9.5 Rural finance

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The nature of agricultural production imposes significant discontinuities between the time resources are committed (immobilized) in production at planting and the generation of revenues after the harvest. Farmers who do not have sufficient resources to invest in such immobilization for the required part of the year, including both for purchased inputs and for living expenditures in the waiting period, depend more than the people in other sectors on the availability of credit. Facilitation of access to credit for the rural poor has therefore a role in the panoply of policy instruments for alleviating rural poverty.

The environment for rural financial intermediation has changed significantly in recent years. The concept of privatization has been embraced by an ever increasing number of countries, and the role of markets in the determination of prices for traded agricultural products has been enhanced. Food and agricultural input subsidies, including those for agricultural credit, have been reduced or eliminated. A larger share of rural credit comes from private sources, and a declining share from the state. As subsidies on credit are reduced the cost of credit increases, and as subsidies on other inputs are reduced the credit requirements rise.

Until the early 1980s most attention was focused on formal finance, i.e. that sector of the financial system regulated by a central monetary authority; only occasionally was mention made of financial activities that were not regulated, i.e. informal finance. During the 1980s, however, research increasingly showed that informal finance plays an important role in rural development, especially for poor people: small farmers, landless people, micro entrepreneurs, and particularly women within these groups. It also became apparent in a number of countries that the informal system operated more efficiently and equitably than did the formal financial structure.

Far too often talk about financial services is limited to credit alone. Surprisingly large amounts of savings deposits can be mobilized even in low-income countries and among people who would fall in the category of the poor, when a reliable and effective system for doing so exists. There are a number of studies which confirm that a large percentage or, in some cases, the entire seasonal lending for agricultural production could be financed with locally mobilized funds (local in this context meaning rural). Again, this requires improvements and further developments in the financial system, which at village and district levels makes possible the mobilization of savings. At the national level, the financial system must also be capable of transferring such savings from surplus to deficit areas, at the same time maintaining the confidence of savers in the safety of their deposits. As an agrarian economy develops, the flow of savings generally has been from rural areas to urban centres, a flow often stimulated by the adverse terms of trade for agriculture stemming from government policies that explicitly or implicitly tax the sector (see Chapter 7).

Specialized credit institutions and commercial banks

When governments and donors alike started focusing attention on credit as a means of fostering rural development, a variety of specialized, mostly government-owned, credit institutions were created. The overall experience with these types of institutions has been quite unsatisfactory. They were directed to extend below-cost loans to target groups or activities identified either by the government or by external funding entities. Because the selection of those groups or activities was often made on criteria other than commercial ones linked to their financial performance, the loan repayment rate was poor. In most cases the lending agencies were supervised and controlled by ministries which were not equipped to deal with financial institutions. All these negative features, together with excessively high transaction costs, have led many of these institutions into great difficulties, and made them increasingly dependent on state subsidies for survival (see Besley, 1994, for a review of arguments for interventions in rural credit markets).

Simultaneously with government efforts described above, commercial banks were urged to increase their activities in rural areas, particularly by lending to the agricultural sector. Again, results were generally below expectations and the intended target group, often small farmers, benefited little from these measures. Small farmers were ignored because lending to them was expensive and they were considered to constitute a higher risk than large farmers, though there is no adequate empirical evidence to support the latter argument.

Partly on their own initiative and partly as a means of complying with the government directives, commercial banks in some countries have experimented with group lending schemes for small farmers. For example, in Ghana, such schemes were initially fairly successful, but when the numbers of groups increased the staff involved could not manage them properly. This shortcoming was reflected in loan default and consequently considerable sums were lost in these schemes. However, during the last three to four years some Nigerian commercial banks have made special efforts to build up lender customer relationships with selected cooperatives, so that the latter can satisfy the demand for credit by their members. Initial results have been encouraging.

Except for a few recent successes, both specialized credit institutions and commercial banks often lack adequate institutional and operational arrangements at the grassroots level. In particular, they are too far removed from their clientele to make optimum lending decisions and to implement sound loan collecting procedures.

