Replanting Challenges for Oil Palm Smallholders

Creating Access to Long Term Finance at Scale

Picture source: WWF – James Morgan Page 1

The Oil Palm Sector in Indonesia – Quick Facts

Indonesia is the largest palm oil producing …independent smallholder farmers account for
country… 42% of production
Top 5 Palm Oil Producing Countries ('000 Mt) Smallholders Companies State-owned Enterprises

Indonesia 35,000
Malaysia 21,000 42%
Thailand 2,300 51%
Columbia 1280
Nigeria 970 7%

Source: Index Mundi, 2016 Estimates Source: Daemeter, 2015

Deforestation linked to palm oil expansion … while replanting finance is a large investment
threatens Indonesia’s tropical forests… opportunity

✓ Low yields for smallholder farmers, producing 45% ✓ Urgent: In the next 25 years (2017- 2041) every year
less compared with plantation companies approx. 175,000 hectares of oil palm needs to be
✓ Lack of access to credit, especially investment replanted
capital for replanting, often leaving smallholders ✓ Significant Financing Needs: With an estimated
little choice but to expand into neighboring forests replanting cost/Ha of USD 4000, the investment
due to overaged plantations opportunity is USD 700 Million per annum

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Access to Finance – Challenges

✓ Diverse population and geographically scattered in areas underserved by banks

✓ Small individual loan sizes
Farmers
✓ Lack of hard loan collateral available
✓ Insufficient savings capacity

✓ Lack capability and willingness to engage in lending to micro enterprises and

smallholders
Financial ✓ High operational costs to service smallholders and unattractive risk/reward
Sector
equation
✓ Lack of quality financial info and inconsistent data lead to uninformed credit
decisions

✓ Land legality issues and need for land rights formalization

✓ Lack of adequate infrastructure impedes smallholders’ access to markets
Public ✓ Lack of enabling environment and insufficient government support (insurance,
Sector
loan subsidies, credit guarantee schemes)
✓ Weak enforcement of oil palm zero expansion laws

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Replanting – A Farmer’s Perspective

Annual Yield Profile for 20-year Old Trees and Full Replanting
Besides the impeding factors related to
40.00
financing…
30.00
✓ Current outstanding debts;

Yield (tons)
20.00
✓ Issues related to collateral and land certificates
(pledged already/ partly, or on name of previous 10.00

owner) 0.00
0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32
..farmers may be reluctant to replant due to: Year
Yearly FFB Tons (without Replant) Yearly FFB Tons (with Replant)

✓ Short-term horizon bias as they forego 5 years of Source: Financial Access based on data from Azman I. and Mohd N. M. (2002)

income
Cumulative Yield Profile for 20-year Old Trees and Full Replanting
✓ Lack of alternative income streams;
1,000.00
✓ Risk-averse mentality of farmers;

cumulative yield (Tons)

800.00
✓ Lack of replanting knowledge and skills of farmers;
600.00
400.00
200.00
Research shows that replanting 0.00
0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32
decision should be made latest when
Year
trees reach age 27 Cumulative FFB Tons (without Replant) Cumulative FFB Tons (with Replant)
Source: Financial Access based on data from Azman I. and Mohd N. M. (2002)

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 Replanting – A Farmer’s Perspective (II)

Comparison low and high quality seeds

Replanting with better quality seeds
Low-quality Seeds
60 combined with tailored GAP training can
Tons

50
High-quality Seeds
and GAP
lead to up to 40% yield increase…
40 Up to 40%
increase ✓ Higher volume and possibly higher quality, increasing
30
smallholder profitability
20
✓ Alternative income-generating activities to face cash
10
shortages during the initial 3–4 years after replanting
-
1 4 7 10 13 16 19 22 25 28 31

Source: Financial Access

…and as CPO price and demand are
CPO price and demand estimation
$1,000 100 expected to grow further, farmers will

Millions MT
$800 80 have the capacity to repay replanting
$600 60 loans while improving their livelihood.
$400 40
✓ Average loan tenor is 13 years
$200 20
✓ Grace period of 5 years to mitigate replanting-
$- 0
2014 2015 2016 2017 2018F 2019F 2020F 2021F production gap with possibility to include cost of
living stipend to compensate foregone income
Global Demand (MT) Total Indonesian Consumption (MT) $/MT

Source: World Bank, Oct 2017 and DBS CPO Forecast, 2017

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Innovative Smallholder Finance Approach

