Rural Finance and Coffee Smallholders in Viet Nam. Case Study in Dak Nong Province

Rural Finance and Coffee Smallholders in Viet Nam Case Study in Dak Nong Province 19

OCCASIONAL PAPERS Knowledge for development effectiveness Rural Finance of Coffee Smallholders in Viet Nam Case Study in Dak Nong Province by Sauli Hurri and Quang Nguyen Ngoc International Fund for Agricultural Development Rome, Italy The nineteenth in a series of discussion papers produced by the Asia and the Pacific Division, IFAD 19

2016 by the International Fund for Agricultural Development (IFAD) The opinions expressed in this publication are those of the authors and do not necessarily represent those of the International Fund for Agricultural Development (IFAD). The designations employed and the presentation of material in this publication do not imply the expression of any opinion whatsoever on the part of IFAD concerning the legal status of any country, territory, city or area or of its authorities, or concerning the delimitation of its frontiers or boundaries. The designations developed and developing countries are intended for statistical convenience and do not necessarily express a judgement about the stage reached by a particular country or area in the development process. All rights reserved ISBN 978-92-9072-706-4 Printed December 2016

Table of contents Acronyms 4 Introduction 5 Coffee in Viet Nam 7 Production and productivity of the Viet Nam coffee sector 7 Coffee market trends for Viet Nam 8 Overview of coffee farms in Viet Nam 9 Coffee production and trade in the rural Dak Nong province 11 Dak Nong coffee farms 12 Small-scale coffee traders 14 Financing of coffee smallholders in Dak Nong 17 Formal and semi-formal financing 18 Informal financing: small-scale local traders 20 Coffee farmer risks and risk management 23 Ageing tree stock 23 Climatic conditions 24 Theft of harvest 25 Price volatility 25 Informal loan risks and risk management 26 Insufficient farm planning 27 Risks and risk management of coffee production financiers 29 Formal financiers: security by collateral and ensured investment quality 29 Semi-formal financiers: security by social networks and group cohesion 30 Informal financiers: security by business reputation and value chain fund flows 31 Conclusions 34 References 35 Figures Figure 1 Coffee production volume, coffee production area and coffee average yield in Viet Nam. 8 Figure 2 Volume of coffee exports for (top) major producer countries and (bottom) world total in tons. 8 Figure 3 Coffee export prices (US$/kg). 9 Figure 4 Coffee price (US$/kg) for exporters and provincial traders. 10 Figure 5 Coffee farmer average revenue stream US$/ha. 10 Figure 6 Map of Dak Nong province. 11 Figure 7 Smallholders coffee products and their market channels in Dak Nong. 14 Figure 8 Rough estimation of coffee investment, revenues and profitability, VND million/ha. 17 Figure 9 Coffee farmer access to finance in Dak Nong. 17 Figure 10 Informal coffee financing and trade in Dak Nong. 32 3

Rural Finance and Coffee Smallholders in Viet Nam Case Study in Dak Nong Province Acronyms BIDV DARD SCGs VBARD VBSP WEOF WU Bank for Investment and Development Department of Agriculture and Rural Development savings and credit groups Vietnam Bank for Agricultural and Rural Development Vietnam Social Policy Bank Women s Economic Opportunity Fund Women s Union of Dak Nong 4

Introduction There are more than half a million smallholder coffee farms in Viet Nam, and the number is growing. Virtually all of the farms are owned by rural households, with an average of 1 hectare of coffee land per farm. Coffee constitutes the main source of income for these households. Global market demand for coffee is growing, and potential household profits from coffee farming are high. Smallholders can earn up to US$5,000 per hectare per year, making the crop very attractive for people in rural Viet Nam. However, to achieve high profits, smallholders need a significant amount of working capital to finance the required annual input materials. In rural Viet Nam, smallholders rarely have capital available to use for farm investments. Access to formal financing is also limited because households have insufficient collateral assets and because the coffee sector is associated with a range of production and market risks. Many smallholders must grow their coffee with insufficient input materials, diminishing their farm s annual income to below US$1,000 per hectare; alternatively, they must approach informal sources of financing for the required input material loans. Increased demand for such financing has led to the emergence of dynamic informal capital markets, which in turn have enabled the continued growth of the coffee sector, further increasing the financing demand. Practices within this growing informal system directly influence the livelihoods of a vast number of people, but the information available on the current conditions and dynamics of such informal financing is limited. The purpose of this study is to assess Vietnamese coffee smallholders long- and short-term investment needs, and to understand in detail current local practices for financing such investments. The research process included desk research into overall coffee sector development, and subsequent field research in the Dak Nong province of Viet Nam s Central Highlands, where coffee is the dominant agricultural commodity. Section 1 of the report describes the general situation of the coffee sector and coffee farmers in Viet Nam. Section 2 introduces the reader to the specifics of coffee smallholders in Dak Nong province, including their relationship with local traders. Section 3 explains coffee smallholders access to finance in Dak Nong, including formal, semi-formal and informal capital markets. In section 4, farmers most critical production and market risks are explained, including descriptions of existing and suggested risk management strategies for increased profitability and sustainability. Section 5 explains how farmers risks are transmitted to financiers as default risk. Lastly, various financing risk management strategies are described to explore potential means of improving the quality of financing in the coffee sector, from the point of view of both financiers and smallholders. 5

