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«Productivity of Rural Credit: A Review of Issues and Some Recent Literature M.S. Sriram W.P. No.2007-06-01 June 2007 The main objective of the ...»

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However, it would not be appropriate to say that all supply induced programmes have not worked. We argue that even microfinance programmes by and large are supply side offerings. Microfinance places several constraints on the borrower by its design. While there might not be a project by project evaluation, it directs investments in certain types of activities because of the design constraint. All microfinance programmes have non-negotiables. These pertain to the discipline. The design of microfinance programmes expect a regular contact with the members and all loans to be repaid with a certain frequency. This is a supply [design] induced constraint. This forces the borrowers to either look for enterprises that provide such a frequent cash flow or service the new loan from an extant cash flow. For an economy that is largely oriented towards constrained by seasonal income, the requirement of generating cash flows to service the loan and also to save significantly changes the rules of the game. This change is sharper in Grameen groups, because the frequency of contact is weekly with no scope for default. Thus people in these programmes are forced to look activities that yield frequent cash flows.

Page No. 14 W.P. No. 2007-06-01


Research and Publications This strategy may induce livelihood diversification, without actually stating so. In our data a reason for Dharmapuri district having a large percentage of people involved in enterprise may be due to microfinance programmes that were operating for more than two decades. MYRADA – and organisation that pioneered the self-help group movement did its early work in Dharmapuri district. Not only are the figures of self-employment distinct in Dharmapuri district, we found that the groups financed wide ranging activities in the district. In our study we found that SHGs in Dharmapuri had a significant role in meeting the financial needs [savings as well as loans] of the respondents. The supply side constraints of microfinance initiatives pertain to design of the programme and not to the design and delivery of financial products.

Non Agricultural Rural Credit: Demand Induced Opportunities

When we look at the need for rural credit beyond agriculture the demand side indicates some market opportunities. The needs of the rural households are no different from the urban counterparts. However, the products offered need to be structured properly in order to make them meaningful for the rural areas. One compelling need is that of smoothening the seasonality of cash flows. The formal institutions do not really operate in this space. The Self Help Groups [SHGs] do not seem to see consumption loans as a taboo. The rice credit line experiment in Andhra Pradesh demonstrates how food security can intervene in reducing vulnerability. The scheme had dual purpose of cost savings – as rice is purchased in bulk for the collective – and providing food security for the households. It is argued that food stocks helped the poor to bargain for better wages as they did not have an immediate need not work out of desperation.8 If this is indeed the case, it increases the financial yield for the wage earners and demonstrates that credit has made a difference. The experiment recognises that there are large numbers of wage earners and the human body is the most productive asset owned by them. This scheme, operated through SHGs, can be easily linked with the formal institutions.

The other demand induced needs for can follow the employment pattern in the rural areas. Microfinance deals with income diversification in a limited way, but does not address livelihood issues contributing diversification of income streams. Seasonal migration is a case in point. Seasonal migrants work through a set of contractors called Mukaddams. We undertook a study in Ahmedabad and Hyderabad cities focussing on seasonal migrants in the construction sector. The study shows intricate relationships between the Mukaddams and the workers similar to the relation the farmers have with their input suppliers – a web of interlinked transactions, where the workers are given advances, taken for work, supported for bare subsistence and later given a lump sum wage. It is however not clear how vulnerable the migrants are. However as final wage settlements happen at the end of the season, it is likely that they are dependent on the Mukaddam to realise the current income, and to seek future employment opportunities. There are opportunities for providing an initial loan to reduce the financial dependence on the Mukaddam, and scope of providing for cash conservation at the destination and services of remittences. This is complex as the economic activities are happening at two stations – the base of the household and the changing destinations from where they are working.

The other demand induced loan that is widely documented is for emergency purposes, for which the dependence on informal systems is imperative. While some microfinance initiatives address this by retaining a cash balance, or refinance a bridge loan from the informal sources, it is not widely prevalent. Structuring this from the formal source is a challenge.

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Research and Publications The current needs of the households come from complex web of relationships. It might not be possible to address every need from the formal sources. It needs re-engineering of the current products to address the spectrum of needs. Formal sources may not want to address all the needs. From the view of productivity, we have illustrated how consumption loans on the lines of rice credit line actually may add to productivity, while the other loans are more in the nature of vulnerability reduction. A Study indicates that indicates that reducing vulnerability in itself could be a laudable goal (Maheshwari, 2004). She compares the pattern of borrowings of members of 2 year old SHGs as against members of 8 year old SHGs and concludes that the cost of borrowing is not different between the two groups. At the initial stages, while the SHG members are heavily dependent on the money lender, they also manage their finances by borrowing informally from their friends and relatives who lend at near zero costs. As the SHG grows, their dependence on money lender gradually reduces, and concurrently the access to informal finance from networked relationships also reduces. This does not affect the cost of borrowing significantly, but makes the households less dependent on the moneylender. The argument is similar vulnerability argument extended in the rice credit line scheme.

In addition there are needs pertaining to asset creation. Some assets lead to augmentation of income sources, some lead to better quality of life. However, we cannot ignore the economic activities that relate to asset creation. Our data from the three districts show the absence of formal sources even in planned events like housing because the design of products is contextually inappropriate. Addressing these needs possibly reduce the dependence on one source and thus make the households less vulnerable. This in itself could have positive multiplier effects on income yields and productivity.

