Call it what you will, but in smallholder finance, subsidy is here to stay. Like many nascent markets, particularly those that target bottom of the pyramid consumers, investing in global smallholder finance requires some form of subsidy to mitigate risks and create an investable opportunity. While funders and investors can leverage many different types of subsidy our new ISF Briefing Note examines the dynamics shaping one particular and important form — grant funding from international donors. In 2016, our state of the sector report Inflection Point coined the term “smart subsidy,” referring to the strategic use of private and philanthropic capital to mitigate risks in smallholder investments. Understanding the current subsidy dynamics is a first step on the path to making subsidy “smarter” going forward.

The role of grant-based subsidy in market development

In smallholder finance, subsidy – and more specifically grant-based subsidy – plays a crucial role in accelerating the development of an inclusive market. These subsidies take many forms but can generally be categorized according to two main approaches.

  1. Pre-Competitive Market Development: subsidies that are intended to create a strong enabling environment by funding public-good services that benefit many or all market participants.
  2. Advancing High-Potential Models: subsidies that aim to identify, develop, and scale individual business models and organizations that can redefine the smallholder finance impact frontier.

These two approaches are complementary to one another, and are key to developing an inclusive smallholder finance market.

Where does grant-based subsidy come from?

There are roughly 25 significant grant funders that currently support global smallholder finance market development. The majority of these are foundations, though a small number of bilateral and multilateral donors also contribute substantially.  Within this group of significant donors, there is a high level of diversity in grant-based activities; as each donor’s grants are driven by their own highly individualized agendas. These agendas vary widely with regards to specific geographies, financial business models, and types of funding recipients they support. It is these individual agendas which also determine whether a donor funds Pre-Competitive Market Development, Advancing High-Potential Models, or a mix of the two subsidy approaches. For a list of donors included in the analysis, and information on their individual priorities, refer to Appendix A in the full brief.

What are the different agendas that shape grant-based subsidy?

By reviewing the stated priorities and ongoing activities of the significant grant funders, we identified a series of six underlying types of agendas that determined why, when, and how donors were contributing grant funding to smallholder finance development. At one end of the spectrum, smallholder finance is the ‘primary agenda’ for the donor – making it the end goal of the donor’s grant funding. At the other end of the spectrum, smallholder finance is an ‘intersecting agenda’, where smallholder finance is either a pre-requisite for achieving another primary goal or represents a sub-section of a broader goal. While each donor is unique, these six agendas encapsulate the major collective interests of the significant grant donors shaping the development of the smallholder finance market.

Getting the most of scarce grant resources

Grant-based funding plays a critical role in the development of the smallholder finance market, but relative to the scale of the global smallholder finance agenda, grant resources are scarce. This scarcity heightens the need for strategic and disciplined use of these funds. Looking ahead, we believe the global community can get more value from these grants through the following activities:

  • Donors can increase coordination, cross-learning and shared initiatives. With each funder pursuing an individual agenda, there needs to be more active conversation about what is being learned, what is still needed and where collaborative investments can achieve more than the sum of individual actions.
  • Grants can be structured to reduce transaction costs and re-focus efforts toward long-term, strategic market building activities. Donors need to be aware of the costs associated with administrating and managing their contributions, shifting strategies and narrow special interests. Actively working to reduce these burdens on grant recipients, by establishing transparent long-term strategies and seeking to streamline reporting requirements, will ultimately allow donors to make more progress toward achieving their underlying agendas.
  • Donors can further support market development by actively linking short-term catalytic subsidy to long-term subsidy and investment.  Grants are important to catalyze market development but will not be sufficient to meet the long-term subsidy needs of the market. To account for this, donors need to be proactively planning and facilitating grantees’ access to other sources of private capital and long-term government subsidies.

Getting smarter on subsidy

We are aware that this briefing note raises complex questions related to subsidy and how to optimize the role of donors over the short and long terms – effectively, the “smart subsidy” aspiration. In following research, we intend to continue to delve into these issues, believing that transparency, innovation, and engaged conversation is the path forward toward closing the global smallholder finance gap.

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