Rural Finance and Coffee Smallholders in Viet Nam Case Study in Dak Nong Province To conduct the research, both primary and secondary data were used. For collection of primary data, two 10-day field trips were conducted in Dak Nong province. In the course of these field trips, triangulated information was generated by interviewing a wide range of local stakeholders. Focused group discussions or individual semi-structured interviews were held with poor, medium-income and better-off farmers, as well as with grass-root farmer associations, savings and credit groups, small- and medium-scale traders, enterprises, informal, semi-formal and formal financiers, and province/district/ commune authorities. In total, around 200 stakeholders were interviewed. For secondary data, statistical archives and relevant previous studies were the main resource. In particular, archival data was extracted from ITC Trade Map (7/2015), FAOSTAT (7/2015) and USDA Vietnam Coffee Annuals 2010-2014, which together provide a comprehensive picture of Viet Nam coffee productivity, production volumes, prices and export volumes. 6

Coffee in Viet Nam Coffee production was introduced to Viet Nam by the French at the end of the nineteenth century; however, industrial development of the coffee sector commenced only in the 1980s. From modest beginnings 30 years ago, Viet Nam s coffee industry has grown at a rapid pace, and Viet Nam is now the world s second largest coffee producer, with current annual exports of around 1.5 million tons (ITC Trademap 7/2015). Coffee is now the main source of income for more than 500,000 rural households (USDA 2014), and some 400,000 workers, including around 100,000 migrants, are employed in the coffee sector during the harvest (World Bank 2011). In Viet Nam, both Robusta and Arabica varieties of coffee are commonly grown, but Robusta is more widespread, accounting for approximately 93 per cent of total coffee production by area (USDA 2014). Robusta is grown mostly in the Central Highland provinces of Dak Lak, Lam Dong, Dak Nong and Gia Lai, at altitudes ranging from 500 to 800 metres above sea level. Arabica is grown at higher altitudes, up to 1,500 metres above sea level, in the provinces of Quang Tri, Son La and Lam Dong. This study focuses on Robusta production in Dak Nong province. Production and productivity of the Viet Nam coffee sector Over the past 15 years, the production area for coffee in Viet Nam has increased steadily from approximately 470,000 hectares to the current 670,000 hectares (figure 1). Despite the government of Viet Nam s master plan to maintain its coffee production area at 500,000 hectares, Viet Nam s coffee cultivation continues to expand in major coffee-growing provinces in response to high world prices in recent years (USDA 2014). During the past 15 years, while the coffee production area has expanded by 43 per cent, average productivity has also increased, from 1.5 tons/ha to 2.5 tons/ha. Consequently, overall production volume has expanded sharply, from around 700,000-800,000 tons in 2000 to around 1,800,000 tons in 2014. Productivity of Robusta production in Viet Nam is well above the world average, although still lower than in Brazil. Such high yields can be attributed to high input application, irrigation, good agricultural practices, optimum spacing and good planting material (World Bank 2011; USDA 2014). However, a large proportion of currently yielding coffee trees were planted during the 1990s and are now reaching estimated replacement age, which will affect production. Along with prevailing soil and nutrition imbalances, as well as infestation problems, it is predicted that future yields will fall unless remedial action is taken. By 2020, an estimated 50 per cent of Viet Nam s coffee trees will need to be replaced (World Bank 2011). 7

Rural Finance and Coffee Smallholders in Viet Nam Case Study in Dak Nong Province Coffee market trends for Viet Nam The volume of the global coffee market has grown steadily during the past 15 years, with total exports increasing from around 5 million tons in 2001 to 6.5 million tons in 2014. Viet Nam has benefited significantly from this expanding market, and during the same period the country has increased its coffee exports from around 300,000 tons to more than 1.4 million tons. Viet Nam and Brazil are now the world s largest coffee producers. In 2012, Viet Nam temporarily held the position of largest producer, during a period of drought in Brazil (ITC Trademap 7/2015). Figure 1 Coffee production volume, coffee production area and coffee average yield in Viet Nam. Statistics: FAOSTAT (7/2015) and USDA Vietnam Coffee Annuals 2010-2014. 2,000.000 1,500.000 1,000.000 500,000 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Tons Ha 3.00 2.00 1.00 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Tons/ha Graph: authors. Figure 2 Volume of coffee exports for (top) major producer countries and (bottom) world total in tons. Statistics: ITC Trademap 7/2015. 2,500,000 Tons/years Tons/years 2,000,000 1,500,000 1,000,000 500,000 0 8,000,000 6,500,000 4,000,000 2,000,000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Brazil Viet Nam Colombia Indonesia 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 World Graph: authors. 8

