Financing smallholder agricultural production in Kenya : an economic analysis of the credit market

Abstract

Agricultural growth is dependent upon technical change, and adoption of new technology is dependent on the availability of funds and terms of financing among others. Yet smallholders are usually capital constrained. To address the capital constraint,the Kenya government has over the years participated in the development of agricultural credit programs, but not without problems. The government has not been able to meet credit needs of farmers, especially small holders, and many farmers have been reluctant to apply for loan funds. The agricultural sector receives only about 10 percent of the total formal credit extended to the Furthermore, for funds meant for agricultural purposes have been diverted to other uses by the borrowers, and repayment performance has been generally poor, around 35-50 percent. The supply side remedies such as enhancing correct utilisation of loan funds and improvement of repayment are usually addressed by the government, "but no mention is made of any plan to identify and understand the demand factors with a view of eliminating or reducing the demand side constraints. This study set out to bridge the gap by establishing the serviceable demand side constraints and determining the best way to finance smallholder Kenya agriculture. Model farms were determined and pattern farm budgets developed for them. Linear programming (LP) was applied to identify constraints and respective budgets worked out. Situations of attempting to ease the most limiting constraints via loan funds were examined in each case, and where applicable, farm investment analysis carried out. Farm Investment Analyses (FIA) were undertaken to determine the attractiveness of additional investment and financing in smallholder agricultural production. The simulation study examined the possibility of improving farm production by altering resource levels and objective function coefficients. Where such an improvement was technically possible, its feasibility via loan funds was also examined through FlA. It was found that additional funding would, more often than not, alter the existing farm plans. However, in a number of cases such alteration would not be viable. That is, the returns would be too low to pay for the investment, or in some cases the returns would not offer enough incentive for farmers to participate in desirable farm improvement programs. Nevertheless, in three of the twenty patterns it was found that additional funding would alter existing farm plans. Returns to borrowed funds would be sufficient to pay for the investment, and would also be adequate to attract farmers' participation in desirable farm improvement programs. It was deduced that the credit market so far has failed because it has not considered each case on its own merit. An improvement of the credit market was proposed.