THE ROLE OF A CREDIT GUARANTEE IN ALLEVIATING CREDIT CONSTRAINTS AMONG ...

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THE ROLE OF A CREDIT GUARANTEE IN ALLEVIATING CREDIT
CONSTRAINTS AMONG COFFEE FARMERS’ COOPERATIVES IN
ETHIOPIA

by

NEGUSSIE EFA GURMESSA

Submitted in accordance with the requirements

for the degree of

DOCTOR OF LITERATURE AND PHILOSOPHY

in

DEVELOPMENT STUDIES

at the
UNIVERSITY OF SOUTH AFRICA

SUPERVISOR: DR CATHERINE NDINDA

November 2016
DECLARATION
I hereby declare that ‘The Role of Credit Guarantee in Alleviating Credit Constraints among
Coffee Farmers’ Cooperatives in Ethiopia’ is my own work and that all the sources that I have
used or quoted have been indicated and acknowledged by means of complete references.

____________________________ 4 November, 2016
(Negussie Efa Gurmessa)

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ACKNOWLEDGEMENTS

Throughout this study, I received various support from many individuals and organisations. I am
thankful to all. Firstly, I would like to express my sincere gratitude to my supervisor, Dr
Catherine Ndinda, for her extraordinary commitment and patience in reviewing my work, in
identifying relevant materials, in providing critical comments and guidance. Her understanding,
encouragement and support were immensely useful in making this study possible. I also received
tremendous moral support and encouragement from my colleagues in CABI. I am very grateful
to all of them. In particular, I wish to extend special thanks to Mr Morris Akiri and Dr Charles
Agwanda who encouraged me to undertake my study on a CABI-led Credit Guarantee Scheme.
This study was made possible through a financial support provided by my employer (CAB
International) and the financers of the project - Common Fund for Commodities and Rabo Bank.

I am also grateful to the different individuals and organisations who participated in the study in
various ways. In particular, I owe special thanks to the credit managers of the selected banks and
Directors of MFIs, primary cooperatives and their management, coffee and cooperative experts
at various levels for their cooperation, time and contribution in providing necessary information.
I am particularly thankful to zone and district coffee and cooperative experts who participated in
data collection for their devotion and patience during the field data collection. Director of Coffee
and Tea Development of MoANR, Mr Fikru Amenu and his team deserve special gratitude for
their moral and logistic supports during the study. Furthermore, I would like to express my
sincere appreciation and thanks to Dr Hailemariam H/wold for his useful guidance on
econometric modelling of the quantitative data analysis. Special gratitude also goes to my
friends, Getachew, Kindie (Dr) and Shiferaw, for their encouragement and moral support.

Finally, my special thanks go to my wife, Meskerem, for her understanding and moral support
throughout this study. And of course, I owe my children special gratitude and love. The study
obviously compromised my care and attention towards them. As a responsible father, I hope that
I demonstrated to them the value of hard work, commitment, determination and endurance. It
was not that easy juggling family life, full-time job and a PhD study.
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ABSTRACT

This study explored the role and effectiveness of a credit guarantee scheme targeting coffee
farmers’ cooperatives in Ethiopia. The study, among other things, aims at exploring how
provision of a credit guarantee influences supply of institutional credit to coffee farmers’
cooperatives as well as examines cooperatives guaranteed loan utilisation, the resultant
changes/impacts and intervening factors. Credit guarantee schemes largely trace their roots in the
liberal and neoliberal economic and social contexts. One of the key issues the current study tried
to address is examining how a credit guarantee scheme operates in a partially liberal capitalist
context where there is pervasive state intervention in the key sectors of the economy, including
financial and coffee sectors. The study was conducted in eight zones of the two major coffee
producing regions of Ethiopia – Oromia and Southern Nations, Nationalities and Peoples’
regions. A mixed method with structured questionnaires (at two stages), key informant
interviews, focus group discussions and extensive observation were used to collect data from
primary cooperatives, financial institutions, coffee extension and cooperative experts. Qualitative
analytical methods, descriptive statistics and econometric model were used in analysing the data.