Figure 3 Coffee export prices (US$/kg). Statistics: ITC Trademap 7/2015. 5.00 4.00 US$/kg 3.00 2.00 1.00 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 World Viet Nam Graph: authors. In terms of value, the global coffee market has increased more sharply, from around US$6 billion in 2001 to US$21 billion in 2014. During the same period, Viet Nam s coffee export value increased from US$390 million to US$3 billion. Viet Nam is clearly increasing its share of the global market in terms of both volume and value. However, the relative increase in Viet Nam s market share by volume has been greater than its share in global value. Share of trading volume has increased from 6 to 21.5 per cent, while the share of value has increased from 6.5 to 14 per cent (ITC 7/2015). The difference between shares for value and volume is due to the price development of Viet Nam Robusta coffee. As shown in figure 3, during 2001-2004 the Viet Nam export price for Robusta coffee was still tracking the global average price, but since then Viet Nam has had to sell its growing coffee volume at significantly lower prices than other exporters. Arabica has become a higher value coffee variety than Robusta, and only 7 per cent of Viet Nam s coffee production is Arabica. Viet Nam is the largest Robusta producer in the world, while Brazil is the main producer of Arabica (ITC 7/2015). Overview of coffee farms in Viet Nam In Viet Nam, more than 500,000 households rely on coffee production. The majority of coffee farmers are smallholders with around one hectare of coffee production land (World Bank 2011). These small plots are the main source of income for most coffee farming households. The coffee sector in Viet Nam is the second largest in the world, after Brazil s, and is tightly connected to global trading. The sector is characterized by an extremely competitive environment, and the coffee farmers themselves take a dynamic role in trading and price negotiations. The farmers have access to daily updates of global market prices, and coffee growers receive approximately 95 per cent of the free on board value (World Bank 2011; USDA 2014). USDA statistics also indicate that farmers can sell their product very close to the export price, as illustrated in figure 4. The figure also shows regular low prices immediately after the harvest in November, compared with peak prices during the growing season in May. Again, local prices track these fluctuations, and it is not uncommon for farmers to stock coffee in their villages in the expectation of positive price changes. 9

Rural Finance and Coffee Smallholders in Viet Nam Case Study in Dak Nong Province Figure 4 Coffee price (US$/kg) for exporters and provincial traders. Statistics: USDA Vietnam Coffee Annuals 2010-2014. 3.0 2.5 2.0 US$/kg 1.5 1.0 0.5 0 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 May-14 Graph: authors. Export price Local price Figure 5 Coffee farmer average revenue stream US$/ha. Statistics: FAOSTAT; ITC 7/2015. 7,000 6,000 5,000 US$/ha 4,000 3,000 2,000 1,000-2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Farm revenue US$/ha Graph: authors. On average, owing to increased productivity, increasing global market prices and the dynamic trading role of smallholders, coffee household revenue streams have increased more than threefold over the past 15 years. This has allowed significant economic and social development of communities engaged in coffee farming, as well as the emergence of a vibrant private-sector network at all levels of the value chain. Figure 5 illustrates these increased revenue levels. However, to achieve these higher revenue flows requires intensified farming methods with increased input use, and the prices of input materials are increasing as a result of high demand. Poorer households in particular have difficulties in financing the required investments for high-yielding coffee. The extensive coffee farming practised by poorer farmers does not generate enough profit for investment beyond consumption needs, and banks are not willing to lend to households without collateral. The poorer smallholders are left with the choice of either borrowing from informal sources, with varying conditions and levels of risk (see section 3), or limiting their investment and thus continuing with extensive farming methods and lower revenue. Because of these obstacles, many poor farmers have not been able to increase their income, despite being part of an expanding global value chain in which better-off farmers continuously improve their conditions. This is discussed below. 10

Coffee production and trade in the rural Dak Nong province As mentioned above, the location of this case study is in Dak Nong province, a coffee province in the Central Highlands of Viet Nam. The province has a dynamic and rapidly growing coffee sector, with a vast network of local Robusta producers and traders, as described in this section. The province is located in Viet Nam s Central Highlands. Natural conditions in the province, including soil and climate, are highly suited to cultivating long-term industrial crops. These positive conditions have led to mass migration into Dak Nong over the past 20 years, and the province has become one of the most ethnically diverse in Viet Nam, with 40 ethnicities represented. The total land area of Dak Nong is 652,000 hectares, of which 574,000 hectares (88 per cent) is farmland. The total population of Dak Nong is 565,529 (2015). 1 The province map is shown below. Figure 6 Map of Dak Nong province. Source: http://investinvietnam.vn/report/parent-region/87/135/dak-nong. aspx (09/2016) 1. http://www.vietrade.gov.vn/en/index.php?option=com_content&id=1235:overview-of-dak-nong-province-part- 1&Itemid=273 (09/2016) 11

