Paper

The Impact of Formal Finance on the Rural Economy of India

Does the benefits from agricultural credit programs outweigh the costs?

Expanding the availability of agricultural credit has been widely used in developing countries as a policy to accelerate agricultural and rural development. However in most cases credit and credit institutions were heavily subsidized. The paper empirically evaluates costs and benefits of agricultural credit programs. Results show that:

  • Rapid expansion of commercial banks in rural areas has had a substantially positive effect on rural non-farm employment and output;
  • Output effects of rural finance has been much smaller in agriculture than in the non-farm sector;
  • Overall impact of rural credit on rural wages has been positive, as creation of non-farm employment has added more to total employment than has been subtracted by substitution of capital for labour in agriculture. Therefore even agricultural wages have risen modestly.

Yet there have also been high costs to the government from this policy created by factors such as poor repayment. In fact, the analysis implies that government costs of providing credit could have exceeded net agricultural benefit.

About this Publication

By Binswanger, H. & Khandker, S.
Published