An integrated end-to-end approach from origination to M&E

Preliminary Data Credit Risk Execution & Monitoring &

Sourcing
Screening Collection Reports Structuring Evaluation

Environmental & Farmer Identification Data Analytics & Portfolio Credit Risk
Supply Chain Analysis & Data Collection Credit Scoring Development Monitoring

✓ Selected farmers are

structured into a
✓ Landscape analysis ✓ Identification of
borrower portfolio
to determine area eligible supply shed
centred around off- ✓ Periodic risk review
eligibility including and socialization with ✓ Descriptive statistics
takers or and credit score
biophysical and farmers on target farmer
cooperative/farmer renewal
environmental risks sample and analysis
groups
posed by farmers in ✓ Survey of risk distribution
✓ Remote sensing
certain crops or administration
✓ Portion of credit risk including
geographical areas through enumerators ✓ Development of
will be moved down deforestation/
individual cashflow-
the value chain, onto environmental
✓ Supply chain ✓ Validation of based risk profile
larger, more compliance
analysis and collected data and
financially sound
mapping data cleaning
organizations

Technical Assistance
✓ MFI Capacity Building and Smallholder Graduation Approach

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Partnership Models
Characteristics Guaranteed Partnership Lending
Partnership Arrangements • Adapt the classic plasma model to be more
attractive to non-plasma smallholders and
previous plasma small-holders
• Technical training and assistance to the KUD
and farmer groups
• Post-replanting labor provided by farmers,
and in some cases supervised by the
company
Types of Participants Indonesian domestic banks with:
• A stable, relatively low-cost rupiah deposit
base,
• Significant branch footprint,
• And added incentive: Shareholders support
of the Government’s replanting objectives.
Key Limitation Continued dependence on the corporate
guarantee
Distributed Risk Partnership Lending
• Requires willingness to bear credit risk,
particularly in the pre-production stages.
Participants could include:
• Foreign banks lacking a strong local funding
base,
• Development banks,
• Credit guarantee providers,
• Other financial funds/institutions willing to
offer guarantee facilities or other products
allowing them to bear more of the risk
burden.
Need for a corporate guarantee under most
examples to date drastically limits its
applicability.
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Alternative Financing Structure

The replanting loan can be tailored to reflect

the cash flow capacity of the farmers during
and after replanting:
✓ Replanting phase: high risk; characterized by a
production and cash flow gap between replantation
and first production.
✓ Production phase: lower risk after successful
Production Gap
replanting; farmers will progressively increase
production and generate cash as new trees mature.

Year 0-4 After Year 4

Currency IDR (preferred) IDR (preferred)
Tenor 4 years (WAL 4 years) 8-10 years (WAL 4/5 years)
Interest Rate 12% (targeted) 16%
Interest Payment Monthly Monthly
Disbursement Phased in first 2 years None
Repayment Schedule Grace Period Declining
Guarantee Provided by off-taker Provided by off-taker
Risk Medium/High Low
Farmers’ Ability to Repay Low/Medium High
Development Institutions/ Impact Commercial Banks/ Institutional
Potential Investors
Investors Investors

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Recommendations

1. The investment case for farmer replanting needs to be more attractive. Low average

production levels due to low quality planting material;

2. Continue to explore and develop efficient, integrated “strategic” subsidies;

3. Continued development of company-farmer partnership models;

4. Conduct pilot testing on “Model 2” finance and more detailed design with piloting on

the “Model 3” approach;

5. Explore efficient smaller-scale (lower cost and requiring less than 300 ha) replanting

solutions.

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More Information

“Innovative Replanting Financing

Models for Oil Palm Smallholder
Farmers in Indonesia - Potential for
upscaling, improving livelihoods and
supporting deforestation-free supply
chains”
“Current practices and innovations in
smallholder palm oil finance in
Indonesia and Malaysia: Long-term
financing solutions to promote
sustainable supply chains”

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Contact
Financial Access Head Office Financial Access Jakarta
Emmaplein 2 Jl. Kemang timur Raya No.66
1075 AW Amsterdam Jakarta Selatan 12730
The Netherlands Indonesia

Eelko Bronkhorst Edoardo Cavallo

Partner, Financial Access Adviser, Impact Investment Solutions, Financial
T: +31 6 4324 57 71 Access
E: eelko.bronkhorst@financialxs.com T: +62 812 88 5396 95
E: edoardo.cavallo@financialxs.com
Imelde Adjaffon
Senior Analyst, Impact Investment Solutions, Financial
Access
T: +31 6 26 483 742
E: imelde.adjaffon@financialxs.com

www.financialxs.com
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