Rural Finance and Coffee Smallholders in Viet Nam Case Study in Dak Nong Province Dak Nong coffee farms Table 1 Coffee area and productivity in Dak Nong. There are 132,499 households living in Dak Nong province, of which 87 per cent are rural households and 85 per cent are Robusta coffee growers, so nearly all rural households in the province are involved in coffee production. The provincial poverty rate in 2014 was 14 per cent, equivalent to 18,000 households (3EM 2014). Around 80 per cent of the poor (14,500 households) live in rural areas of the province, indicating that there are significant numbers of poor households involved in coffee production in Dak Nong province (3EM 2014). As with other provinces in the Central Highlands, coffee has been widely grown in Dak Nong since the 1980s (World Bank 2011). At the beginning of the 1980s, coffee was planted and managed by state-owned agricultural and forestry enterprises. In a government reform called Doi Moi (1986), agricultural land was partly privatized, with agricultural land allocated to households through land use certification (Resolution 10 1989; Land Law 1993). Later, during the 1990s, the coffee sector expanded at a rapid pace, with coffee becoming the key crop and the main source of income for many farming households in Dak Nong (World Bank 2011; 3EM 2012, 2014). During the years 2000-2014, the growth of coffee production in the Central Highlands continued, and it is now reaching the limits of sustainability in some areas (see Ageing Tree Stock section for details). Growth has been sustained by increasing global market demand for coffee and an expanding labour force in the Central Highlands, following mass migration from the north. In 2014, the estimated coffee area of the Central Highlands was 576,200 hectares, which is considerably higher than the MARD masterplan recommendation of 430,000 hectares (Trinh et al. 2013; Phuong et al. 2012). The coffee area of Dak Nong similarly continues to expand, as illustrated in table 1, below. The average area of land given over to cultivation of Robusta in smallholder households in Dak Nong is around 1 hectare, and coffee farm sizes range from a minimum of 0.2 hectares to a maximum of 5 hectares. Around 20 per cent of households have small plots (0.2-0.5 hectares) of coffee land, while around 10 per cent have relatively large areas (more than 3 hectares) (3EM 2014). Various studies (Marsh 2007; World Bank 2011; 3EM 2014; USDA 2014) have found that land accumulation is increasing in the Central Highlands, including in Dak Nong, where the number of both larger and smaller plots is increasing. The better-off are often able to invest large parts of their coffee profits and savings in new land purchases, while the poor often have to sell their registered farming lands to finance consumption and production needs. To continue coffee farming, the poor often have to cut down forest areas and develop new coffee plots. The expansion of coffee areas, therefore, is due not only to converting land from other agricultural crops to coffee, but also to forest land encroachment (Phuong et al. 2014). Year Total Dak Nong Per average household Area (ha) Yield (ton) Average area (ha/hh) Range of area (min-max ha/hh) Average productivity (ton/ha) Range of productivity (min-max ton/ha) 2011 91 081 179 658 0.91 0.3-3.0 2.1 1.2-3.5 2012 115 327 204 587 1.09 0.2-3.0 2.0 1.0-3.0 2013 117 357 220 380 1.06 0.3-5.0 2.5 1.2-3.5 2014 118 832 238 897 0.90 0.3-5.0 2.5 1.2-3.5 Statistics: 3EM 7/2015. Table: authors. hh = household. 12

The practice of poor households selling their farming lands and clearing new, unregistered areas for coffee production has resulted in severe forest destruction in Dak Nong over the years. The provincial government has tried to stop this practice through various policies and remedial actions, including forest investigation and demarcation, and the conversion of illegal coffee production lands back to forest plantation. The province has been able to bring large-scale illegal forest land conversion to a halt, but it is a more complex task to return converted areas to a forested state. The government has recognized that most of these areas are held and cultivated by poor farmers and ethnic minorities, who have no alternative income resources beyond coffee farming on illegal land. These areas, therefore, continue to be used for coffee farming without formal recognition by the government. Farmers are allowed to continue de facto, but have no Red Book (Land Use Right Certificate). Without Red Books, farmers face critical restrictions on their access to formal financial services and government support programmes. As described above, coffee is a crop with high revenue potential, but only when using intensive farming methods and high input investments. Poor farmers in Dak Nong find it difficult to save or borrow the required input investments for intensive coffee production. The overall productivity and quality of coffee beans by the poor is therefore low, even given the small areas of coffee land they have access to. Poor households productivity is down to a minimum of 1.2 tons/ha of coffee beans, while better-off households productivity reaches 3.5 tons/ha (and in some rare cases even 5 tons/ha). Poor coffee smallholders invest an annual average of US$750-$900/ha for key inputs, 2 including fertilizer, pesticide and fuel for irrigation. The equivalent investment by better-off households is around US$1,600-$1,800/ha. The difference is largely accounted for by the use of fertilizer. The end product of the Dak Nong coffee farmers is either cherry (fresh coffee fruit) or bean (processed/dried coffee bean). By selling fresh cherries, without processing and drying at the farm, farmers lose around 30-50 per cent of total potential revenue. 3 However, roughly 10 per cent of Dak Nong households (mostly poor) must do this because of a shortage of household labour, insufficient finances to hire labour or to buy or rent pulping machines, and risk of theft, as described below. 4 The percentage of farmers selling fresh cherries is in gradual decline, as households are aware of the pre-processing income opportunity and therefore try to acquire the necessary resources (labour time, cash loans) for pre-processing. The work required by households includes picking cherries, removing the skin by pulping machine and drying the beans under the sun. The non-processed fresh cherries are worth only US$0.2-0.3/kg, compared with a coffee bean average price of US$1.8/kg during the 2014-2015 season (around 4 kg of cherries produce 1 kg of processed beans). Incremental input investment by better-off households significantly increases revenues and profitability. The poorest coffee households can produce annual revenues of only around US$900/ha, while better-off farmers revenue stream can reach around US$6,400/ha. Gross profit (revenues minus annual key input costs, excluding household labour) of poor households ranges between US$450 and US$1,800/ha, while that of better-off households can range from US$2,700 to US$4,500/ha. The difference is dramatic, making if difficult for the poor to keep up with improvements in production technologies, and even to maintain their coffee fields with ageing trees. 2. Exchange rate: US$1=VND22,000. 3. Price for cherry coffee ranges from US$0.2 to US$0.3/kg (4-4.5 kg cherries produce 1 kg processed bean). Price depends on coffee quality (ripeness and size of fruit). 4. Estimates obtained during field visits, supplemented by interviews with farmers and traders. 13

