. Although informal lending rates are cited as varying from 24 to 36 percent, such markets not being so fluid and well organized, access to opportunities may not be easy, apart from the higher risk involved in such investments compared to keeping money in an institution having the backing of the Government.

Table 15.12 “Real” interest on savings and savings growth

Several factors inhibit savings mobilization. Banks do not have the freedom to design savings products carrying different rates of return and cash flow features to meet varying saving characteristics. Rates and other terms being standard, there is a sterile uniformity among the banks. This lack of variation dampens any semblance of competition to attract savers. As lending rates cannot be varied by the management, there is no way for the bank being able to distinguish a good customer with large deposits and maintaining a good account from, say, a one-time borrower. Any disciplinary minimum ratio of banks’ own funds and mobilization as a condition of refinancing and discounting, if it exists, is weakly enforced. So, there is no pressure to mobilize savings and deposits. Where agricultural credit is concerned, the low rate of interest based on 2.5 percent discounting by the central bank to meet all lending needs, has taken away the purpose of mobilizing deposits costing 8 percent. More the deposits, the higher would be the loss to ACB.

Total demand for funds has grown 3.2 times and loans to sectors other than the public sector have grown faster than that for the public sector apparently stimulated by the policy reforms. The public sector, however, continues to dominate the capital market, with its share dropping a little bit from 74.72 to 70.46 percent. In absolute terms also, public sector absorption of available resources is still very substantial indeed.

b) The financial sector in need of enlargement

Priority areas enumerated in the agricultural policy have not fared well. Loans for irrigation declined in 1999 to a little more than a third of 1990. Greenhouses, which form the thrust for improved quality and competitive costs for export, have limped from SP301 million to SP475 million in 1999. The share of these special purpose loans declined from 20 percent of total loans to 12 percent in 1999, besides registering a fall in absolute terms from SP1 695 million to SP1 271 million.

Table 15.13 Loans for agriculture priority purposes (SP million)

Funding of food related industries by IB increased from SP298 million in 1990 to SP976 million in 1999, registering a growth of 3.3 times. The share of this sector grew from 20 percent in 1990 to 39 percent in 1999 of the total lending by IB.

Syrian agriculture has responded well over the years to rapidly increasing population, over 3 percent annually till the 1980s and close to that number thereafter, by providing adequate supply of calories. Wheat production increased from1.2 million tonnes in 1991 to 2.5 million tonnes in 1998, ignoring the steep fall in 1999 because of acute drought conditions - an increase of 101 percent. Similarly rain-fed wheat, barley, lentils and chickpeas, the principal food items, registered increases over the same period of 46 percent, 67 percent (but in 1996 after which there has been a decline), 213 percent and 216 percent respectively, presenting, on the whole a very good performance. Figures of loans classified by crops^[88] show that 71 percent of the loans-in-kind went to wheat and 19 percent for cotton. All other crops took up the remaining 10 percent of loans issued. This is indicative of the narrow base of the formal rural credit system. This, together with the trend of average loan size having increased by 32 percent in the last few years, shows that formal credit has enormous potential for reaching out to other crops and smaller farmers to increase overall productivity.

c) About a future strategy

Issues relating to reform of rural finance institutional arrangements and policies are more crucial than they seem, considering the strong potential impact they could have on providing stimulus to development of small and medium entrepreneurial activities, and opening immense possibilities for various avenues of off-farm income generation. The new income opportunities have a salutary moderating effect on the short run adverse impacts of structural changes accompanying the reform process.

Substantial improvement in the farmers’ capacity to hold the produce is to be promoted through micro-level institutions with stores and refinance facilities to advance monies against the grain deposited. Cold stores for fruits and vegetables and packing houses for export are rightfully in the domain of the ACB. When it has consolidated its position in the core area of production loans, it could look into these and other areas for profitable lending. ACB should get out of retail lending and move more into wholesaling of credit, operating through cooperatives, private mini-banks and micro-finance groups in backward segments which, by the nature of their location and size, could more easily develop and maintain closer relationships with local communities and be able to operate at lower costs, provide better service and enforce high recovery rate. ACB should, in due course, become the rural bankers’ bank. Investments in technological innovation, extension, creating market certainty and post harvest infrastructure are important for increasing debt capacity among the farming community, as well as for a sustainable growing rural financial system. Close guidance for technologically weak farmers through effective extension, crop insurance or credit guarantee and incentives for consistent good repayment record are needed.