Table 1: Loan Characteristics

average of three years of experience as accountants. Presidents, on the other hand, had higher qualifi cations, but secretaries played a more important role in the day-to-day

than 50% of PACs

was poor and only

5% of PACs provi-

sioned loan losses.

governance in the

other collateral.

This reliance on informal sources is consistent with the view that formal lenders and PACs in particular may ration credit. Two pieces of evidence from the survey support this view. First, 60% of respondents would like to borrow more from PACs at prevailing rates if they could. This percentage drops to 40% when asked about moneylenders. Second, about half of the respondents that requested credit in 2006 were rejected. Rejection rates among small farmers, at 60%, were higher than among large farmers (47%). Among marginal farmers, rejection rates were lower at 40% but so were credit requests. Only half of the marginal farmers report asking for credit compared to 76% of small farmers and 86% among large farmers. Anecdotal evidence suggests that marginal farmers request fewer loans because they anticipate being rejected, so that only the better potential applicants apply, explaining the lower rejection rates.

PACS Management and the Role of Politics

We also inquired into the management practices of PACs. The evidence pointed to a lack of proper incentives to improve repayment. Secretaries of PACs, for instance, were by and large remunerated using a fixed compensation scheme, unrelated to repayment or other performance measures. On average, these secretaries had only 1.5 years of formal education. They had been trained in accounting for less than two months, and had only an

clear evidence of misalignment between the perceptions of members and those of PACs committee members and presidents. The perception of outside influence is a telling example: between 20% and 30% of members perceived that admission and termination of members and credit decisions were influenced by outsiders. In contrast, no president or committee member thought so. In addition, nearly 40% of members thought that PACs loan decisions tended to favour certain members, while less than 10% of presidents and committee members thought so. Respondents were usually sceptical about the motives of PACS management. They believed, with a probability of close to 50%, that PACs presidents do not look after members’ interests, and they assigned a probability of 40% to the proposition that the president would abuse his power in his own interest.

The first hint of the potential role of politics comes from looking at the political connections that PACs members and management had relative to non-members. The data showed that close to 60% of PACs members had the same political affiliations as the head or ward member of panchayat. In the case of presidents or committee members, this fi gure climbed to nearly 75%. Most committee members had the same political affi liation as the president.

Consistent with this finding, there is evidence that links the behaviour of government-run credit providers to the electoral cycle. Cole (2009), for example, found that agricultural credit increased by 5 to 10 percentage points in an election year, particularly in districts with high levels of electoral contestation. This pattern was not found in non-election years or in lending by private banks. Cole also showed that this pattern is costly as elections negatively affect loan repayment, and election-year credit booms do not increase agricultural output either. An explanation for why government-run lending institutions in India are more generous during elections comes from Cole, Healy and Werker (2012), who used rainfall, public relief, and election data to examine the reaction of voters to the response of governments to adverse shocks. They found that voters only responded to government relief efforts during the year immediately preceding an election.5

Unfortunately, as borrowers take advantage of the lax enforcement of credit contracts, the culture of subsidies and frequent government relief undermines the culture of repayment. The data clearly show that farmers anticipated with probability over 50% that a relief package that benefi ted PACs (but not MFIs or informal lenders) would be announced in case of a drought. Since farmers would not benefi t from a relief package if they repaid the loan before the announcement was made, all farmers had an incentive to wait (even after the loan due date) until the announcement (if any) was made.

We also asked farmers about their perceived probability for different events related to loan repayment, and their answers showed similar patterns (Table 2, p 76). For example, farmers perceived that in the event of a drought, their loan with a PACs would be rescheduled with a probability of 70%; this perceived probability dropped to 55% for commercial banks and to only 25% for MFIs.

The same pattern occurred with the perceived probability of loan forgiveness. Besides, PACs appeared more likely to issue loans in amounts lower than requested. (The difference between PACs and MFIs was nearly 30%.) They were also less likely to issue new loans even if the previous ones were fully repaid. PACs were to be trusted less with savings and more likely to deduct a share of the

Economic & Political Weekly

NOTES

loan as a bribe. MFI loans, on the contrary, were perceived as 18 percentage points less likely to suffer this problem. Besides, loans from PACs were perceived as less likely to be repaid even if a good

Table 2: Perceptions on Credit and Repayment

provided by existing research is only partial and incomplete.

We have, however, some good indications of where the right path might lie. Providing good institutions, such as registries exhibit a strong correlation with higher ratios of private credit to GDP. Interestingly, information infrastructure, such as credit registries, matter more compared to creditor rights in poorer coun

tries than in rich countries.

harvest followed a drought than were e ither loans from commercials banks or MFIs.

Finally, respondents were asked to provide a ranking of lenders they would pay first if they had an outstanding loan from different lenders but did not have enough money to meet all repayment obligations. As it turns out, PACs loans always appeared last in the repayment priority list, behind all other loan types. The first in the list was always a loan from an MFI. Thus, the frequent announcement of relief measures appears to undermine the culture of repayment.

