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The impact of formal finance on the rural economy of India

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  • Binswanger, Hans
  • Khandker, Shahidur

Abstract

India has systematically pursued a supply-led approach to increasing agriculturalcredit. Its objectives have been to replace moneylenders, to relieve farmers of indebtedness, and to achieve higher levels of agricultural credit, investment, and output. India's success in replacing moneylenders has been outstanding. Between 1951 and 1971 their share of rural credit appears to have dropped from more than 80 percent to 36 percent. (It may have dropped to as low as 16 percent by 1981, but that estimate is disputed). Still, institutional credit is far from reaching all farmers. Only about a quarter of cultivators borrow, and no more than 2 percent take out long-term loans. Most small farmers have little access to credit, and long-term credit goes mostly to large farmers. Overall, farm debt has probably not increased sharply in real terms, as formal credit has primarily substituted for credit from other sources. Moreover, with the rapid growth of commercial banks in the 1970s, the system mobilized more deposits than it lent in rural areas in 1981. Of course, enhanced deposit services are a useful service of the rural population, but one must ask what has been the impact of heavy rural credit and better financial services on agricultural investment, production, and rural incomes. The authors'econometric results suggest that the rapid expansion of commercial banks in rural areas has had a substantially positive effect on rural nonfarm employment and output. The availability of better banking facilities appears to have overcome one of the obstacles to locating nonfarm activities in rural areas. Expanded rural finance has had less of an effect on output and employment in agriculture than in the nonfarm sector. The effect on crop output has not been great, despite the fact that credit to agricluture has greatly increased the use of fertilizer and private investment in machines and livestock. There has been more impact on inputs than on output, so the additional capital investment has been more important in substituting for agriclutural labor than in increasing crop output. But overall, rural credit and expansion of the rural financial system have had a positive effect on rural wages. Creating nonfarm jobs has apparently added more to total employment than the substitution of capital for labor has subtracted it in agriculture. So, wages have risen even for agricultural workers, albeit modestly. The supply-led approach to agricultural credit that has been pursued for three decades has clearly benefited current borrowers and farm households formerly indebted to moneylenders. It has also spurred fertilizer use and investment in agriculture. It has been less successful in generating viable institutions - and has failed to generate agricultural employment. The policy's costs to India's government have been high as portfolio losses associated with poor repayment ultimately have to be borne by the government or one of its institutions under optimistic assumptions. The benefits of the agricultural income are at best no more than 13 percent higher than the cost to the government of the extra agricultural credit. If assumptions about the cost of supplying the credit and about repayment rates are less optimistic, the social costs - and the costs to the government of providing the credit - would have exceeded the benefits in agricultural income. The expansion of commercial banks to rural areas paid off in nonfarm growth, employment, and rural wages. The question is: Could these benefits have been achieved without imposing agricultural credit targets on the commercial banks and credit cooperatives? Or did the commercial banks expand only because they were forced to lend to agriculture? The authors could not answer these questions with the data at hand.

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Bibliographic Info

Paper provided by The World Bank in its series Policy Research Working Paper Series with number 949.

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Date of creation: 31 Aug 1992
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Handle: RePEc:wbk:wbrwps:949

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Keywords: Banks&Banking Reform; Environmental Economics&Policies; Financial Intermediation; Economic Theory&Research; Agricultural Research;

References

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  1. Haggblade, Steven & Hazell, Peter, 1989. "Agricultural technology and farm-nonfarm growth linkages," Agricultural Economics, Blackwell, vol. 3(4), pages 345-364, December.
  2. Braverman, Avishay & Guasch, J. Luis, 1989. "Rural credit in developing countries," Policy Research Working Paper Series 219, The World Bank.
  3. Khandker, Shahidur R., 1989. "Improving rural wages in India," Policy Research Working Paper Series 276, The World Bank.
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Citations

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Cited by:
  1. Bell, Clive & Rousseau, Peter L., 2001. "Post-independence India: a case of finance-led industrialization?," Journal of Development Economics, Elsevier, vol. 65(1), pages 153-175, June.
  2. Robin Burgess & Rohini Pande, 2004. "Do Rural Banks Matter? Evidence from the Indian Social Banking Experiment," The Centre for Market and Public Organisation 04/104, Department of Economics, University of Bristol, UK.
  3. James Ang, 2008. "Private Investment And Financial Sector Policies In Developing Countries," Development Research Unit Working Paper Series 07/08, Monash University, Department of Economics.
  4. Prasada Mecharla, 2002. "Determinants of Inter-District Variations in Rural Non-Farm Employment in Andhra Pradesh: A District Level Data Analysis," PRUS Working Papers 13, Poverty Research Unit at Sussex, University of Sussex.
  5. Huang, Qiuqiong & Rozelle, Scott & Howitt, Richard E. & Wang, Jinxia & Huang, Jikun, 2006. "Irrigation Water Pricing Policy in China," 2006 Annual meeting, July 23-26, Long Beach, CA 21241, American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association).
  6. Baiyegunhi, L.J.S. & Fraser, Gavin C.G., 2010. "Determinants of Household Poverty Dynamics in Rural Regions of the Eastern Cape Province, South Africa," 2010 AAAE Third Conference/AEASA 48th Conference, September 19-23, 2010, Cape Town, South Africa 97078, African Association of Agricultural Economists (AAAE);Agricultural Economics Association of South Africa (AEASA).
  7. Khandker, Shahidur R. & Faruqee, Rashid R., 2003. "The impact of farm credit in Pakistan," Agricultural Economics, Blackwell, vol. 28(3), pages 197-213, May.
  8. Ricardo Luis Chaves Feijo, 2001. "The Impact of a Family Farming Credit Program on the Rural Economy of Brazil," Anais do XXIX Encontro Nacional de Economia [Proceedings of the 29th Brazilian Economics Meeting] 090, ANPEC - Associação Nacional dos Centros de Pósgraduação em Economia [Brazilian Association of Graduate Programs in Economics].
  9. Schreiner, Mark, 1997. "Ways Donors Can Help The Evolution Of Sustainable Microfinance Organizations," Economics and Sociology Occasional Papers 28327, Ohio State University, Department of Agricultural, Environmental and Development Economics.

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