Policy Objectives Production versus Income

The traditional approach of directed, subsidized credit for agriculture, whether offered through State banks or via rediscount lines through commercial banks, has been closely tied to production of principal crops and livestock products. Mexico provided a classic example. Every year, the chief agricultural experts in the central Ministries meticulously calculated the acreage expected to be planted by crop throughout the country, with emphasis on the irrigation districts, and on that basis estimated the required amounts of inputs and the associated credit needs, as well as the required timing of delivery of the funds, using standardized crop-by-crop formulas based on actual practice. The corresponding amounts of

26. K. Hoff and J. E. Stiglitz, 'Introduction: imperfect information and rural credit markets - puzzles and policy perspectives', The World Bank Economic Review, 4(3), 1990; reprinted in From the World Bank Journals, Selected Readings, The World Bank, Washington, DC, USA, 1995, pp. 269-272.

27. J. Yaron, M. P. Benjamin and G. L. Piprek, 1997, p. 7.

loanable funds were then made available to farmers through State-owned banking institutions. It was a task taken seriously at high levels in the government and monitored closely from a political perspective.28

Many other countries have followed similar procedures. Although some of this credit may have substituted for private sources of funding, it cannot be denied that there was a net output effect, that production of the targeted crops would have been lower in the absence of the considerable amounts of funding channeled to the sector in this way.29 Assessments of this traditional approach to agricultural credit are presented throughout this chapter; the point to make here is that its aim was increasing agricultural output, not necessarily agricultural income, much less rural income. Although directed credit may have fulfilled part of its objective of increasing the production of selected crops, it has generally had low private and social returns. Its overall effectiveness in promoting agricultural development has been undermined by the following factors:

(a) In authorizing the loans, no selection criteria were used that measured the profitability of the investment. (Most of them were short-term loans.) Nor was a determination made of the comparative advantage or economic profitability of the products to which the credit was directed. Indeed, in Mexico and Central America, most of the directed credit has gone to grain production, and studies have shown that most of those products do not have a comparative advantage in that region.

(b) Rates of interest were subsidized, and so it was possible to cover them with low-return investments of the funds.

(c) Loan repayment requirements usually were lax so that the average real rate of interest paid, ex post, was even lower, often negative. This meant that part of the credit became a grant which helped sustain the production of crops whose acreage otherwise would have reduced because of their lack of profitability in the absence of that subsidy.

By delaying the transition out of uneconomic crops into other lines of production, the directed, subsidized credit programs often have acted as drags on the sector's growth rate.

In contrast to this way of administering credit, an approach of rationing loanable funds through market interest rates, accompanied by sound portfolio management which generates high rates of repayment, ensures that the funds go to more productive uses. This latter mode of operation fits the policy objective of increased sector income rather than increased output of selected products. It is argued in Chapter 2 of this book that income is a more appropriate objective than production.

Many of the profitable investments in rural areas are found in non-farming pursuits, especially in the marketing of outputs and inputs. The well-known Grameen Bank in Bangladesh has made a high percentage of its loans to rural women who market agricultural produce and handicrafts: 91% of its borrowers were women in the late 1980s.30 Later, its lending for rural cell phones became so extensive that this activity was spun off into a separate enterprise.

28. In the early 1970s, this author worked in an agricultural planning office in what was then the Ministry of the Presidency in Mexico, and one of the principal responsibilities of the office chief each year was this determination of agricultural credit needs and the justification of the budget proposal in the Ministry of Finance. See, for example, Secretaría de la Presidencia, Dirección Coordinadora de la Programación Económica y Social, Sector Agropecuario: Aspectos Metodológicos de la Programación, Mexico City, Mexico, 1976, p. 123.

29. 'The additionality of directed credit programs for agriculture cannot be quantified, but in the short run the programs often resulted in increased investment and seasonal credit that benefit agriculture' (J. Yaron, M. P. Benjamin and G. L. Piprek, 1997, p. 22).

Rural households, especially those with lower incomes, tend to have diversified sources of income and so financial facilities which best serve their needs are not directed solely to agricultural lending.

A loan portfolio that embraces diverse uses of the funds, with an important role for non-farming uses, is less risky for a financial institution than one that specializes in agricultural loans. The successful Bancafé in Honduras started as an institution that lent only to coffee farmers but it expanded and consolidated its financial position by diversifying its portfolio significantly, so that eventually coffee loans came to represent somewhat less than half of its total.31

Thus the primary objective of reforms of the rural financial sector in developing countries has come to be, justifiably, supporting the expansion of rural income.

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