Rural Finance and Coffee Smallholders in Viet Nam Case Study in Dak Nong Province Small-scale coffee traders Compared with agricultural producers in other regions of Viet Nam, coffee farmers in the Central Highlands, including in Dak Nong, have easy access to commodity markets. A wide range of coffee traders are located in Dak Nong province, and farmers are free to select their preferred business partners, usually on the criteria of price, reputation and distance. Traders include informal traders, registered business households and small enterprises. The traders are present in most villages, communes, district towns and the provincial capital. The distance from farm gate to the nearest trader is usually less than 2 km. The price is negotiated individually before a transaction takes place. Large numbers of traders and a well-functioning price information system (traders and farmers are updated daily via various media) guarantee the functioning of a coffee price mechanism, whereby local prices follow international exchange rates. Figure 7 provides an overview and the following paragraphs describe Dak Nong coffee trading. Interviews conducted in Dak Nong revealed that nearly all traders are coffee farmers who have accumulated savings and entered the business of trading in coffee. In the usual case, a coffee-producing smallholder sells his or her harvest to a local trader, either at the commune or at the district level. Local traders typically handle 300-1,000 tons of coffee annually, which is equivalent to the total production of 200-600 smallholders. The traders usually focus their activity in one or two communes, in the area where their own coffee farms are located. In these farming communities, the traders have established their networks and reputation, and it is on this basis that farmers choose whether or not to enter into business with them. Traders usually organize the transportation of coffee from the farm gate, and purchase either fresh cherries (sometimes still on-tree) or pre-processed coffee beans, directly on site. Payments take place immediately. Coffee farmers in Dak Nong do not have to wait for payments. Figure 7 Smallholders coffee products and their market channels in Dak Nong. Coffee cherry 10% of farmers Normal coffee bean 86% of farmers 4C coffee 2-3% of farmers Fair Trade/wet processed coffee <1% of farmers Local traders/agents/ input suppliers Local traders/ enterprises 4C registered local traders/ enterprises Dak Man Coffee Company in Buon Ma Thuot city, Dak Lak Trade of coffee Trade of coffee and farm input materials 14

In turn, local small-scale traders find the best price offer from among the larger coffee agents in Dak Nong or in neighbouring provinces. These are usually registered business households or small- and medium-sized enterprises (SMEs) specializing in coffee trading. Prices follow the market mechanism and traders negotiate each transaction separately, tracking market price fluctuations. In Dak Nong, the average margin between the farm gate price and the price at large-scale traders is around 1.4 cents/kg, which includes transport costs of around 0.45 cents/kg. To increase profitability, traders sometimes hold the coffee in stock to wait for the price peak some months after the harvest period, as previously described. This has been a common practice in previous years, but in 2015 the volume of stock stored locally fell because the price was unusually volatile, thus increasing the risk of such a strategy. In response to increasing global demand for high-quality and ecologically produced coffee, various coffee companies and associations are now entering into trading ecological and/or fair profit coffee products. Various certification mechanisms have emerged in the markets, among which the most popular in Viet Nam are 4C, UTZ, Rainforest and Fair Trade. Coffee farmers and traders get higher prices for their products by adopting these certifications. In Dak Nong, around 2-3 per cent of coffee farmers have learned how to follow 4C certification requirements (trained by Nestlé or another 4C company), and there are also some traders specializing in 4C coffee. The price of 4C coffee is currently around 1.4 cents/kg above market prices, representing an average revenue increase of US$34/ha. However, some 4C requirements and conditions limit implementation of the certification mechanism: (i) the related procedures and paperwork are reportedly too complicated; (ii) transactions must take place via officially registered traders, and with a minimum volume of 500 tons of 4C coffee; (iii) official invoices must be provided and transactions are subsequently taxed; and, especially, (iv) market demand has been volatile in the province. Consequently, although in the long term certification mechanisms show high potential for all stakeholders, many traders and farmers currently consider the advantage insufficient and have for the time being discontinued their participation in these schemes. In the Dak Min district of Dak Nong, a smaller-scale initiative by Fair Trade coffee has been more successful. The Thuan An Cooperative, with 112 farmers, is certified for Fair Trade coffee production and trade, allowing stable market access to a dedicated Fair Trade company with advantageous pricing, including a premium of US$410 for the cooperative for each traded ton of coffee. By Fair Trade regulation, 20 per cent of the premium is to be used for environmental protection and 25 per cent for social support of poor families. In addition, this cooperative has introduced the wet processing mechanism previously described. Box 1 describes wet processing in Dak Min. An average coffee farm invests US$900-$1,800 annually in fertilizers and pesticides, so the total market volume of coffee input material trade in Dak Nong is in the region of US$140 million, creating a significant business opportunity in this rural province. Most of the local traders trade in both coffee products and farm input materials. Typically, a trader sells the input materials to a farmer household during the growing period, and then buys the farm s produced coffee at the end of the season. The ranges of input material sales volumes from local traders are US$130,000-US$900,000 for fertilizers and US$23,000-US$230,000 for pesticides. The margin extracted by traders is around 2 per cent, and trading revenues range from US$3,000 to a maximum of US$23,000. Most traders offer to transport input materials to the farm gate; if significant costs occur, however, these are added to the price. 15