Cooperatives and other rural organizations in rural finance

To overcome these crucial problems, increasing efforts are being made to involve in the provision of financial services various rural organizations, such as cooperatives, informal groups of small farmers and other rural people, and traders dealing with agricultural inputs and produce. Cooperatives permit economies of scale for their members in access to financial services. They are particularly well suited to providing financial services to rural people as they operate at grassroots level among people who know each other well, a basic condition for trust. Often a cooperative is the only financial institution (or formal organization) in a rural area, and is therefore an obvious structure for the operation of new financial services to supplement the traditional, informal sources of credit.

Cooperatives and other less formal group arrangements have the potential of reducing the transaction costs of lending to small farmers and other segments of the rural population subject to disadvantages as well as of improving the management of risk. Successful lending programmes have shown the importance of factors such as homogeneous borrowing groups, which are jointly liable and themselves assume some managerial and supervisory responsibilities, and are bound in loyalty by a common bond other than credit. Important factors for the success of cooperatives include bottom-up institutional development, extensive training at all levels, reliance on savings mobilization and equity contribution rather than external funds, gradual expansion of activities, and strict monitoring and auditing.

Informal rural finance

For the rural people, and particularly for the rural poor, the main sources of credit have been and continue to be various types of informal arrangements. Although more common among poor people, informal loans and savings activities are known among and between all economic classes. Traditionally, informal rural finance has been viewed by outsiders as a plague for poor people, whereas in fact large numbers of the poor benefit from it. Furthermore, contrary to widely held opinions, there is surprisingly little evidence in recent studies of exploitation. Women, in particular, often have to resort to informal finance because of institutional and legal barriers to formal credit such as lack of collateral or requiring a husband's signature on loan agreements.

A great number of financial intermediaries operate in the informal financial markets. Probably friends and relatives are the most common source of credit, particularly in rural areas, in some countries accounting for more than half of all informal loans. In most cases, no interest or collateral is involved and repayment conditions are very flexible. These attributes have great merit for those without collateral, such as the landless or those without land titles, and in situations where production risks are high. Furthermore, loans are often received in kind, such as seeds and fertilizers, and may be repaid also in kind.

Rural communities of some countries may save jointly for a variety of purposes, generally not for lending but for the bulk purchase of farming inputs (e.g. in Zimbabwe) and for various social functions. Informal rotating savings groups among women have also become popular as a means of maintaining their financial independence. More sophisticated groups are the ROSCAs (rotating savings and credit associations), which are found in many low income countries and which have been extensively studied in recent years. In many areas, more individuals participate in ROSCAs than deal with formal financial institutions; recent research in the Cameroon suggests that the volume of deposits moving through ROSCAs may sometimes be larger than amounts held in banks (Schrieder, 1989).

The predominance of informal credit arrangements in rural credit markets necessitates the analysis of the complex transactions that occur in such markets. Recent developments in the analysis of informal credit institutions emphasize the role of informational deficiencies in shaping such transactions. In developing countries, incomes of rural borrowers are uncertain, collateral is often lacking and repayment, if not willingly made, is extremely difficult and costly to enforce. Thus, when a loan transaction takes place, it is very costly for the lender to determine the default risk of a borrower and monitor that her/his behaviour makes repayment likely.

Borrowers and lenders in their effort to reduce transaction costs of screening and monitoring loan performance may link the terms of the loan contract to transactions taking place between them in other markets. Such transactions may be between traders and farmers (traders making loans to farmers for purchases of inputs), landlords and labourers (landlords making advance payments to workers to secure their labour when needed in the future), etc. Such interlinkages lower the transaction costs of screening the borrower's creditworthiness, provide a source of control by the lender on the borrower's earnings and income, and give the opportunity to the lender to affect the probability of loan repayment by manipulating the terms of trade in other markets. For instance, a trader who is also a lender may provide better prices for modern inputs to his borrower, since the use of such inputs reduces the probability of default on the loan (Hoff and Stiglitz, 1990). High information and transaction costs often restrict loans to members within geographical or social boundaries (a village or kinship group) where transactions are sanctioned by the community. This type of behaviour may explain the high segmentation of rural credit markets.

