Merilio Morell is Forestry Officer (institutions), Forestry Policy and Institutions Branch (FONP), FAO Forestry Department.
This article presents the findings of a study by the Policy and Planning Division of FAO's Forestry Department on the community forestry funding mechanisms used in Costa Rica and Nicaragua until 1993.
In Costa Rica, the tax exemption mechanism proved useful for the establishment of sizeable areas of forest plantations
The FAO study (FAO, 1994) focused its attention on mechanisms specially designed for farmers working their own small or medium-sized farms. The baseline data were collected by national consultants (Borges and Meza, 1992; Bereta and Salinas, 1992) working under the technical guidance and supervision of the FAO Policy and Institutions Branch.
The study seeks to highlight the lessons learned from the use of financing mechanisms (it lists the types of mechanisms used, their aims, selection criteria and the findings obtained) and to use that knowledge to determine how to improve the effectiveness of the funds allocated to forestry development.
Although the study reviewed the experiences of only two countries, it shed light on: i) the effectiveness of the financing mechanisms in ensuring rural community involvement in forest resource management: ii) the suitability of these mechanisms for achieving economic and environmental objectives; and iii) the major institutional capacities and other prerequisites for policy analysis as well as sectoral and administrative planning necessary to ensure that the mechanisms are appropriately designed and implemented.
Four types of financing mechanisms were identified: tax exemption, special funds, reforestation contracts and loans for reforestation. The aims of these mechanisms were to: increase the supply of raw material for industry; establish agroforestry systems; promote a change of attitude among the people with respect to forest resources; and transfer funds to regions affected by low crop production. The positive results and major shortcomings of the mechanisms are described below.
The tax exemption mechanism proved useful for the establishment of sizeable areas of forest plantations. By 1993, some 50000 ha had been reforested in Costa Rica. Initially, the mechanism focused only on taxpaying entrepreneurs, with the objective of increasing national supplies of industrial timber. At the request of small farmer organizations and technical experts, the mechanism was extended to include farmers working their own small and medium-sized farms. These farmers planted 10000 of the 50000 ha reforested. When this mechanism was amended to include the farmers, the additional objective of developing forest awareness was introduced.
Achievements included the establishment of a sizeable area of plantations in a relatively short time, job creation, the development of business expertise and the introduction of related activities, such as commercial nurseries and consulting firms. From a social viewpoint, for the first time farmers were able to participate in a scheme that had previously been reserved exclusively for tax-paying firms or individuals.
However, there have also been criticisms and allegations of inequity, economic inefficiency and negative environmental effects. As regards equity, the most common criticism is that the mechanism benefited only tax-payers. As has already been mentioned, the scheme in Costa Rica was amended to include farmers with title deeds to their land (but not farmers without title deeds).
The study documented several examples of economic inefficiency. It was estimated that in Costa Rica only 50 percent of the reforested areas would achieve the growth and density needed for economically viable industrial use. In Nicaragua, the proportion was 27 percent. Also, when the first Costa Rican plantations reached the prescribed size for commercial felling, it became apparent that wood processing activities would not be economically viable because of the long distances from the plantations to the mills, the lack of infrastructure and the shortage of transport facilities and wood processing machinery. National Costa Rican technicians also reported that, for a time, incentives were excessively high, allowing the reforestation companies to buy land covered with natural forests, harvest the trees and then take advantage of the tax relief scheme. This led to a greater concentration of landownership and more deforestation, two results contrary to the scheme's initial objectives. The feeling was that this type of mechanism would be in conflict with the macroeconomic policies on which economic adjustment programmes are based, since these policies recommend the removal of subsidies.
Special funds, such as the Forestry Development Fund (FDF) of Costa Rica, represented a further effort to help low-income farmers, allowing those without title deeds to their land to participate. These mechanisms were as popular as those based on tax relief but did not produce such good results because fewer funds were allocated to them and other schemes operating at the same time offered better facilities and benefits to the same clientele.
The tax exemption mechanism allows individuals and legal entities a portion of their tax liabilities provided that portion is invested in government-prescribed forestry activities. The maximum percentage of income tax that may be retained and the maximum unit cost of the relevant activities are usually stipulated.
In Costa Rica, Act 4465 of 1969 allows up to 16 percent of income tax liabilities to be invested in reforestation. That mechanism was set up with the aim of establishing forest plantations to supply the saw mills and to reduce pressure on the natural forests.
This mechanism may be used only by individuals and companies with income tax liabilities who own or acquire land for the purpose of establishing their own reforestation projects. The tax relief scheme was not designed to promote community forestry activities. However, it is included here because it formed the basis for farmer-oriented mechanisms.
