NEW SOLUTIONS FOR OLD PROBLEM

The main objective of the next stage of economic reforms in Azerbaijan is to find new forms and mechanisms of financing agriculture. Due to high risks in this sector of economy over the past few years, it was impossible to attract private banks. Besides, relatively expensive commercial loans are not suitable for the development of agriculture. In order to provide farmers with access to long-term and low-cost financing, the government took a number of measures this year, including the development of a new law on agricultural insurance and the introduction of the Azerbaijan Agricultural Lending Assessment System (AzALES).

State's share in agriculture

In fact, during the independence period, the lion's share of investments in rural production has been provided mainly through state lending funds, as well as direct budget financing. International financial institutions (IFI) have also played a role in the development of agriculture market through soft loans and grants, which helped to implement more than two dozen joint projects for $700 million with the government of Azerbaijan.

However, the state is still the leading funder in agricultural financing. Moreover, the Entrepreneurship Development Fund (SIF), created by the decree of President Ilham Aliyev on August 1, 2018 on the basis of the National Fund for Entrepreneurship Support (NFES), which has been active since 1992 operating under the Ministry of Economy, acts as the main donor of agricultural enterprises. “Over these years, the Fund provided c. ₼2.3 billion of soft loans to about 36,000 small and medium-sized enterprises (SMEs). This contributed to the creation of 166 thousand new jobs,” Sahib Mammadov, the Deputy Minister of Economy said. Remarkably, 68% of SIF beneficiaries are farmers and various agricultural enterprises, which accounted for approximately ₼1.5 billion over the 27 years of activities.

“SIF has so far issued ₼155.7 million soft loans for the development of agriculture in Azerbaijan. In particular, ₼110.7 million was provided for crediting the construction of 26 complexes for breeding livestock, ₼25 million for the creation of 12 milk processing enterprises, ₼14.9 million for the creation of 10 meat processing enterprises, and ₼5.1 million for development beekeeping,” S. Mammadov said.

However, in recent years, microfinance has occupied an insignificant place in the loan portfolio of the fund. The main amount of funds was allocated to finance medium and large undertakings that provide greater efficiency and guaranteed return on investment.

Budget financing of agriculture, including through SIF, will continue in subsequent years. However, the new agricultural strategy is based on the gradual decrease in the dominant role of the state as a donor to the agricultural sector.

In the near future, agricultural sector needs additional investments to implement the new export strategy and to capitalise on the production segment. After all, the government sets a new task for the agricultural sector, which is to increase exports of processed products with high benefit, increase profitability and reduce production costs by creating efficient agricultural clusters. To do this, industrial type agricultural parks with modern processing infrastructure will be localized, large grain-sowing and livestock complexes will be formed, and logistics bases will be built to move from one-time small-scale wholesale operations to long-term contracts. One of the new trends in agriculture is a change in the structure of agriculture: increasing production in the field of viticulture, valuable industrial plants (cotton, tobacco, tea) and developing of both light and food export industries.

Obviously, funding all these projects through the state budget is difficult and wrong in terms of market economy. Therefore, in recent years, the government has been consistently implementing reforms that stimulate private investment and the capitalisation of rural enterprises through bank lending.

Insurance is priority no.1

Unfortunately, inadequate bank funding of agriculture and related industries is probably the most long-standing industry problem. The share of agricultural loans in the total loan portfolio of local banks did not exceed 6-7%, even in the best years for the economy. The main reason is associated with high risks of lending to farms. According to experts of the International Finance Organization (IFO), small farmers use 75% of agricultural lands in Azerbaijan, which is an average of two hectares per farmer. Development of agricultural cooperatives is just beginning, and the number of large agricultural farms with vast land plots, equipment parks and farm buildings is still small. The bulk of the small-scale villagers are not able to provide enough valuable and liquid collateral to obtain the necessary loans from banks. The situation is aggravated by the fact that although Azerbaijan is in the zone of risky farming, however, the practice of using insurance instruments, it can be said, is not.

It is supposed to overcome this long-standing problem by expanding the participation of insurance companies in the agricultural sector, and for this purpose, the Law on Agricultural Insurance was adopted on June 27, 2019, which will enter into force on January 1 of next year. The need to develop new legislation was due to the fact that the law “On the promotion of insurance in agriculture” adopted in 2002 and the mechanisms for its implementation were not effective enough and were not actually demanded by agricultural producers. Thus, according to the studies of the Accounting Chamber of Azerbaijan, on average 90-95% of the funds allocated annually from the state budget to cover 50% of the insurance premium on agricultural property insurance, for the most part, remained unused. In particular, in 2018, premiums of Azerbaijani insurance companies in the field of agricultural insurance amounted to 2.7 million manat, payments - 755 thousand manat. Moreover, most of the payments and fees in this area came from insurance of farm animals, and crop production, due to its high risk and loss ratio, like all previous years, was largely out of the attention of participants in the insurance market.