The analysis of informal markets shows that the scope of financial market liberalization will be limited if the basic reasons for the distortions in rural credit markets (i.e. informational asymmetries) are not sufficiently dealt with. Given the significant role of interlinked transactions in rural credit markets, actions by governments in other markets as well as risk reduction policies may have beneficial secondary effects on rural credit markets. For instance land titling, increasing market integration, improvements of rural infrastructure and other risk-reducing policies, will increase the credit receiving capacity of rural borrowers and reduce the importance of information constraints. High segmentation in rural credit markets may introduce monopolistic elements. Existing evidence points to the existence of such elements in the behaviour of lenders. In cases where highly priced rural credit is the result of monopolistic or collusive behaviour by local lenders, entry should be encouraged.

The conclusion of the preceding discussion is that highly specialized credit institutions are no longer considered the most suitable type of rural finance, particularly not for the rural poor. Intermediaries which accept savings deposits, such as local banks, cooperatives and other rural organizations, have gained popularity among the rural people themselves and have demonstrated promising results. It is commonly accepted that there should be a choice of institutions offering financial services and that they should compete with each other and thus improve services to their customers. Acceptability of institutions by prospective customers should be the main criterion in promoting different types of financial intermediaries in rural areas. For the poor people in rural areas it is extremely important to have informal financial intermediaries included and to have appropriate operational linkages between them and formal financial institutions established.

9.6 Marketing

The structure of rural markets influences the incidence and persistence of rural poverty, because it is instrumental in determining the way in which trade takes place and the processes governing the terms of exchange. Marketing systems in developing countries are diverse in structure and often complex. They comprise arrangements for credit, storage, transport, and involve a hierarchy of intermediaries, e.g. Iarge and small private operators, cooperatives and state agencies engaged as traders, processors, distributors, wholesalers and retailers. The one common characteristic shared by many developing countries is that transactions, especially by the poor, tend to be relatively small. The rural poor participate in those exchanges as producers with small quantities of cash crops or food surpluses to sell, as net purchasers of food and other basic necessities for own consumption, as petty traders in staple food producing areas, and as labourers in agricultural production, food processing and local distribution.

The limited scope of the market increases both transaction and production costs; the former because of informational deficiencies, and the latter because of the limited nature of specialization and division of labour. Moreover, where the formal market structure is absent or incomplete, the small trader, consumer or producer is impeded by barriers to entry, insecure property rights and poorly enforced laws. In response, there are frequently alternative "organizational forms" and "rules and conventions" that provide a structure for exchange.

State intervention

State interventions in marketing have been quite common in many developing countries. The policy instruments used in these interventions have ranged from steps taken to improve market infrastructure, to price interventions, to creating and fostering marketing parastatals and cooperatives. The pros and cons of direct government involvement in agricultural marketing are part of the wider issue of the role of the state in economic life which has come under increasing scrutiny in the context of structural adjustment policies. This wider issue is discussed in Chapter 7. Here, the focus is mainly on the significance for the rural poor of a government role in agricultural marketing.

Improving market infrastructure

A well-recognized role for policies in this area is the provision of marketing facilities and support services. These include urban and rural wholesale and retail markets, rural assembly markets, auction rooms, etc.; collection, analysis, and dissemination of marketing information on prices, quantities, qualities and crop conditions to enhance market integration and market transparency; establishment of a uniform system of grades, weights and measures; and provision of marketing extension services, e.g. advice on what to grow, how to handle it and where to market it. These public sector activities can bring significant long-term benefits to the poor as consumers and small farmers, particularly through reduced transaction costs and lower real prices of food. Whether government intervention should range beyond these functions raises more contentious issues relating to price policy and direct state involvement in marketing.

Price interventions

Price interventions can take many forms and have multiple objectives. Stabilization of prices and/or incomes (not the same thing and often incompatible with each other) can confer important benefits to the poor because they provide a more secure investment climate, easier access to credit and reduced short-term stress on household consumption. Even when such stabilization schemes are appropriate and cost effective, however, care must be taken not to introduce sustained price biases. If prices do not conform to the long-run opportunity costs represented by world market prices (see Chapter 7), the resulting misallocation of resources can seriously hinder economic efficiency, growth and poverty alleviation.