Forestry subscriber certificate (CAF)
The CAF was introduced in 1986 following amendments to the tax relief mechanism, allowing individuals and companies to take advantage of that mechanism without having to establish their own plantations. The amendment also allowed for the establishment of companies specializing in promoting and implementing reforestation projects. The conditions for participation in the scheme are: proof of legal ownership of forest land and submission of a reforestation plan meeting the evaluation criteria established by the Forestry Department (DGF).
Forestry loan certificate (CAFA)
Since farmers working their own small farms do not pay income tax, they cannot take advantage of either the tax relief scheme or the CAF. The CAFA (established in 1987) is designed to benefit small and medium-sized farmers whose farms do not exceed 150 ha and whose annual income is not more than 2.5 million colonel.
In order to take part in this scheme the small farmers must be members of a community development organization. To obtain funding, the organization must submit one reforestation project for all its members. Each farmer signs a contract with the organization undertaking to meet his or her reforestation commitments. A major requirement here is that farmers must submit documents certifying that they are the legal owners of their land.
The capital used for the FDF was obtained through a foreign debt-purchasing operation and was, therefore, not replenishable annually as in the case of tax relief. At the time of the review it had not been decided how to obtain a regular flow of funds. The only proposal was the establishment of revolving funds to be set up using profit obtained from the sale of timber from the plantations established through the fund. The aims of the mechanism were to increase supplies of industrial timber, develop forest awareness and persuade farmers to self-finance (involving fund) reforestation costs.
The reforestation loan mechanism was difficult to implement and unpopular with farmers. This was due to the application of strict banking regulations, incompatible with the cash flow situation in most forestry activities. Banking regulations require banks to recover interest on capital from the first year of the loan. This is not financially possible in operations such as reforestation or the establishment of agroforestry systems. Moreover, the guarantees that were required, together with the banks, proven record in recovering loan capital, made the farmers very wary about using the funds available through this scheme. As land is usually the farmers, only asset, using it as collateral is very risky since, if their operations fail, the very survival of their families would be jeopardized. Also, many farmers in both Nicaragua and Costa Rica occupy land for which they have no legal title, with the result that a large proportion of intended beneficiaries were not entitled to credit under the present legal framework. This kind of mechanism could be very useful for financing activities such as nursery establishment and small business ventures.
This type of mechanism provides cash for forestry investments only. The cash is set aside for specific forestry activities are either not required to replace the capital or required merely to replace a proportion of it from the proceeds of the final harvest. This article identifies two examples of this type of scheme: the Forestry Development Fund (FDF) in Costa Rica and the Revolving Fund in Nicaragua.
Forestry Development Fund (FDF)
The FDF (Costa Rica) is geared towards farmers without title deeds for the land they work and does not require them to produce written proof of ownership of the land to be reforested. The FDF's objectives include the production of industrial timber, the strengthening of farmers' organizations, forest conservation, forestry technology improvement and innovation, high-quality seed production, the establishment of self-sufficient forestry units and the development of forest awareness. They are to be met through contiguous planting, the establishment of live fences, windbreaks and mixed tree crops for timber and other purposes, such as coffee production. The establishment of agroforestry systems is also encouraged. In practice, most of the capital made available to farmers through the FDF is used to establish contiguous forest plantations. As in the case of the CAFA, the most frequently grown species are teak, gmelina, pochote and laurel.
The FDF operating funds were obtained through an external debt purchasing transaction between the Costa Rican and Netherlands Governments. To be able to take advantage of the fund, farmers have to be represented by a community development organization whose procedures are the same as those described for the CAFA. The community development organizations must promote projects of more than 100 ha of plantations and no fewer than 20 participating farmers. They must also submit a proposal for the establishment of a revolving fund. The latter requirement seeks to ensure that funds will be available for future forestry activities in the localities initially benefiting from the FDF. The revolving fund would be established through farmer contributions, equivalent to 30 percent of the expected value of the plantation output.
The reforestation cost used to calculate individual farmers, funding is US$ 762. The community development organizations are given 70 percent of that amount (US$ 533) on the assumption that the farmers, families will provide the remaining 30 percent in the form of labour. The organizations retain US$ 104 for administrative expenses and the farmers receive a net sum of US$ 429.
Altogether, 10560 ha were reforested through the FDF. When interviewed during the preparation of the Costa Rican case-study, farmers indicated that the FDF's flexibility makes it appropriate for improving their traditional production systems. Some of the criticisms levelled at the mechanism by the farmers and the community development organizations were: the promotion of monospecific plantations and of species other than those preferred by the farmers, the technicians' requirement that the farmers plant on land with cropping potential and the lack of consideration given to regional agroecological and cropping characteristics. The fact that less money is provided through the FDF than through the CAFA is resented and criticized by the farmers and, consequently, they tend to prefer the CAFA.
