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Financial Challenges and Proposals for Sustainable Production in Brazil

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Published: December, 2018

Summary and Proposals

In Brazil, the sustainability of food production is associated with modernizing farming practices and better utilizing vast areas of cleared and abandoned land. The country has a rare opportunity in which economic growth can align with the protection of natural resources.

Efforts to increase agricultural production and strengthen environmental protection have made significant achievements. Since the 1970’s, Brazil has undergone a process of agricultural modernization, intensifying production and making continuous gains in productivity. In 2004, it implemented an effective satellite monitoring system that drastically reduced deforestation rates in the Amazon. In 2012, with the approval of the new Forest Code (Lei de Proteção de Vegetação Nativa nº 12.651/2012), Brazil made headway in its ability increase the protection of its natural resources, especially in private lands. The new Forest Code not only complements the satellite monitoring system in strengthening conservation, but it also has the potential to catalyze agricultural advances, establishing a ceiling for area expansion and prioritizing productivity gains.

While Brazil’s historical trends are moving in the right direction, key questions remain. How can this process be accelerated? What is the role of public policy? How can existing financial instruments in Brazil be reformed to align a production and protection agenda? Climate Policy Initiative (CPI/PUC-Rio) has identified three directives for policy alignment that will make important headway in reforming rural credit and creating stronger incentives for environmental conservation.

First, the process of intensifying production, especially converting pastures to crops, substantially changes the risk profile of economic activity. Producers who operate with a greater degree of intensification need to manage risks more accurately, either because the capital needed for investments requires a favorable balance between risk and return, or even because the activity is more susceptible to climatic risks or pests. For example, extensive livestock farming is much more resistant to weather shocks than crops. In this direction, agricultural policy in the United States suggests that Brazil needs to review the financial instruments of the sector, opening space for growing participation of risk management tools (prices, climate, and pests).

Second, the implementation of the new Forest Code, which offers a unique opportunity to consolidate food production sustainability in Brazil, faces important challenges that require significant effort and resources. The European Union’s Common Agricultural Policy provides a model for why better alignment between the rural credit policy and the Forest Code is necessary. On the one hand, rural credit resources can substantially contribute to the implementation of the Forest Code. On the other hand, the code contains an element of provision of public good (environmental conservation) that would justify targeting public subsidies, an even more important issue in Brazil’s current context of fiscal crisis.

Third, the overall design of the rural credit system needs to be improved. On the one hand, the complex and tangled web of multiple resources and programs makes the operation of the system very costly. In addition, agricultural plans are annual, which adds volatility and uncertainty. These elements of the system end up generating artificial variations in the availability of resources that are not associated with the productive potential or needs of the sector and making it more susceptible to political interference. On the other hand, rural credit distribution channels are heavily focused on the public sector, with predominant participation of Banco do Brasil, Banco da Amazônia and Banco do Nordeste at the municipal level. Promoting greater participation of private banks could increase the efficiency of the system and release public resources to other areas.

These three directives point to an agenda that would reframe financial instruments for the agricultural sector.

Short-term Proposal:

  • Expand credit limits for producers in compliance with the new Forest Code. Verification of compliance is the responsibility of the State Secretariats of Environment, which shall issue a document of conformity.

This proposal has the merit of promoting a greater alignment between the Forest Code and rural credit without creating great ruptures in the availability of resources to the sector since it does not increase the total amount of funding for rural credit; rather it only alters limits for loans based on compliance. In addition, it creates incentives for states to advance in the implementation of the code, even with the definition of parameters still pending.

Medium-term Proposals:

  • Expand the rural credit-planning horizon to three or five years. Plans with longer horizons improve the predictability of resources.
  • Simplify programs and lines, reducing the cost of managing the system.
  • Reduce excessive restrictions on resource use, which stiffen producers’ decisions.
  • Implement rules that promote incentives for efficient resource use.
  • Increase transparency and reduce political interference in favor of specific groups.
  • Promote competition with increased participation of private banks. An expansion of private sector participation can generate innovations in the rural financial sector. Initially, private banks can still rely on sources of funds that are currently exclusive to public banks.

These measures make policy more predictable and prepare the market for the reduction of public sector participation. It is important that there are no breaks in the process of simplifying programs and lines.

Long-term Proposals:

  • Develop financial instruments that are more suitable for the needs of the sector, such as insurance and financial derivatives.
  • Strictly align subsidies with the provision of public goods.

The reframing of financial instruments, in which public resources migrate from the credit channel to the promotion of insurance instruments and financial derivatives, should have a long-term perspective. This is because current credit instruments are significant for the sector, accounting for about 40% of the gross value of agricultural production. Thus, the process of disintermediation must be gradual. In the end, the government subsidy should be directly allocated to finance the core activity that the public sector wishes to foster. It is the most transparent and effective way of allocating public resources.