General Issues pertaining to Rural Credit: Influence of multiple sources It is evident that the needs of rural credit are not being met by a single agency. The

nature of relationships is quite diverse as described below:

• Borrowing from social networks based on reciprocity; there is no appraisal, paper work or collateral. Several times these loans are interest free. This is works on unorganised social capital.

• Forming SHGS and carrying out financial intermediation through them, disproves the notion that the poor cannot save. The paperwork is minimal, collateral is absent and interest margins remain within the community. This works on the organised and formalised social capital.

• Borrowing from informal money-lenders happens when the amount is larger than what social networks can offer. This attracts a high interest, but is timely, quick and flexible. Collateral is negotiated. This disproves the notion that the poor cannot service a high interest rate loan.

• Tied Credit – loans tied to complementary non-financial transactions in land, labour and commodities. The lender deals with the borrower in a ‘non-lending’ capacity as well, the terms are opaque and tend to be exploitative, even though the transactions costs of borrowing are low.

• Formal financial institutions on the semi-regulated space like companies, chit funds, microfinance institutions

• Formal financial institutions with state support and patronage in the regulated space like co-operatives and banks.

Page No. 16 W.P. No. 2007-06-01


Research and Publications The question is whether it is desirable to have one dominant source of credit for the rural areas. While it might be desirable to move the financial transactions from the informal [and possibly exploitative] sources to the formal space, the argument that it should be from a single source needs to be examined. It might not be practically possible for a single source to finance the diverse needs of the rural population. Based on our study in the three states we were able to map out the purpose of borrowing [or withdrawal of savings] and the source from which the households borrowed [or

withdrew savings] as indicated by our data. The mapping is reproduced below:

Chart 1: Pecking Order of Savings/Loan Outlets and Purpose of Savings/Borrowings

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The chart indicates a pattern on how the rural population manage their finances.

There are emergency needs at one end and asset purchase at the other. The households straddle between multiple sources for different purposes. Moneylenders seem to be cutting all across the segments, because they are accessible.

The question is whether financial services should be available from diverse sources or limited sources. From the point of view of the customer, it is desirable to have multiple sources offering the services, so that the customer has choices. For the providers it might be good to be a single provider so that any adverse usage and excessive borrowing can be avoided. Ultimately the formal sector will have to find mechanisms of occupying a significant place in each of the need segments. For that, it is extremely important to understand the product attributes of the demand side, so that credit becomes efficient adds value.

Desirable Policy Interventions

Our policy interventions look for a quickfix solution. The interventions are finance led.

We have to start recognising that there are no easy solutions; no short term solutions.

We need to understand the changing face of Indian agriculture. The provision of financial services is one small part of the issue. The policy has to recognise the fact that rural lending is inherently risky because of the volatility of the underlying economy and there is far less potential for institutions to cover costs. The institutions have to maintain a balance between defaults and administrative/collection costs.

Banks do not seem to have a clear idea on what it costs to lend in the rural areas, therefore it might be desirable to institute segmented costing systems where productwise profitability could be arrived at. If the state still has to make an intervention, it could be used as a basis to target interest subsidies if they are absolutely necessary.

Our argument would be against any interventions in the interest rate space. Instead of controlling at the supply level, it might be a good idea to make rural lending

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attractive, by removing formal and informal interest rate ceilings. We have seen the microfinance market flourish because the commercial decisions such as interest rates were left to the local conditions. We also see diversity in interest rates applied in the microfinance sphere depending on the situation, but that it is making access friendlier and has had an impact is beyond doubt. Banking needs to be unshackled at this stage.

Our data from the field [1616 households] indicated that a large portion of the respondents had borrowed from moneylenders, while a smaller portion had borrowed from SHGs and Banks. We are not reporting the data from other sources [like friends, chitfunds, companies] here as the numbers are small and do not add significantly to the discussion. If we look at the data carefully, we can find that when it comes to the formal sources like the banks, more people think that the loan being cheaper [cost] is an important attribute than access. It is the opposite in case of moneylender. While this data indicates that people might not be extremely happy with the cost of borrowing from the moneylender, they are quite happy with the fact that it is easily accessible. The microfinance/SHG loans are somewhere in between, ranked high on access and also indicating that the low cost of loan is important to the borrowers.

Given that microfinance groups charge higher than the banks it clearly shows that if we crack the issue of access, there is certainly more headroom to increase the yields to the banking sector and people would be quite happy to bear the increased premium.

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We have to recognise that any intervention in rural areas has to have a large nonagricultural element to it. This is the only way we can recognise the seasonality of agriculture. It is absolutely essential to ensure that there are diversified livelihood opportunities across the country. This could happen through dovetailing the livelihood opportunities with other schemes of the government like the rural employment guarantee scheme. It may be also useful to look at migration in a constructive sense and possibly facilitate benign migration in seasons from areas that are poorly endowed with natural resources. Unless the economy is lubricated with constant flow of cash from diverse activities, the vulnerability is only going to increase. In addition there are the usual sore points that have been discussed in literature ad-nauseum – issues like recognition of tenancy rights; bringing the land records up to date; providing forward/backward linkages; setting up of warehouses and cold chains and clearing the infrastructure bottlenecks;.

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