The new agricultural insurance mechanism in Azerbaijan was developed on the basis of models operating in Turkey and Spain, taking into account the experience of the US, Canada, and Israel. The goal is to develop a regulatory mechanism for the agricultural sector, taking into account high risks existing in this area, and also covers the insurance of crop production, aquaculture and livestock. According to the law, agricultural producers will be insured against risks associated with natural disasters, fires, industrial accidents, infectious diseases and poisoning, from attacks by wild animals, the spread of parasites, and actions of third parties. The law provides for compensation within seven days in the event of an insured event.

“As soon as the law is adopted, agricultural insurance will work on the basis of a public-private partnership mechanism and will be implemented through a joint insurance system. Separate measures are developed for each sector, in particular, techniques and rules for risk assessment and damage management, which will be determined by independent experts.

"The new law also provides for subsidising insurance premiums. So, a farmer will cover part of the costs, and the state will do the same for the other part," Firdovsi Agashirinov, head of the Department for Supervision of Insurance Activities of the Financial Markets' Supervision Authority of Azerbaijan. According to Aghashirinov, guarantees are also provided for reinsurance on accumulated funds.

The problem of ensuring the protection of farmers from risks will be solved. The new law “On Agricultural Insurance” will mainly help attract funds from commercial banks to the agricultural sector. As a rule, banks do not issue loans to farmers if they have not insured their crops or livestock. That is why banks covered only 3.6% of loans allocated to agriculture. According to experts, thanks to banking risk insurance, the process of reducing the level of credit rates, commissions and other payments, which today amount to 25-30% of the total loan amount, will begin over time.

AzALES system for agricultural loans

The introduction of agricultural lending assessment system developed with the support of the European Bank for Reconstruction and Development (EBRD) and the EU-backed Frankfurt School of Finance and Management will also help to solve the problem of expanding private financing on agriculture. “The system was introduced at a critical moment when the Azerbaijani government uses important resources to modernize the agricultural sector as part of its economic diversification strategy. The success of many initiatives included in the government’s agricultural roadmap directly depends on improving the access to agricultural loans, especially for small and medium-sized rural producers,” Simon Gatti, head of the cooperation department of the EU Delegation to Azerbaijan said.

AzALES system will be centrally managed and supported by the Agency for Agricultural Lending and Development (AKIA) under the Ministry of Agriculture of Azerbaijan and will be available for the entire financial sector of the country. This mechanism will allow financial institutions to use centralised and reliable agricultural data, increasing efficiency and transparency and reducing costs, and provide agricultural loans in a more systematic way. In particular, AzALES covers all commercially demanded crops and livestock products in Azerbaijan and will help lenders assess risks more effectively, process loan applications faster and improve the access of small private farms to financing.

“Azerbaijan has powerful potential in agriculture due to the diversity of cultivated crops. However, difficulties with access to long-term, reliable and low interest loans, especially for farms in remote areas or without real estate collateral, hamper the development of the agricultural sector,” Ivan Duarte, head of the EBRD’s Baku office. “Providing banks with a more efficient credit assessment system for agribusiness will help improve the quality of services for the sector, which is often considered risky.”

The new system has already proved its effectiveness in Turkey, where a similar tool, TARDES, was launched in 2014 with the support of the EBRD. For five years, the system approved 460 thousand applications for agricultural loans totalling 2.6 billion euros, and the number of problem loans in agriculture significantly decreased too.

According to the chairman of AKIA, Mirza Aliyev, lending institutions in Azerbaijan, mainly their regional branches, have not enough qualified employees for credit risk assessment, which makes banks and non-bank lending organisations (NBLOs) often adhere to a conservative policy on granting loans. “As a result, farmers' applications are rejected or the process of issuing loans is delayed, or the credit institution requires real estate worth several times higher than the loan amount on bail,” M. Aliyev said. With the introduction of the AzALES system, AKIA specialists will be able to track the causes of failures of credit organisations, and this practice will help to improve and adjust the scope of agricultural lending. Thanks to AzALES, bank requirements for farmers regarding collateral will be reduced by 20-30%: the system will assess the solvency of borrowers and there will be no need for excessive collateral.

In other words, the new effective tool will significantly expand the potential of AKIA, which is the second organisation after the SIF in terms of lending to agriculture. 67% of the AKIA's loan portfolio is formed of bank funds, the remaining volume is shared by NBLOs (19%) and credit unions (13%). In the first half of 2019, the agency provided ₼82.05 million to finance 719 farmers in Azerbaijan, including the purchase of 1,432 units of agricultural machinery.

All these transformations optimise the process of attracting private capital to the agricultural sector, which will increase the return on investment in the industry, speed up the pace of production, and reduce the state’s burden in the development of agriculture.