The Problem of Directed and Subsidized Credit

In setting the context of monetary and banking policy, it is worth recapitulating and extending the arguments concerning directed [selective] credit and subsidized interest rates. Fry has made the following observations:

Selective credit policies invariably produce the opposite results to those intended. That governments continue to pursue them is explained largely by the political pressures exerted by vested interests created by these policies in the first place. The Asian developing countries pur suing selective credit policies most vigorously -Bangladesh, India and Nepal - tend to be those recording the lowest rates of economic growth. Selective credit policies . . . have simply failed to improve domestic resource mobilization and allocation.148

Selective credit policies go hand in hand with interest rate policies. The defects of low interest rate policies are compounded by selective credit policies that differentiate and subsidize . . . particular categories of borrowers. The most obvious disadvantage of selective credit policies is that capital rather than labor is subsidized. .. . Abandoning directed credit programs must constitute one of the first steps of any sensible financial development program. If the government is too weak to take this step, it may well be too weak to implement any well-conceived macroeconomic policy.14

Even the more successful rural financial intermediaries in the developing world have had difficulties with directed credit programs:

BAAC (of Thailand) and BRI (of Indonesia) continue to implement mandated government credit programs with poor results. The losses from these operations are either covered by government funds in the case of BAAC or absorbed by the profits generated by the unit desas in BRI. These transfers represent a loss of resources and inhibit profitability in both cases.150

These lessons are very basic ones. Nevertheless, an argument for some occasional and transitory exceptions is presented above (under 'rediscount lines') and later in this section.

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