Rural Finance and Coffee Smallholders in Viet Nam Case Study in Dak Nong Province Box 1. Best practice excursion: Dak Nong coffee wet processing The Thuan An Cooperative in the Dak Min district of Dak Nong, comprising 112 farm households with a total coffee area of 198 hectares, is engaged in wet processing of coffee cherries. Wet processing uses water flow as the primary means of extracting the coffee seed. The wet processing cooperative was established in 2012, with the aim of increasing the trading value of coffee through the introduced technology. Initial investment was supported by Irish Aid through provision of medium-scale wet processing machinery. In 2015, the cooperative produced 350 tons of wet processed coffee beans, and sold these to Dak Man Coffee Company in Buon Ma Thuot (Dak Lak province). Under the current agreement, the price of wet processed coffee is 27 cents/kg higher than that of unprocessed coffee. Interviews with the cooperative leaders suggest that wet processing costs are 4-9 cents/kg, mainly for water, electricity, petrol and labour. Transport and loading costs are covered by the buyer company. Through wet processing and sales to Dak Man Coffee Company, therefore, farmers secure incremental profits of 18-23 US cents per kilogram of coffee beans. According to the cooperative leaders, and confirmed by a recent international value chain report (Kristensen 2015), demand for wet processed beans is currently unlimited because of significantly improved quality. In most cases, local traders buy agricultural input materials from either first- or second-tier agents that have a connection to the material producer companies or importers. Among the fertilizer and pesticide producer companies, An Giang, Phu My and Binh Dien have good reputations and experience high demand, as a result of which their prices are increasing. Lower-price and lower-quality products, including cheap import ware, are entering the markets and have a negative impact on both productivity and the environment. On the other hand, 4C and other certification mechanisms have increased demand for nature-preserving and high-productivity fertilizers. To be able to purchase input materials directly from the producer companies, and thus save costs, traders need to register their business so that they can issue invoices. By registering, the traders can also directly sell coffee products to large-scale buyer companies, including those with quality certification mechanisms in place, offering higher prices. In Dak Nong, it is estimated that there are 400-600 active traders to cover the overall trading volume created by 110,000 Dak Nong coffee smallholders, but only a small number of these are registered business households or enterprises. Trading units are typically households or families, with one to four family members usually managing the business and additional labourers being hired for loading and transport. There are only small costs associated with the warehouse and shop, as these are often an integral part of the household residence. In most cases, if the traders have not registered their economic activity, there are no additional registration fees or tax payments. The overall costs are therefore low, and such small business can be profitable even when margins are under pressure from stiff competition. For many traders, registration would lead to lower profitability in the short term. From the perspective of the province s economic development, a higher rate of registration would increase public tax revenues, increase use of certification mechanisms, increase access to formal credit, increase management capacities and improve government oversight of sector development. The Dak Nong Department of Planning and Investment has a programme to support enterprise registration in the province, but its budget and scope of activity is limited to quarterly dialogue events. 16

Financing of coffee smallholders in Dak Nong As discussed above, Dak Nong smallholders use an annual production investment of US$450-US$1,800 for 1 hectare of Robusta coffee, generating revenue streams of US$900-US$6,400. With higher-intensity investment, revenue streams from a given coffee field increase significantly. For every additional US$4 invested, it is estimated that revenue increases by around 4 US dollars. The more intensive coffee farms are significantly more profitable. Figure 8 illustrates this situation. To produce coffee and to increase its profitability, farmers need financing for their input investments. This section of the study discusses the various financing sources available to farmers. Figure 9 summarizes the three categories of coffee production financiers, including formal, semi-formal and informal. Figure 8 Rough estimation of coffee investment, revenues and profitability, VND million/ha. 160 140 120 VND million 100 80 60 40 20 0 Investment Revenue Data and graph: authors. Figure 9 Coffee farmer access to finance in Dak Nong. Formal financing Semi-formal financing Informal financing VBARD WEOF Local traders VBSP BIDV Lien Viet Adapted from Tam 2011; Hurri et al. 2015 17