Marketing agencies

In the past, rural traders were often mistakenly associated with exercising monopoly power and exploitation of small farmers and this presumption in fact was one argument for the creation of marketing boards. In practice, however, rural traders often operate with low overheads and margins, and there is little systematic evidence that small farmers have been disadvantaged. Indeed, in many cases, agricultural parastatals have not performed any better, and sometimes far worse, than private agents. Often they tax farmers indirectly by absorbing a large part of prices of commodities they handle. This has discouraged production or at times encouraged farmers to bypass the formal sector in favour of the informal sector, with the additional costs which that entails.

Despite these deficiencies, however, some marketing boards have performed well, successfully extending to small] farmers the benefits of large-scale marketing organizations - especially in remote areas, e.g. the Grain Marketing Board in Zimbabwe. In other cases, marketing boards have been operationally efficient and relatively cost effective, but due to inappropriate pricing policies and multiple objectives imposed by governments they were led to accumulate large losses, with subsequent burdens on government budgets.


Advantages of economies of scale similar to those for parastatals are often cited for cooperative ventures. The smallholders can benefit from the economies of scale in processing, storage or transport, where there are few private agents competing to provide these services. Vertical integration would be attractive to the small farmer producing traditional cash crops, or milk and livestock products, but is less appealing for those producing food crops, which require little processing and which are sold locally. However, timeliness and appropriateness of pricing decisions, and the coordination of processing, storage and transportation call for considerable managerial competence. Finding appropriate leaders, with the broad range of management skills required, is often difficult.

The overall lesson of experience with direct state involvement in marketing is that less of it is better than more of it, but some continuation of such a role will be necessary to ensure a smooth transition to a system based on private agents. The critical question is how to move smoothly from one organizational form to the other. Where major disruptions in services take place, it is likely that the poor will suffer first and probably most. Finding ways to avoid the adverse impact of reform on vulnerable groups, while attaining the benefits of a more efficient market structure, will be the main challenge in marketing in developing countries for some time to come.

9.7 Selected direct anti-poverty interventions

Rural public works

Public employment schemes have long been used in many developing countries in emergency situations, such as during periods of drought and famine (and, more recently, during periods of macroeconomic stabilization and adjustment), and when there is large-scale, transitory unemployment and underemployment in the rural sector. However, in recent times, many developing countries have incorporated such schemes as regular elements of an anti-poverty strategy.

The experiences of Asia and sub-Saharan Africa provide useful examples of the worth of public employment schemes used for poverty alleviation during periods of drought and associated threats of famine in the 1980s (e.g. Botswana in 1983-85, India in 1987). In South Asia, rural public works (RPW) form the core of government anti-poverty strategies, creating useful employment for many of the rural unemployed and underemployed, as well as significantly reducing income variability. In Latin America many countries, such as Bolivia, Chile and Peru, have used public employment schemes to counter the temporary drops in labour demand that occurred during periods of structural adjustment or macroeconomic shocks.

Apart from providing substantial welfare benefits for the poor, RPW programmes often contribute to economic growth through the creation of assets such as roads, schools and canals. Social and economic returns to assets created through such programmes can be enhanced by ensuring that the projects are well integrated into existing rural development plans. Community participation in project design and execution can help to select highest priority projects, avoid wastage and promote labour-intensive methods. It can also help in the maintenance of the assets after they are created, even though regular financial provisions for maintenance are also necessary.

While there are few estimates of the cost effectiveness of RPW, simulations for 1980-2000 based on Indian data suggest that RPW programmes can have a greater impact on the poor than investment in irrigation or schemes of public distribution of food at subsidized prices (Narayana et al., 1988; Parikh and Srinivasan, 1989). However, care must be exercised in targeting the poorer households if the aim is poverty alleviation. This has. been achieved, for example, in the Maharashtra Employment Guarantee Scheme and the

Bangladesh Food for Work Programme, where the programmes pay lower than-market wages. In contrast, Bolivia's Emergency Social Fund (ESF), which largely financed local infrastructure projects executed by private contractors and permitted the hiring of construction workers at market wages, was not well targeted. Fewer than one-half of the workers employed on ESF schemes were drawn from the poorest 40 percent of Bolivian households (World Bank, 1990).

