Developing Countries the Record on Directed and Subsidized Credit to Farmers Has Been Poor

Improving Rural Finance in Developing Countries The record on directed and subsidized credit to farmers has been poor. Sound policy reforms, therefore, need to tackle the defects of the institutional structure of the particular rural economy Avishay Braverman and Monika Huppi O "ver the last three decades, governments tively supported these interventions. For ex- ket failures. Under certain circumstances, in- in many developing countries have inter- ample, about one fourth of all World Bank terventions in the rural financial markets of vened heavily in rural financial markets. lending to agriculture during the 1980s, or developing countries may still be warranted, Their intervention has been motivated by the $9.7 billion, went to agricultural credit. provided acceptable institutional structures belief that a shortage of affordable credit con- The performance of most credit programs exist to administer such programs. strained agricultural growth and develop- has, however, fallen short of expectations. Reasons for intervention ment and prevented the integration of small Although various factors account for the lim- farmers into the market economy. The most ited success of subsidized credit programs, The main justification for intervention in frequent forms of intervention have been ad- the failure of these programs can at least par- rural credit markets has been a perceived ministrative allocation of funds, interest rate tially be attributed to defects within the insti- shortage of affordable credit, which has gen- ceilings, and establishment of specialized ru- tutions designated to carry them out and, in erally been attributed to imperfections in rural finance institutions. Many donors have ac- part, to the assumptions underlying past poli- ral financial markets, and the discrepancy be- cies. As a result, a growing literature is devel- tween private and social rates of return. oping that seeks alternative forms in manag- Because of the seasonal nature of agricul- ing and channeling credit to rural markets, tural operations, cash flows and cash needs of This article draws heavily on the work carried out that could eradicate or at least significantly rural producers are not synchronized. In addi- by the Agricultural Policies Division, as well as work reduce the problems previously encountered. tion, the income of agricultural producers is by researchers outside the Bank. For example, see It is questionable whether abolishing credit highly influenced by climatic conditions. "Rural Credit in Developing Countries" by Avishay subsidies alone would eliminate the major in- Hence, lending to agriculture is more difficult Braverman andj. Luis Guasch, Policy, Planning, than regular commercial lending. Lending in and Research Working Paper No. 219, The World efficiencies that currently afflict rural credit Bank, and "The Role of Groups and Credit systems in developing countries. It is also rural areas often implies servicing a geo- Cooperatives in Rural Lending," by Monika Huppi doubtful that a simple laissez-faire policy graphically dispersed clientele, which in- and Gershon Feder, The World Bank Research would effectively reach small farmers with increases transaction costs. Administratively Observer, July 1990. stitutional rural credit and counter other mar- imposed ceilings on interest rates have often 42 Finance & Development / March 1991 ©International Monetary Fund. Not for Redistribution prevented commercial lenders from passing funds, they have often had to follow adminis- about 15 percent in Asia and Latin America, on fully these costs to borrowers. Together trative guidelines, rather than creditworthi- have had access to formal credit, with five with the frequent absence of collateral and dif- ness criteria, in allocating their credit. To percent of borrowers often receiving as much ficulties in enforcing contractual obligations, guarantee availability of cheap funds, govern- as 80 percent of the credit. Thus, instead of all the preceding factors tend to discourage ments have often imposed low interest rate narrowing income inequalities, low interest commercial banks from engaging in rural ceilings on all formal lenders. But such ceil- credit programs have often increased them. lending. ings have had adverse effects, preventing Since large farmers generally borrow larger Where commercial lending institutions are these lenders from covering their operating amounts than small producers, the former active in rural areas, they almost exclusively expenses and loan losses. As a result, govern- benefit more from credit subsidies than the cater to large farmers. Lending to small farm- ments have had to intervene to cover such latter. When interest rates do not reflect the ers is a problem because of the substantial bills. In some cases, governments have even true cost of capital, the distribution of benefits unit costs in processing and administering covered part of interest payments for certain from official loans is generally even more re- small loans, lack of collateral and the often un- categories of borrowers from these lending in- gressive. Cheap funds lead to excess demand justified belief that small agents are bigger stitutions (for example, small-scale farmers or of capital, so that subsidized loans must be ra- risks than large farmers. producers of a specific crop). High rediscount tioned. Because rural lenders prefer large bor- The absence of strong formal credit mar- margins have allowed rural financial interme- rowers (especially when low interest rate ceil- kets has given rise to informal financial mar- diaries to only finance a small part of the ings do not allow them to cover the higher kets in rural areas of many developing coun- granted subloans themselves, while the rest transaction costs involved in lending to small tries. Most of these markets are characterized has been financed by the central bank at sub- farmers), small farmers tend to be rationed by relatively quick disbursement of funds and sidized rates. Nonrural financial inter- first. low transaction costs. But they have high in- mediaries have frequently been obliged to buy The continuous availability of cheap funds terest rates due to such factors as high risk, obligatory bonds yielding below-market rates. and ceilings on interest rates have prevented limited diversification of the loan portfolio, The proceeds of these transactions have then specialized agricultural credit institutions and and, sometimes, monopoly rents. While it is been made available to rural financial inter- other formal lenders from mobilizing rural not uncommon for friends and relatives to mediaries. savings and thus building up their own lend at zero interest (or even negative rates in Effects of rural credit programs sources of funds. Specialized agricultural real terms), money lenders have been found to lending institutions have, therefore, never de- charge 200 percent or more. A study among The effects of three decades of intervention veloped into true and viable financial interme- rice farmers in the Philippines, for example, in rural financial markets have, unfortunately, diaries between net savers and net borrowers. found that 15 percent of the producers paid been dismal. A number of case studies have Studies in rural areas of various developing more than 200 percent in interest on their shown that the availability of subsidized countries have, however, shown that even loans from the informal market, while 20 per- credit has had little, if any, effect on agricul- small producers in poor areas can and do save cent of them had loans at zero interest rates. tural productivity. Unless lenders employ significant amounts, if given the opportunity In Chile, studies show that relatives, friends, strict (and often costly) supervision, the fungi- to do so. The problem, therefore, is not so and patrons lent to farmers at zero or even bility of money makes it difficult to guarantee much a shortage of funds in a particular area, negative interest rates, while stores, traders, that borrowers use funds to finance agricul- but rather a lack of possibilities to manage li- and moneylenders lent at rates as high as 360 tural investments. Further, it is impossible to quidity over time. Credit unions and other percent. ensure that borrowed funds are used to fi- credit cooperatives in Cameroon, Guatemala, Private banks' reluctance to lend to agricul- nance higher investment than would have Rwanda, South Korea, Taiwan Province of ture in general, and to small farmers in particr taken place without subsidized credit. Credit China, and Togo, for example, have been very ular, and the uncertainty regarding the avail- project evaluations in countries as diverse as successful in mobilizing savings in rural ar- ability of high interest credit in the informal Kenya, Mexico, and the Philippines, for exam- eas. Extensive saving mobilization campaigns market, have been the main reasons for gov- ple, have found that the use of funds for pur- and innovative offers for deposits adapted to ernment intervention in rural financial mar- poses other than the ones stated at the time of local rural conditions have helped many of kets. It has also been argued that the limited borrowing was a major factor that severely these credit cooperatives to increase their own availability of affordable capital delays, if not limited the programs' effects on productivity funds and attain near self-sufficiency in terms prevents, the adoption of new production increases. One argument often used in favor of funding. In Rwanda,

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