Rural Finance and Coffee Smallholders in Viet Nam Case Study in Dak Nong Province Formal and semi-formal financing Among the formal financial institutions, the Vietnam Bank for Agricultural and Rural Development (VBARD) is the largest credit provider for farmers and agricultural enterprises nationwide (Tam 2011). It accounts for 56 per cent of the rural financial markets in Viet Nam (Tam 2011), and in Dak Nong province the bank s total market share is around 47 per cent (3EM, 2015). VBARD is a commercial bank, with around 60 per cent of its capital owned by the government. In addition to profit-oriented banking business, VBARD also has a development function within Viet Nam. It implements the State Bank s nationwide policies for rural development, including Decision 2213/ QD-TTg (2009) and Decree 41/ND-CP (2010) for preferential rural credit conditions (7 per cent per year on a loan of up to US$2,300, compared with commercial rates of 10 per cent). VBARD also coordinates a coffee rejuvenation programme in the Central Highlands, providing households replanting coffee with free coffee seedlings and loans with the same preferential conditions as Decree 41 mentioned above. Table 2 lists the overall number of VBARD Dak Nong clients in the coffee sector, as of 30 June 2015. In Dak Nong, VBARD has approximately US$200 million of outstanding loans. Around US$80 million of the portfolio is for households and enterprises engaged in coffee production, constituting VBARD s largest sector of investment in Dak Nong. As indicated in table 2, most of the coffee sector clients are households or individuals. These client farmers usually borrow the loan amount for a period of 12 months, and have access to the preferential 7 per cent annual interest rate. In Dak Nong, virtually all farmers know about VBARD because of its dynamic communications and wide networks. However, a large proportion of farmers are unable to access VBARD loans because of the collateral and procedural requirements. This is the case in most of Viet Nam s provinces (Tam 2011). Table 2 VBARD loan portfolio for coffee sector (30 June 2015). Category Coffee trading/ processing Coffee planting Total coffee sector Households and individuals Loan amount (US$) Number of clients 8 001 000 304 67 491 818 10 717 75 492 818 11 021 Limited company Loan amount (US$) Number of clients 4 522 773 92 - - 4 522 773 92 Private enterprise Loan amount (US$) Number of clients 882 591 16 - - 882 591 16 Total loans Loan amount (US$) Number of clients 13 406 364 412 67 491 818 10 717 80 898 182 11 129 Non-performing loan (NPL) Loan amount (US$) 1 372 818 NPL rate in coffee loans NPL/total loan amount 1.7% Data: VBARD. 18

As is normal practice in all commercial banks in Viet Nam, households need to submit Red Books as collateral before a loan request is approved. Coffee farmers in possession of a Red Book normally have access to loans of up to US$2,300 per hectare of coffee land, and in the case of land rejuvenation the normal maximum loan size is U$6,800/ha. This is also the case at VBARD, although its implementation of rural credit Decree 41 allows farmers without collateral to borrow up to US$2,300 at a preferential interest rate (7 per cent per year). In practice, although collateral is not officially required under this ongoing policy programme, the bank reportedly still requires a Red Book as a security for the loan. As noted above, many Dak Nong coffee farmers still have no Red Book certificates for their farmland, especially when this is considered encroached forest land where coffee farming is not officially sanctioned. This restricts access to formal finance, especially for poor households. Currently, VBARD has about 11,000 loan customers, which represents less than 10 per cent of the total households involved in coffee production in Dak Nong. Given VBARD s report, noted above, that the bank s total share of the province s rural capital markets is 47 per cent, it is estimated that less than 20 per cent of Dak Nong farmers have access to commercial bank loans. Another major financial institution in Dak Nong is the Vietnam Bank for Social Policies (VBSP). This bank is a state-owned, non-commercial and non-profit entity, with a focus on subsidized social policy lending to poor households and disadvantaged groups. Poor and near-poor farmers can borrow up to US$1,400 from this bank, for a loan period of up to three years, at a monthly interest rate of 0.65 per cent, and without collateral. The services of this bank reach around 98 per cent of poor households and disadvantaged groups in Viet Nam (Tam 2011). Interviews suggest that, because of easy access to these loans, farmers in Dak Nong appreciate VBSP procedural practices. However, poor households are no longer able to access VBSP loans for intensified investment in coffee production because most households that have received such loans in the past have spent them on consumption or on the initial costs of agricultural production, and not yet returned the principal to VBSP. Furthermore, the overall effectiveness of VBSP is questionable and the subsidy programme imposes a heavy fiscal burden on the government (Tam 2011; World Bank 2014). Easy loan procedures, without proper support or review of households investment plans, lead to a high level of risk credit (Cuong et al. 2007; Tam 2011). Another state-owned commercial bank in Dak Nong is the Bank for Investment and Development (BIDV). This bank is also active in lending to coffee business and production. BIDV more usually lends to enterprises than to individual households. However, in Dak Nong, 70 per cent of the bank s total loan portfolio of around US$140 million is for individual households. This is because a special BIDV policy supports farmers in the Central Highlands. The terms of this policy are similar to those of State Bank Decree 41: annual interest of 7 per cent, a maximum term of 12 months and a maximum amount of US$2,300. Loan application procedures are similar to those of VBARD, including the critical requirement for Red Book collateral referred to above. The Lien Viet Post Bank is a new but active financial service provider in Dak Nong. The bank s Dak Nong branch was established in 2014, and has a specific focus on agricultural development and, in particular, on small-scale retail banking for rural households. As of 30 June 2015, the bank had 1,474 household clients, with a total loan portfolio of US$14 million. The loans are largely used for coffee and pepper plantation. The bank offers commercial interest rates of around 9-10 per cent annually, 19