The study reveals that most primary cooperatives have weak institutional, business and financial
capacities, and limited access to institutional services including credit. The findings show that
cooperatives generally have limited role in the coffee production end, but they play an important
role in its marketing. The study suggests that coffee or multipurpose cooperatives are not ideally
suitable to serve as intermediaries for bank loans. The study reveals that the vast majority of the
study cooperatives have potential demand for loans, but revealed low actual demand. Different
sets of internal (demand side) and external factors influence cooperatives’ potential and actual
demand for loan in different ways. The assessment of the guarantee scheme under analysis
shows that though most of its design and operational features are in line with international
practices, there are some obvious limitations. Low risk coverage level, limitation in the total
volume of the guarantee fund, lack of capital enhancement mechanism for the lending banks,
short life span of the scheme, lack of flexibility and adaptation and reliance on a single lending
bank are among the notable limitations. In terms of utilisation of the guarantee fund and outreach
of the lending activity, the scheme attained limited achievements with a low leverage ratio.
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However, substantial financial additionality was attained among the borrower cooperatives, but
the intervention had little impacts in improving the terms and conditions of loans. The positive
effects on the economic/business activities of beneficiary cooperatives include acquisition of
processing facilities, increase in member size, increased volume of coffee processed and dry
cherry traded and improvement in the income generated from such business activities. However,
the scheme had limited effects on cooperatives’ human resources and type of management. A
number of internal and external factors appear to influence effectiveness of a credit guarantee
targeting farmers’ cooperatives.

Several recommendations were made. First, there is a need to integrate attractive features into the
scheme that can be periodically revised and adapted. These may include raising the risk coverage
level especially at the initial stage, including liquidity boosting mechanism, lowering guarantee
fee level, devising longer-term arrangement, integrating strong capacity building and technical
support and other incentive packages. Second, the lending banks need to develop suitable loan
products, revisit and improve their lending terms, requirements and approaches. Third, if they are
to effectively demand for and make proper use of such guaranteed loans, cooperatives need to be
supported so as to enhance their organisational, business and technical capacities. Fourth, there is
a need for the government to further strengthen provision of a more supportive and enabling
legal and institutional environments and relax some of the regulatory frameworks so as to
facilitate the lending-borrowing activities.

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LIST OF ABBREVIATIONS
ADLI Agriculture Development-led industrialisation
AIDB Agriculture and Industrial Development Bank
AMC Agricultural Marketing Corporation
ATA Agriculture Transformation Agency
CBE Commercial Bank of Ethiopia
CBO Cooperative Bank of Oromia
CFC Common Fund for Commodities
CGS Credit guarantee scheme
CSA Central Statistical Agency
DBE Development Bank of Ethiopia
DFID Department for International Development
ECX Ethiopian Commodity Exchange
EPRDF Ethiopian Peoples’ Revolutionary Democratic Front
FCA Federal Cooperative Agency
FGD Focus Group Discussion
GDP Gross Domestic Product
HDI Human Development Index
HDR Human Development Report
ICA International Cooperative Alliance
ICO International Coffee Organisation
IIRR International Institute of Rural Reconstruction
ILO International Labour Organisation
ITC International Trade Centre
KII Key Informant Interview
LGS Loan Guarantee Scheme
MFI Microfinance Institution
MoA Ministry of Agriculture (Ethiopia)
MoFED Ministry of Finance and Economic Development
NBE National Bank of Ethiopia
NGOs Non-governmental Organisations
OBoFED Oromia Bureau of Finance and Economic Development
OCFCU Oromia Coffee Farmers’ Cooperative Union
OECD Organisation for Economic Cooperation and Development
PASDEP The Plan for Accelerated and Sustained Development to End Poverty
PEA Project Executing Agency
PIA Project Implementing Agency
RUSACCO Rural Saving and Credit Cooperative
SACCO Saving and Credit Cooperative
SAP Structural Adjustment Programme
SBA Small Business Administration
SME Small and Micro Enterprises
SNNPR Southern Nations and Nationalities People’s Region
TIN Tax (payers) Identification Number
UNDP United Nations Development Programme
USAID United States Agency for International Development
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TABLE OF CONTENTS

DECLARATION ............................................................................................................................ ii
ACKNOWLEDGEMENTS ........................................................................................................... iii
ABSTRACT ................................................................................................................................... iv
LIST OF ABBREVIATIONS ........................................................................................................ vi
TABLE OF CONTENTS .............................................................................................................. vii