Reforestation contracts have been shown to be appropriate for research and demonstration activities requiring farmer participation and the use of farmers' land. While this mechanism has an important role to play in extension activities, its future use for other purposes is unlikely unless financing terms and conditions are improved.
The end of a myth
The results obtained through the use of tax exemption and special funds are proof that farmers respond to economic incentives and market signals. However, most incentive programmes have failed to use these mechanisms. Instead, the preferred incentives for farmers have been those of a non-cash nature, such as agricultural inputs, extension programmes and food for work. Incentive programmes seem to be based on the assumption that farmers respond better to incentives of a moral or ethical nature than to market signals and economic incentives in the context of a market economy.
This mechanism allows public or private research or extension organizations case reviewed, the Costa Rican government agency Centro Agrícola Cantonal de Hojancha [CACH]) to provide the funds and carry out all the reforestation work on farmers' land. Land is the farmers, only contribution. Under an agreement, 60 percent of the output goes to CACH and the remainder to the farmers.
An area of 12 ha was planted using this mechanism. The reforested plots were used to demonstrate the feasibility of reforestation in areas that were not appropriate for agriculture and that were previously left idle. The funds to operate the scheme were provided by the United States Agency for International Development (USAID).
The same mechanism was later used on a number of occasions in Costa Rica; for example, in 1979 during trials for the MADELEÑA project (a joint project involving CATIE and the DGF, with the financial support of USAID-ROCAP). The reasons for using the mechanism in this project was to study the growth of tree species for wood production. These contracts stipulated that the farmers would receive the plantations, total output. Another experiment using this mechanism, the LENA reforestation project, took place in 1981. LEÑA's aim was to study the behavior of fast-growing species and their potential for use in reforestation programmes. Some 100 ha were planted under the contracts established with the MADELEÑA and LENA projects. The farmers have said that much of their present confidence in forest planting is due to the experience acquired in these plantations and to their demonstration effect.
Project CEE NA-82/12 was implemented between 1984 and 1989, with the support of the European Economic Community. Farmers received the capital they needed to cover reforestation costs (inclusive of labour) and, later, to manage the plantations, for a period of three years. At the end of that period, if it was determined that the farmers had correctly followed all the technical advice their debt was cancelled. The same project provided loans for the establishment of nurseries, repayable in five years. These loans were granted only to organizations with several years' experience and previous success in rural areas. The main aim of these projects was to conduct trials on the introduction of new species.
This type of scheme operates in the same way as commercial loans. Money is channelled to the farmers for a fixed period, during which they pay interest and at the end of which the capital has to be repaid. The lender ensures that the capital will be repaid by obtaining guarantees from the borrowers or from third parties. Three cases where this mechanism is in use were identified: one in Costa Rica (the AID-032 project) and two in Nicaragua (Credit for Reforestation and Credit for Conservation and Management).
Credit for reforestation (Nicaragua)
This mechanism is ongoing in conjunction with two projects, Chinorte Rural Development, with financial support from the Swiss Cooperation for Development Agency, and Heroes y Mártires de Veracruz, funded by the Netherlands Government and implemented by FAO. The credits are jointly administered by the National Development Bank, project technical management and IRENA. The aim of these projects is to establish plantations for wood production. Funding, equivalent to 51 person-days, four rolls of wire and 2 kg of wire staples, is provided for each hectare reforested. The lending terms are a five-year grace period and repayment over six years. At the time of the review, the interest rate had not been set but it was expected to be between 8 and 14 percent. The main loan conditions are: to show that the land is legally owned, to undertake to reforest not less than 0.7 ha, to accept the reforestation plan prepared by the project technical experts and to participate in a local fire monitoring programme.
Credit for forest conservation and management (Nicaragua)
Also implemented in conjunction with the two above-mentioned projects, this mechanism differs from the former in that the loans are interest-free. Its aims are natural resource conservation and management, with community participation. Among the funded activities under way are the establishment of agroforestry systems, natural forest management, live fence establishment and soil conservation works, such as gully erosion control and the establishment of live barriers. The maximum received by each beneficiary is the amount needed to reforest 1.4 ha. This limit was set in order to keep participants, debts low and to increase the number of participants.
The fund is administered by the projects, technical team. The projects are responsible for organizing and training loan recipients and it is hoped that, once trained, they will take over loan management through a revolving, self-sustainable fund.