Rural Finance and Coffee Smallholders in Viet Nam Case Study in Dak Nong Province which makes them less attractive than the subsidized loans offered by state-owned banks (VBARD, VBSP and BIDV). Despite this, the bank is quickly growing its clientele in rural areas, thanks to its agricultural focus and the advantageous post office network, which is significantly wider than the networks of other banks. The Lien Viet Post Bank has purchased the savings functions of Viet Nam Post Offices at all levels, and the bank can now access rural customers through a vast network of post offices all the way down to the communes. The bank believes that it will play a significant development role in the future of Dak Nong, in expectation that the level of loan subsidy will decrease. A semi-formal financing institution has also been established in Dak Nong by the provincial Women s Union (WU). The new institution is a social fund, the Women s Economic Opportunity Fund (WEOF), and is managed and promoted by a specific management unit and by the existing WU network in districts, communes and villages. The fund lends microcredit to households through established savings and credit groups (SCG) at the village level. Group members have access to loans of up to US$1,500 for a maximum loan term of 18 months. Collateral is not required and the interest rate is 10 per cent per year. Farmers can use the credit for various agricultural purposes, including the purchase of seedlings and fertilizers, but also for non-agricultural purposes such as tuition fees or weddings. To date, around 3,000 households have accessed the fund (Ruotsi 2015). Interviews with borrowers indicate that the fund is effective for coffee farming because SCG members have easy access to fund loans, which in turn are sized appropriately for input material investment. The simple application procedures are suited to local conditions and repayment schedules can be tailored to expected household revenue streams. The fund takes advantage of the existing WU network and established women s groups to establish the required loan security, replacing traditional collateral requirements. The risk management strategy of WEOF is further explained in section 5. Informal financing: small-scale local traders Alongside formal and semi-formal financing institutions, there are a large number of informal microcredit providers in Dak Nong. These informal providers are the main source of credit for smallholders, including coffee farmers. There are two typical forms of informal microcredit in Dak Nong: (i) loans from friends and relatives; and (ii) farm investment loans by small-scale coffee and agricultural input traders. Table 3 Summary of the formal financial sector in Dak Nong. Category Portfolio size (US$) No. of household customers Interest rate (%) Collateral requirement VBARD 80 million 11 021 7-10% Strict collateral policy without exceptions, including under Decree 41 VBSP 77 million 78 000 6.5% No requirement due to social policy programme nature BIDV 140 million 4 000 7-10% Strict collateral policy without exceptions, including under Decree 41 Lien Viet Post Bank 14 million 1 474 9-10% Collateral required; business plans and reputation further secure loans WEOF 1.2 million 2 548 10% No physical collateral; women s groups and reputation secure loans Data collected from FSPs by authors 30 June 2015. 20

Field observations suggest that Dak Nong farmers in urgent need of credit for coffee production or other purposes often borrow cash from friends or relatives, whenever possible. Such loans can be provided with no interest rate in the very short term but, if the loan term is longer than a month, a standard monthly interest rate of 1.5-2 per cent is usually applied. Since coffee is the main source of income for most farmers in Dak Nong, farmers are often able to pay back these loans after the harvest season, so loan terms of around 1-12 months are usual. The most widespread informal credit mechanism is made available by small-scale agricultural traders. Virtually all coffee farmers take credit in kind from traders, in the form of fertilizers and pesticides required in the farming cycle. Small-scale agents advance fertilizers or pesticides to farmers, in the form of a loan in kind, expecting to receive payment with interest during the harvest season. Farmers need to pay a 6 per cent average increase in product price, and a monthly interest rate of around 2-3 per cent on the loan in kind. Repayment is made in cash or, as is often the case, farmers sell their product to the same trader they received the input advance from, and repayment is made in coffee stock in conjunction with sale of the harvest. Loan amounts are deducted from the sales price and the whole loan mechanism takes place without cash; such schemes can to an extent function as farming contracts between farmers and traders. Around 80 per cent of the coffee farmers interviewed reported receiving loans in kind from the same traders to whom they sell their coffee products. Poor farmer households in Dak Nong are observed to use informal credit mechanisms to finance nearly all of their input investments of US$680-US$900 per year. Subsequently, a large part of the revenue from harvest is used to pay back loans from the previous farming cycle, and any amount remaining is commonly used for consumption. New loans are therefore required to cover the input material costs from the beginning of the next farming cycle, implying loan periods of 10-12 months and interest payments of up to 45 per cent for early-season investments. The overall loan service cost for poor farmers is up to 25 per cent of the gross profit. The better-off farmer households usually take loans in kind from input traders. In contrast to poor households, however, the better-off can significantly reduce interest payments by covering the costs of early-cycle investments, using the previous harvest income. The loan in-kind mechanism is therefore applied only to mid- and end-cycle investments, which account for around US$900 of the total input investment cost of US$1,400/ha. By avoiding the longer-term loans, and taking advantage of higher productivity, the better-off can keep their loan service costs at around 4 per cent of gross profit. In comparison, the poor have lower overall revenues than the better-off, and have to pay significantly higher costs to finance their investments. In addition to loans in kind, Dak Nong small-scale traders sometimes provide cash microcredit to local households within their operation area. Normal conditions for this include monthly interest rates of around 2-3 per cent, a loan duration of 1-12 months and a loan amount of US$450-US$1,400. Loan purposes vary from household to household, but usually include both consumption expenditures and input investment for coffee production. Considering the urgent financing needs of farmer households and their limited access to formal financial institutions, it is clear that the dynamic informal financial market supports the overall development of the coffee sector in Dak Nong. In many cases, farmers production capacity and income levels have increased as a result of the 21