Food and nutrition interventions

Some sections of the poor (e.g. the old and the handicapped, as well as some of the groups referred to earlier) are not likely to be in a position to benefit from the direct anti-poverty interventions like those discussed above. Special interventions to raise their income levels are necessary. Unanticipated fluctuations in food prices may also have serious consequences for the "entitlements" of the poor, particularly for casual agricultural labourers. In this context, there is a strong justification for direct interventions to enhance their access to food, usually in the form of food subsidies. The design and implementation of food subsidy schemes raise many contentious issues. Such subsidies take a variety of forms (e.g. general food subsidies, food rations, food stamps, etc.) and the choice of an appropriate form is often very difficult. The direct welfare effects of food subsidies may be quite different from the indirect effects operating through other markets (Timmer, 1986). The experiences with food subsidization policies are summarized below.

General price subsidy schemes

Their general characteristic is that they supply unlimited amounts of specific subsidized food products to any one who wishes to buy it. The subsidy may cover a portion of the total production, storage and marketing costs. The price wedge may be administered at a point of import, or a point of processing, storage or sale. Such schemes have been extensively used in developing countries because they are administratively convenient, especially where private market channels exist. However, they also tend to be costly, because of leakage of benefits to the non-poor. For this reason some countries have limited general food subsidies applied to commodities that are consumed mainly by the poor, as in Egypt where the benefits of coarse flour subsidies accrue mainly to low-income groups, or to specific geographic regions, as in the Philippines where rice and cooking oil were made available to selected poor villages through local retailers at discounted prices. It is estimated that 84 percent of the total cost of such subsidies accrued as benefits to the target groups.

Ration schemes

An alternative to a general subsidy is to provide a quota, or ration, of subsidized food to each eligible household and let the market supply any further requirements. Ration schemes are designed to ensure access to a regular supply of basic staples at "reasonable" prices. The absolute transfer under a general ration is similar for all income groups. Thus, rations tend to be more progressive than general food subsidies. However, as is true of general subsidies, ration schemes are often limited in coverage-especially of the poor in rural areas - because the infrastructure and distribution networks needed to implement them are lacking. In some parts of India as well as in other countries, including Bangladesh and Pakistan, the benefits of ration systems accrue disproportionately to urban consumers, despite the fact that, as noted earlier, poverty is largely a rural phenomenon in South Asia.

Food stamp schemes

A subsidy scheme that is similar to ration is food stamps, where the rations are measured in terms of nominal currency units rather than in commodity weights or volumes. There are, however, some important administrative differences in their functioning. Food stamps do not require the government to handle directly any commodities. They do, however, require that retailers accept a parallel currency and are able to redeem this currency conveniently.

The experiences with food stamps in Sri Lanka and Jamaica suggest that such schemes can function if they are well targeted. In Jamaica targeting was achieved by selecting well-defined needy groups such as pregnant and lactating women and children under five registered at health centres. However, even if the programme is broader in scope, as was the case in Sri Lanka, where stamps for food and kerosene were provided to families with self-reported incomes below a certain minimum, the financial burden of such programmes can be much smaller compared to the implementations of general ration schemes and other food subsidies. If the inflationary pressures cannot be kept under control through appropriate macro policies, the value of the food stamps can quickly erode, partially nullifying the beneficial effects on the poor.

Despite these two relatively successful experiments, the schemes in Colombia, Egypt, Peru and Venezuela ran into difficulties because of the problems in establishing the stamps as an alternative currency (Alderman, 1991). Taken together these experiences indicate that in the absence of sound macroeconomic management and the lack of a well-developed market network in rural areas, the implementation is likely to be difficult with the gains to the poor eventually eroding.

Supplementary feeding programmes

These are a form of highly targeted ration or in-kind transfer scheme. Their main objective is to reduce undernutrition. Subsidized or free food is distributed through schools, nutrition and health centres or community organizations for direct or home consumption to those deemed specifically vulnerable to nutritional and health risks. The beneficiaries usually comprise children under five, school children and pregnant and lactating women. Additional targeting on the basis of growth monitoring, location or income helps to identify the neediest members within these groups. Older children and adults are also fed in many emergency situations.