CHAPTER 1 .................................................................................................................................. 1
1. INTRODUCTION AND BACKGROUND ......................................................................... 1
1.1. Introduction ......................................................................................................................... 1
1.2. Background ......................................................................................................................... 2
1.2.1. Ethiopia: Country background .................................................................................. 2
1.2.2. The Ethiopian agriculture sector ............................................................................... 4
1.2.3. The Ethiopian Coffee sub-sector and its significance in the country’s economy ..... 5
1.2.4. The role and significance of rural finance in promoting agricultural development . 8
1.2.5. Expansion of the financial institutions: have they adequately supported agriculture? .. 9
1.2.6. The Ethiopian Credit Guarantee Scheme for coffee farmers’ cooperatives ........... 11
1.3. Statement of the problem .................................................................................................. 15
1.4. Objectives of the study...................................................................................................... 19
1.5. Key Research Questions ................................................................................................... 19
1.6. Overview of the research design and methodology .......................................................... 20
1.7. Scope and limitations of the study .................................................................................... 20
1.8. Definition of the Key Concepts ........................................................................................ 21
1.9. Outline of the structure of the thesis ................................................................................. 25

CHAPTER 2 ................................................................................................................................ 28
2. MACRO-ECONOMIC AND INSTITUTIONAL CONTEXTS ..................................... 28
2.1. Introduction ....................................................................................................................... 28
2.2. The Socialist’s command economy .................................................................................. 28
2.2.1. The Ethiopian Socialist or command economic system ......................................... 30
2.3. The free-market economy ................................................................................................. 32
2.3.1. The free-market economic system of Ethiopia ....................................................... 35
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2.3.2. Credit Guarantee Schemes under the Ethiopian context ............................................. 49
2.4. Farmers’ Cooperatives: An indispensable rural institution .............................................. 52
2.4.1. Overview of concepts, evolution and significance of farmer cooperatives ............ 52
2.4.2. Cooperatives’ role in catalysing agricultural development .................................... 54
2.4.3. Cooperatives movement in Africa: Evolution, features and prospects .................. 55
2.4.4. Cooperatives movement in Ethiopia: Evolution and current state ......................... 58
2.4.5. Coffee cooperatives and their role in coffee marketing .......................................... 67
2.4.6. Role of cooperatives in rural finance ...................................................................... 69

CHAPTER 3 ................................................................................................................................ 72
3. INTERVENING IN RURAL FINANCE ........................................................................... 72
3.1. Introduction ....................................................................................................................... 72
3.2. Rural Finance .................................................................................................................... 72
3.2.1. Role and impacts of access to rural finance ................................................................ 72
3.2.2. Rural financial markets and the rural poor: challenges and constraints ..................... 74
3.2.3. Credit demand by smallholder farmers ....................................................................... 75
3.2.4. Factors influencing demand for credit ......................................................................... 79
3.2.5 Estimating loan demand and its determinants: Conceptual & analytical framework .. 85
3.2.6 Analytical approaches employed in examining determinants of loan demand under
the current study ...................................................................................................... 88
3.3. Intervening Through a Loan Guarantee ............................................................................ 96
3.3.1. What is a loan guarantee and why it is chosen?...................................................... 96
3.3.2. Typology, design and modes of operation of Loan Guarantee Schemes ................ 98
3.3.3. Additionality and loan fund leverage .................................................................... 102
3.3.4. What do critics say about loan guarantees? .......................................................... 104
3.3.5. What do empirical studies say about the role and impacts of LGSs? ................... 106
3.3.6. Factors influencing effectiveness and success of a credit guarantee scheme ....... 107
3.3.7. Analytical Approach in Evaluating Loan Guarantee Schemes ................................. 111

CHAPTER 4 .............................................................................................................................. 122
4. DESIGN AND METHODOLOGY OF THE STUDY.................................................... 122
4.1. Introduction ..................................................................................................................... 122
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4.2. Description of the study areas ......................................................................................... 122
4.3. Sampling Design, Data Collection and Analysis ............................................................ 127
4.3.1. Research method and approaches employed by the current study ....................... 127
4.3.2. Sampling procedure .............................................................................................. 129
4.3.3. Data collection ...................................................................................................... 131
4.3.4. Data analysis procedure ........................................................................................ 136
4.4. Ethical measures ............................................................................................................. 142

