Government sponsored credit schemes in India: Proposals for reform

Abstract

In the face of statistics indicating that 40 per cent of the Indian population still lives below the official poverty line, the Government of India has placed increasing reliance on credit as an instrument for the creation of new rural assets and livelihoods for the poor. A number of broadly similar schemes exist (of which the largest is the Integrated Rural Development Programme) each tailored to finance a different range of investments. They all entail organisational and financial collaboration between banks and government departments, although the nature and extent of collaboration varies considerably.

Drawing upon field-work conducted by the author in the Madurai region of Tamil Nadu, this paper compares the impact of two of the schemes and discusses the design features that explain their relative performance.

On the supply side, the chief weakness identified is a tendency towards over-supply of credit relative to real investment opportunities, arising from the institutional separation of target-fixing and borrower identification (government functions) from loan disbursement and recovery (bank functions). On the demand side, the major problem is that the initial scale of operation of most production units fostered by the schemes is too low given the existence of substantial economies of scale in capacity to bear risks.

The final section of the paper considers how these problems may be overcome. Scheme lending should be broken up into projects: with a single sponsoring agency responsible for each throughout its life. The chief role of the banks would be to appraise—and where necessary reject—project proposals submitted to them by sponsoring agencies. In place of targets, overall supply would be determined by the ability of development agencies to formulate projects acceptable to the banks.

While lending on these lines would improve the long-term development impact of credit schemes, it would also have a short-term political cost by reducing the number of borrowers who receive cheap credit. This factor and the resistance of more conservative-minded government officials are likely to be the main barriers to the proposed reforms.

At a more general level, the paper is a response to the call for a ‘more systematic and rigorous analysis of institutions and institutional environments … essential for understanding and implementing effective policy reforms of rural credit markets’.³ It illustrates how the institutional framework of credit provision may be as important as specific terms (such as inclusion of subsidy and restrictions on the end-use of loans) in determining the success or failure of particular schemes.