- Coffee farmers must manage maintenance and operational costs with limited liquidity
- Producers face challenges in accessing affordable financing due to a lack of roaster pre-payment plans and increasing interest rates
- In some coffee-producing countries, interest rates for agroindustrial loans can exceed 30% per annum
THE EXPECTATION for coffee farmers to scale up production is greater than ever. Global consumption continues to rise, and a growing audience for specialty coffee demands innovation at farm level. For most of the world’s producers, however, the finance required to meet these expectations is out of reach.
Farmers must have sufficient funds to sustain production and their livelihoods between harvests. In general, coffee is harvested once a year – meaning that farmers get paid once a year. Between these payments, farmers must deal with significant production costs such as pruning, picking, gasoline, fertilisers, storage and more.
As farmers struggle to manage these daily costs with limited liquidity, “they forgo vital but costly farm maintenance activities, resulting in diminished quality and yields, with some farmers even transitioning out of coffee altogether”, according to ITC’s Coffee Guide.
Aside from operational and maintenance costs, there are other expenses to factor in. For instance, farmers new to coffee production face significant upfront costs such as land acquisition and infrastructure investment.
Long-term investment is also a crucial aspect of running a successful operation. This involves essential tasks such as building or upgrading facilities, purchasing new equipment, and technical training. For most coffee farmers, however, keeping up with basic production costs is already a significant challenge, and allocating resources for long-term investments is wishful thinking.
At the end of the year, coffee producers often find themselves confronted with low prices and substantial losses when it’s time for the annual harvest. And because of the lack of available financing, it is the producers that have to bear all the risk.
The timing of capital is everything
When exporters buy coffee, they often provide farmers with an initial payment and then pay the rest later. This structure effectively obliges the farmer to follow through on the contract. Yet, farmers are already fighting a liquidity trap – they are not in a position to negotiate terms. Coffee producers – especially smallholders – are generally recognised as “price takers”.
“Coffee farmers have negative cash flow during at least 11 months of the year,” says Raphael Studer, CEO of Algrano. “Their need for liquidity is being exploited. In my opinion, fair and sustainable business practices cannot be based on the weaknesses of an actor.”
Without pre-financing options, coffee producers are at risk of accumulating debt. They also struggle to reinvest into their farms, meaning they may face lower crop yields and quality.
However, these arrangements are uncommon for valid reasons. In a volatile market, with no guarantees and limited access to finance, coffee farmers can easily default on contracts to secure higher prices in line with market movements. This is known as “strategic defaulting”.
“Pre-financing is not common due to the fluctuation in coffee prices,” says Adriana María Quiceno Aguirre, business development manager for Latin America at RTS International. “Even with premium coffee, there is a possibility of defaulting on the final customer.”
According to Adriana, coffee associations in many Latin American countries attempted to use futures contracts as a means to secure better prices for their crops. However, some producers ultimately sold their crop to the highest bidder, regardless of existing commitments – a market failure rooted in a simultaneous lack of liquidity and persistently low prices.
If payments are timed more effectively, this could boost productivity and quality while fostering trust and sharing value more equitably across the supply chain. Raphael says this model benefits all stakeholders and requires minimal investment.
“Access to cheap working capital makes producers earn more,” he says. “Interest rates can go above 30% per annum in certain countries. A roaster paying just six months earlier can help the producer earn an additional 15% without having to pay more. This corresponds roughly to two monthly salaries!”
As such, one of the most important elements for coffee producers is cash flow. The fallacy of the industry is that the solution lies primarily in paying producers more money. In fact, the timing of payments may prove to be more significant.
Access to finance is becoming increasingly hard
Coffee is undeniably a risky business, characterised by volatile prices and the effects of unpredictable and extreme weather events. These factors create an inherent level of uncertainty that makes the coffee sector a challenging one to invest in with confidence.
“With increasing interest rates, there are many financially attractive alternatives to financing commodities,” says Raphael. “Lenders are shrinking their trade finance exposures and focusing on a few big trading houses with large lines.”
Financing coffee production is deemed particularly high-risk, and banks often demand a higher level of return. However, since it is unlikely that roasters will provide pre-financing, many producers are left with limited options. As many smallholder farmers have few assets and a high-risk status as far as lenders are concerned, accessing affordable credit is a challenge.
Moreover, global inflation has led to a rise in interest rates, making credit even more expensive for producers. This has brought the situation to a boiling point in some regions, with some smallholders unable to sustain production and pickers reportedly leaving farms.
One way to create more accessible finance for producers is to help derisk them. “We invest a lot in derisking coffee producers, starting with a transparent chain that enables roasters and farmers to form direct relationships of trust,” says Raphael. “We also provide transactional data to prove the creditworthiness of a coffee farmer.”
He suggests that in recent years, the issue of negative cash flow has become prominent in discussions between buyers and producers, resulting in a growing number of roasters making prepayment arrangements.
Meanwhile, Nestlé is piloting a scheme which rewards farmers with upfront cash, provided their crop is grown sustainably. This forms part of the company’s pledge to spend $1 billion by 2030 on its sustainable coffee sourcing strategy, which includes improving farmer income.
While securing better prices for coffee farmers remains an ongoing goal, more attention could be given to challenging traditional trade and payment terms to address the liquidity problems faced by producers. Improving their access to finance has the potential to foster a virtuous cycle of trust, investment, and greater productivity. At the same time, doing nothing to address the problem could be devastating for farmers, and coffee production in general.