CHAPTER 5 .............................................................................................................................. 145
5. EMPIRICAL FINDINGS ON THE ETHIOPIAN COFFEE AND COOPERATIVE
SECTORS .................................................................................................................................. 145
5.1. Introduction ..................................................................................................................... 145
5.2. The Ethiopian coffee sector ............................................................................................ 145
5.3. Are coffee/multipurpose coops suitable to act as intermediaries for bank loans? .......... 164
5.4. Challenges and constraints of coffee or multipurpose cooperatives ............................... 165
5.5. Credit for agriculture, coffee and cooperatives ............................................................... 167
5.6. Cooperatives’ institutional, socio-economic and business characteristics ..................... 177
5.7. Cooperatives’ demand for institutional credit and its determinants ............................... 187

CHAPTER 6 .............................................................................................................................. 200
6. EMPIRICAL FINDINGS ON THE PERFORMANCE AND PRELIMINARY IMPACT
OF THE CREDIT GUARANTEE SCHEME ........................................................................ 200
6.1. Introduction ..................................................................................................................... 200
6.2. Views about the role and benefits of the Ethiopian coffee credit guarantee scheme ..... 200
6.3. Scheme design and operation.......................................................................................... 201
6.4. Utilisation of the loan guarantee and coverage of the scheme ........................................ 206
6.5. Loan fund leverage ratio ................................................................................................. 210
6.6. Assessment of Additionalities attained under the current scheme.................................. 210
6.7. Improvements in the institutional capacity of beneficiary cooperatives ........................ 226
6.8. Impacts on lenders’ and borrowers’ behavior: Incidence of moral hazard .................... 235
6.9. Factors affecting effectiveness of a CGS for farmer cooperatives ................................. 237

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CHAPTER 7 .............................................................................................................................. 242
7. DISCUSSIONS OF THE KEY FINDINGS .................................................................... 242
7.1. Introduction ..................................................................................................................... 242
7.2. The role of cooperatives in coffee processing, marketing and as intermediaries for
channeling bank credit to smallholder farmers ............................................................... 242
7.2.1 Significance of the coffee sector ........................................................................... 242
7.2.2 Coffee Production, Processing and Marketing: The role of cooperatives ............ 243
7.2.3. Cooperatives’ operations and services in relation to coffee business ....................... 250
7.2.4. Suitability of cooperatives as intermediaries for bank loans………………………252
7.3. Credit for agriculture and coffee ................................................................................... 2544
7.3.1. Are agriculture and coffee priority areas for bank lending? ............................... 2544
7.4. Cooperatives’ demand for institutional credit and factors influencing demand ............. 257
7.4.1. Institutional, business and socio-economic features of cooperatives .................. 258
7.4.2. Cooperatives’ demand for institutional credit and its determinants ..................... 265
7.5. Influence of a credit guarantee on institutional credit supply to farmers’ coops ............ 274
7.5.1. Role and contribution of a credit guarantee in stimulating bank lending ............. 274
7.5.2. Scheme design and operation: Is it attractive enough to the lending banks? .. ….275
7.5.3. Utilisation of the loan guarantee and outreach of the scheme .............................. 277
7.5.4. Loan fund leverage ratio ....................................................................................... 280
7.5.5. Salient design and operational features and drawbacks of the scheme ................ 281
7.5.6. What can be proposed for future guarantee schemes? .......................................... 284
7.6. Additionalities obtained under the current guarantee scheme ........................................ 287
7.6.1. What does the financial additionality attained tell us? .............................................. 287
7.6.3. What are the economic additionalities attained under the current scheme? .............. 291
7.6.4. Improvements in the institutional capacity of beneficiary cooperatives ................... 294
7.7. Effect of the credit guarantee scheme on lenders’ and borrowers’ behavior. ................. 298
7.8. What are the factors that affect effectiveness and performance of a CGS targeting
farmers’ cooperatives in the Ethiopian context? ............................................................. 300

CHAPTER 8 .............................................................................................................................. 302
8. CONCLUSIONS AND RECOMMENDATIONS .......................................................... 302
8.1. Introdcution ........................................................................ Error! Bookmark not defined.
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