AID-032 loan project
The AID-032 project was established in 1982 on the Nicoya Peninsula, Costa Rica, under the natural resource conservation programme, CORENA. Managed by small farmers, its aim was to provide loans for reforestation and livestock activities. The lending terms for the reforestation loans were 8 percent interest, a five-year grace period and 12 years for repayment. The loan for livestock activities was based on the same repayment terms but carried a 12 percent interest rate. In terms of administration, AID-032 was the funding agency while the DGF, in its technical capacity, and the National Bank of Costa Rica were the funding intermediaries. The programme was based on the assumption that the benefits generated by the livestock component would provide sufficient funds to cover the cost of the forestry operation. In fact, the financial results of the livestock component were much lower than the feasibility study forecast. Under this programme, 124 ha were reforested. At present, loans are being collected. Because of the low returns on the livestock activities, participating farmers have found themselves in danger of losing their land, as they were legally bound to pay the debts owed to the National Bank.
Costa Rica's Forestry Act 4465 of 1969 states that the state-owned commercial banks should allocate 3 percent of their total loan portfolio to funding for forestry. This scheme has not been used. The lack of demand has been due to the availability of non-repayable loans and to the rates of interest at which these funds would be made available.
The Forestry Development Fund In Costa Rica promoted establishment of mixed tree crops and agroforestry. In the photo, platano and coffee
In Nicaragua, the tax exemption mechanism was also used to promote the establishment of living fences
Such an approach has led to the adoption of policies promoting the use of investment funds for the business sector and extension activities for low-income farmers. Another implication of such an attitude is that low-income farmers are asked to meet national objectives connected with the provision of public goods, whereas the objectives that the entrepreneurs are expected to meet are related only to market goods. This attitude is reflected in the design and implementation of financing mechanisms. In Costa Rica the tax relief mechanism, which mainly provides investment funds, was initially open only to entrepreneurs. In Nicaragua, the mechanisms used most frequently with the low-income farmers provide them with small quantities of food or agricultural inputs. Another implication is that work with the farmers is based on the allocation of small amounts of money so, logically, physical targets are also small. This may give the mistaken impression that work done through the entrepreneurs is more effective, as it has resulted in larger areas being reforested. In point of fact, the empirical evidence obtained through the study contradicts this. There is no evidence to suggest that the business community has been more successful than the farmers in terms of economic efficiency or planting targets.
The mistaken perception that farmers' achievements differ when they are confronted with economic incentives has led to another serious policy error: more was expected of lower-income farmers. When the tax exemption scheme in Costa Rica was opened up to include them, farmers were expected to meet additional social and financial objectives not required of the business sector. The programme with the entrepreneurs sought to increase supplies of industrial raw materials. When the same programme was extended to farmers with title deeds, there was an additional objective: to develop forest awareness. Finally, the special funds for farmers without title deeds added a further objective: to become self-financing. The study confirmed that farmers respond to economic incentives in a market economy in the same way as the business community and that large-scale forestry operations may be carried out and significant targets achieved with their involvement.
Funding mechanisms and macroeconomic policies
Structural adjustment programmes do not rule out the possibility of using forestry policies that include economic incentives. The main aim of such programmes is to eliminate economic inefficiency and boost economic competitiveness. Forestry, incentives are justified when they serve to promote alternative ways of producing public and market goods and services, while improving productivity and economic efficiency. The developed countries, supporters of economic adjustment programmes, themselves continue to use various types of economic incentives.
The importance of institutional capacity for policy planning and analysis
If financial mechanisms, based on proven economic principles, are effective tools for policy implementation, it may be worth asking why they frequently fail to achieve their objectives and why they are economically inefficient. Their most common defects are social inequity, economic inefficiency and negative environmental impacts. While these defects do exist, the findings suggest that the real cause is the lack of institutional capacity and not defects inherent in the mechanisms.
There are many reasons for the inequity that is evident when tax exemption mechanisms are made available only to the business community. As we have seen, one of the major reasons why farmers were not given the opportunity to participate was the belief that they do not respond to economic incentives. The legal framework governing the banks' investment orientations is another major constraint. The guarantees and payment terms laid down in the regulations in force are inappropriate for farmers occupying land without tide deeds and for the cash flow generated by forestry activities. In practice, the best-willed bankers are unable to allocate funds to farmers.
The low growth rates obtained in the forest plantations of Costa Rica and Nicaragua could have been avoided through careful planning to determine standards for species, seed quality, site preparation practices and-management after establishment. The timber from the first commercial fellings might have been used in Costa Rica if account had been taken during the tax exemption planning process as to how the output from the plantations would be used. The necessary technical skills and expertise are available in both Costa Rica and Nicaragua. Ensuring that operations meet the set standards depends on the forestry institutions' administrative capacity: coordination, leadership and supervision.
