Reforms’ unintended fallout

A mint-fresh working paper by the Reserve Bank of India once again trains the spotlight on a problem that, for five decades, every policy-maker has planned to snuff out, failed to, and then wished it would go away if ignored. But financial exclusion simply hasn’t, and we now have the central bank applying its forensic skills to an examination of its magnitude.

The title of Working Paper Series 5/20/13 is almost admonitory: “Persistence of Informal Credit in Rural India: Regulatory Policies Need to Recognise Changing Landscape.” Authored by Narayan Chandra Pradhan, the paper is an updation of sorts; it puts together all extant surveys on indebtedness, the formal and informal channels of rural credit recorded from 1971-72 to 2002-03 by various agencies.

In the absence of survey data beyond the latter date, and in order to extend the discussion to include micro-finance institutions (MFIs), the paper draws on four recent official reports.

At first glance, Pradhan does not tell us what we could not have intuited: Informal lenders continue to exist in varying degrees across the country as important conduits of rural credit. Two-fifths of rural households still rely on informal credit.

What is noteworthy, though, is the period in which the formal sector’s war on informal sources of lending has really taken a beating. That stage coincides with India’s liberalisation reforms.

The post-71 takeoff

The most “remarkable performance” of formal credit growth, as Pradhan puts it, was in the twenty years after 1971, with commercial banks leading the way. From a meagre 2 per cent of the “outstanding cash dues” of cultivator households, banks increased their presence to 28 per cent by 1981. It then sputtered over the next decade, but to nevertheless account for 29 per cent of the total in 1991.

The share of co-operative societies/banks, another major weapon in the formal sector’s assault on informal lending, increased from 20.1 per cent in 1971 to 28.6 per cent in 1981, thereafter dropping to 18.6 per cent in 1991.

But still, so far so good. As Pradhan reminds us, the flush of nationalisation and branch network expansion contributed sizably to the retreat of money-lending.

As the data show, the real decline set in after 1991. That decade witnessed the return of the professional and agricultural money-lender, both of whom increased their presence sizably as banks retreated to urban and more profitable lending.

To quote Pradhan, “This disquieting trend is, in part, due to a contraction in rural branch network in the 1990s, and in part due to the general rigidities in procedures and systems of institutional sources of credit.”

Informal lending revival

The “combined share of all the non-institutional credit agencies in the outstanding cash dues of cultivator households recorded a sharp decline of 32 percentage points during the 1970s…” In the following decade the fall in money-lending was far lower at just three percentage points but increased to 43 per cent in the decade ending 1991.

Pradhan records the steepest fall in these decades for ‘agricultural money-lenders’, whose share came down to 6 per cent in 1991, from about 9 per cent in 1981 and 23 per cent in 1971. “However, the share of ‘professional money-lenders’ queered the results disconcertingly: their share rose to about 9 per cent in 1991, after registering a fall to 8 per cent in 1981, from about 14 per cent in 1971.

But it is in the period between 1991 and 2002 that the most dramatic reversals take place. Overall, the share of informal agencies that had halved in 1991, from 70 per cent in 1971, now rose six per cent by the start of the new millennium. The aggressive return of the agricultural and professional money-lenders underlined the rollback of formal agencies such as banks and cooperative societies.

To examine trends beyond 2002, the last year for data in the All India Debt Investment Survey published in December 2005, the working paper relies on RBI reports and others. Most noteworthy is the Report of the Task Force on ‘Credit Related Issues of Farmers’. Pradhan quotes from it thus: the “…more disquieting feature of the trend was the increase in the share of money-lenders in the total debt of cultivators. There was an inverse relationship between land-size and the share of debt from informal sources. Moreover, a considerable proportion of the debt from informal sources was incurred at a fairly high rate of interest”.

The flight of banks (and regional rural banks (RRBs)) from rural lending as recorded in the data after 1991 had perverse results. Growing commercialisation of agriculture “encouraged the rise of trader-money-lender, as the formal sector finance is inadequate to meet the growing credit requirements of agriculture.

The Task Force (GOI, 2010) noted that the money-lender today comes in many forms – as an outright lender, as a supplier of inputs/consumer goods, as for-profit non-banking finance companies (NBFCs) including the for-profit microfinance institutions, as a buyer of produce, and as an owner of the land on which the farmer is dependent”.

Liberalisation excludes?

If the data have any significance beyond the numbers, what they suggest is that at the very moment of high growth and the introduction of financial inclusion in the policy agenda, the process of exclusion, that is, the exit of formal agencies from the rural sector, had already set in and was to gather pace.

Could it also be inferred that the decline in formal lending evident since 1991 was an outcome of policies that biased banks in favour of commercial and urban-based lending, that turned them away from the rural sector?

Why should the trader-money-lender have made a comeback even in commercial agriculture, as the Task Force reported?

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