The Indian experience with two supplementary feeding programmes provides some useful lessons. Initiated in 1975, the Integrated Child Development Services (ICDS) programme aims to improve the nutrition and health of children 0 6 years of age by simultaneously providing supplementary feeding, immunization and curative medical care to children and pregnant and lactating women, and health and nutrition education to mothers. However, the primary emphasis in the ICDS programme is on providing meals. The results have been mixed, mainly because of difficulties faced in targeting the beneficiaries, strong urban bias and other reasons. By contrast, the Tamil Nadu Integrated Nutrition Project (TINP), initiated in 1980, is area-targeted (to the rural areas of six districts having the lowest calorie consumption in the state), age-targeted (concentrating exclusively on children 6-36 months of age), and need-targeted (depending on weight gain over a certain period). Since the children are on the supplementation programme only for the duration of time their weight gain is below standard, it is essentially a short-term intervention that endeavours to avoid fostering long-term dependence of beneficiaries on public assistance.

Home and community gardens

The production of secondary food crops in home and community gardens and small livestock and poultry rearing or fish farming can make an important contribution to improving household food security by improving food consumption, particularly during times of seasonal scarcity of food. In addition, this would also provide additional income to families from sale of surplus produce utilizing available family labour.


1. Fields (1989). A more recent study on Latin America shows that periods of recession in the 1980s tended to be associated not only with increasing poverty but also with worsening income distributions, meaning that recessions hit the poor the hardest (Psacharopoulos et al., 1992).

2. Evidence from other regions also indicates that small farmers' adoption of new technologies depend on access to credit markets, input supplies, extension, tenure security and problems of risk aversion. Rural women are particularly disadvantaged in these areas.

3. The inverse relationship refers to land productivity (physical yields or gross value of output per hectare) as opposed to total productivity and is, in fact, generally associated with a higher level of inputs per hectare on small farms, in particular labour per hectare. However, in countries where labour is abundant and land is the scarce factor of production, maximizing output per unit of land is of primary importance.

4. A landlord has the option of either cultivating the land himself with the help of hired workers or leasing it out to a tenant for fixed rent or for a fixed share of the output. Suppose first that the only kind of risk is in production. Output depends not only on the inputs, but on the weather. In the owner-operated system, the entire risk is borne by the landowner because the labourers earn a fixed wage and the owner earns the residual. In a fixed-rent system, the tenant bears the entire risk. Thus, given risk aversion, share tenancy may be preferred because it reduces the effects of the risk element in the decision-making process with respect to investment, input use, etc.

5. For instance, squatters on government land in Jamaica devoted half as much land to permanent and semi-permanent crops than did titled farmers. A third of recipients under a government titling programme moved away from short-cycle crops after the change in their status (Feder and Noronha, 1987).

6. A typical ROSCA is a group of 15-30 members who contribute a fixed sum weekly or monthly to a pool which is distributed among members in various, predetermined ways.

7. "An interlinked transaction is one in which two parties trade in at least two markets on the condition that the terms of all such trades are jointly determined" (Bell, 1988).

8. Price interventions have also been used as means of transferring resources between different sectors or interest groups, e.g. in the form of pan-territorial pricing schemes, as in several African countries, of income supports to the producers of selected products, or of taxation of, mainly, export commodities. From an efficiency point of view, alternative forms of intervention, such as lump sum transfers or asset redistributions may be more effective.

9. For an analysis of the experience in the maintenance of common property resources by villagers themselves in rural South India see Wade (1987).

10. However, other efforts to improve the ability of poor households to make better use of the resources available can also have significant nutritional benefits. These efforts include, for example, nutrition education, introduction of appropriate technologies, expansion of water and sanitation facilities, access to cooking fuels, etc.

11. Costs ranged from less than 1 percent of total public expenditure in Colombia during 1978-80 to 10-17 percent in Egypt between the mid-1970s and 1984. In Egypt, only about 20 cents out of each dollar spent reached those in the poorest quartile of the population (World Bank, 1990).

12. Experience in Sri Lanka after 1978 indicates that a targeted rice ration scheme covering the poorest half of the population benefited the poorest groups (bottom 20 percent of the population) much more than the general wheat and bread subsidy schemes implemented during the same time. A similar pattern of transfers is seen in the distribution of food grains through fair price shops in certain states in India. In Kerala in 1977, for example, the poorest 60 percent of the population received 87 percent of the foodgrains distributed.

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