The diversion of funds obtained through the mechanisms to activities other than those initially proposed, together with the payment of incentives in excess of the actual cost of the activities, was due to poor policy analysis skills, an insufficient understanding of economic theory and, at times, the countries, level of political development. It could have been avoided through an analysis of the forest product market components (demand, price, marketing and production costs) to determine the optimum level of funding for each type of objective.
The low level and lack of continuity of funds allocated to operate the financing mechanisms were due to a lack of political power in the forestry sector and to the fact that the investments were not justified. Government investment in forestry is based on the assumption that the proposed activities are essential for the production goods and services that do not respond to market signals. That assumption is not in question. However, decisions seem to be based on the general principle that everything that is done for the rural people and the forests is good. While this is a valid premise, it does not guarantee sustainable and effective funding. To ensure a continuous flow of sufficient funds to meet the magnitude of the problems, there must be ongoing support for the rationale behind the investment and its benefits for society and the national economy must be made clear. The study found no evidence to suggest that investment had been based on comparative analyses with other sectors competing for public funds.
Reforestation loans were used to facilitate plantations for wood production. Pictured is a stand of pine (Caribea hondurensis) in Nicaragua
The financing mechanisms discussed in this article are useful policy tools for promoting rural community participation in forestry development. They will continue to be essential for the implementation of sectoral policies concerning farmer participation and sustainable forest use. Most of the problems arising from their use stemmed from poor planning and an inadequate institutional framework, but not from technical or administrative problems inherent in the mechanisms themselves. Further efforts are required to improve the mechanisms' economic efficiency. More specifically, programmes aimed at providing the countries with an appropriate institutional and policy framework are needed to ensure the economic efficiency of the funds channelled through financial mechanisms. Urgent steps should be taken to develop appropriate analytical skills for policy formulation, the expertise needed to use the economic analysis tools effectively, to translate the policies into operative rules and regulations, processes and procedures and to put them into effect.
The chronic lack of investment capital in the forestry sector is the major problem where financing mechanisms are concerned. This is particularly true in the case of community forestry activities. Identifying new ways of obtaining capital to fund community participation is a matter of top priority. While external grants and the project approach are valuable, they seem unable to provide the levels of investment required to cope with the problems of the countries reviewed. New ways to attract international and national capital must be found urgently. The current project approach will need to be replaced by a programme approach structured according to practical demands and deadlines. The new system should make use of national and international financial markets. Special attention should be given to the opportunities offered by new capital markets in the developing countries and to the opening up of these countries to international investment. At the national level, the proportion of domestic savings, particularly rural savings, allocated to the forestry sector should be stepped up. Establishing links between the business community and the farmers through joint investment arrangements would be a step in the right direction.
To ensure the participation of rural communities, it is vital to take market conditions into account when designing financing mechanisms. The same should be done in order to come to grips with most of the causes of economic inefficiency detected. In many cases, the answer will be to create long-term demand for the services and products generated by the community activities. This would open up the opportunity to establish new cooperation mechanisms between the international funding community and those developing countries taking steps to ensure sustainable forest resource use.
Now that many countries are undergoing economic readjustment and the criteria for efficient public investment are stricter than before, it is essential to: pay greater attention to the definition of financial mechanism objectives; assess the economic, social and ecological impacts more carefully, paying special attention to risk determination; ensure that investments are economically effective; adopt a programme approach; and put in place the institutional requirements for implementing financial schemes. The objectives of financial mechanisms for community forestry activities should, above all, be geared to solving the actual problems confronting those communities. Justification of these objectives is based on their impacts and effects such as the resolution of environmental problems. At the same time, greater efforts should be made to involve the communities in monitoring the efficiency of the financing mechanisms, through the provision of economic incentives based on market economy principles.
A fundamental aspect of the capacity-building programmes through which support is offered to the developing countries should be the overall improvement of investment and administrative capacity via the financing mechanisms.
Bereta, S. & Salinas, D. 1992. Estudios sobre mecanismos de financiamento para actividades forestales comunitarias: cave de Nicaragua. Rome, FAO. (unpublished consultant's report)
Borges, C. & Meza, A. 1992. El financiamiento de actividades forestales comunitarias: el caso de Costa Rica. Rome, FAO. (unpublished consultant's report)
FAO. 1994. Mecanismos de financiamiento para actividades forestales comunitarias. Rome.