Conclusions

If an expanded role for government has to be the solution, care should be taken to ensure that the effects of government intervention have the intended consequences. There is strong evidence pointing to the crucial importance of government institutions for the functioning of the financial sector in general and access to credit in particular. However, instead of replacing private agents in the market, governments can make a more valuable contribution by securing an adequate environment for private credit institutions to flourish and by improving institutional mechanisms in ways that further the availability of credit to poor individuals. The range of policies that would contribute to this goal goes beyond the scope of this article. Building these institutions involves decision-making with long-time horizons, and the guidance efficient, speedy and fair courts is an area where only the government can play an active role. Also, governments can provide much needed registries of credit information, liens and property ownership, and make sure the legislation is reliable and that property rights and responsibilities of companies and fi nancial institutions are properly defi ned. Reforms in these areas may be diffi cult to accomplish in the short term. But there are many other dimensions where progress comes at lower costs. Djankov, McLiesh and Shleifer (2007) use a panel of aggregate data for 129 countries over 25 years to confirm that creditor rights and the existence of (public or private) credit resulted in sizeable increases

in loan recoveries, as market participants were able to bypass the inefficient court procedures then in place. Also, consistent with the evidence we presented in this paper, Caprio and Honohan (2004) advocate the importance of ensuring the independence of bank supervisors from the political sphere, and of the supervised entities themselves, in order for banks to promote social welfare and not their own or that of their offi cials.

In sum, in this paper, we have provided some evidence showing that government-controlled PACS may suffer from weak governance and poor management practices and may be prone to capture by politicians. This is consistent

NOTES

with cross-country evidence that emphasises governance and institutional issues as critical in explaining differences in the performance of public sector interventions.

Notes

1 The ordinance required that repayment collections occur at panchayat offices and retroactively waived loans if twice the principal had already been repaid. It further required registration of MFIs with district authorities, subject to cancellation at any time (Government of AP 2010).

2 PACS with repayment rates below 30% did not qualify for funding, PACS with repayment rates between 30% and 50% would receive one-third of the funds initially and one-third for every 10% improvement in repayment, while PACS with repayment rates above 50% would receive all the funds immediately.

3 We use stratification weights to report population averages.

4 Another government initiative that is often seen as a viable alternative to microfi nance, especially in AP, is the self-help group (SHG) model based on teaching community members how to provide and manage fi nancial services among themselves. Poor women come together in a group that meets periodically, each contributes savings to a group account that is then on-lent to members. To use the term coined by Stuart Rutherford in his 2000 book, The Poor and Their Money, SHGs are an example of a “promoter” approach.

5 The international evidence shows the same patterns. Dinç (2005), for example, demonstrates that increased lending by governmentowned banks right before elections is not specific to India but can be observed in data from 22 developing countries. Khwaja and Mian (2005) also find that in Pakistan, politically connected fi rms are able to secure larger and cheaper loans from state-owned banks and default on these loans much more than other non-connected fi rms.

References

Beck, Demirguc-Kunt and Martinez-Peria (2008): “Bank Financing for SMEs around the World: Drivers, Obstacles, Business Models, and Lending Practices”, World Bank Policy Research Working Paper 4785, Washington DC.

Caprio, Gerard and Patrick Honohan (2004): “Can the Unsophisticated Market Provide Discipline?” in Hunter C William, George G Kaufman, Claudio Borio and Kostas Tsatsaronis (ed.), Market Discipline across Countries and Industries (Cambridge, MA: MIT Press), 349-62.

Cole, Shawn (2009): “Fixing Market Failures or Fixing Elections? Agricultural Credit in India”,

American Economic Journal: Applied Economics, 1(1): 219-50.

Cole, Shawn, Healy, Andrew and Eric Werker (2012): “Do Voters Demand Responsive Governments? Evidence from Indian Disaster Relief”, Journal of Development Economics, 97(2): 167-81.

Daley-Harris, Sam (2009): “State of the Microcredit Summit Campaign Report” (Washington DC: Microcredit Summit Campaign).

Dinç, Serdar (2005): “Politicians and Banks: Political Influences on Government-Owned Banks in Emerging Countries”, Journal of Financial Econo mics, 77 (2): 453-79.

Djankov, Simeon, Caralee McLiesh and Andrei Shleifer (2007): “Private Credit in 129 Countries”, Journal of Financial Economics, 84(2): 299-329.

Government of AP (2010): “The Andhra Pradesh Microfinance Institutions (Regulation of Moneylending) Rules 2010”, Government order MS No 356, Andhra Pradesh Gazette, extra ordinary issue, 19 October, Panchayat Raj and Rural Development (RD-I) Department, H yderabad.

Johnson, Doug and Sushmita Meka (2010): “Access to Finance in Andhra Pradesh”, Institute for Financial Management and Research Centre for Microfinance, Chennai, accessed on 13 April 2012: http://www.centre-for-micro fi na nce.com/wpcontent/uploads/attachments/ csy/ 695/CMF_ access_to_Finance_in_Andhra_Pradesh_2010.pdf

Khwaja, Asim Ijaz and Atif Mian (2005): “Do Lenders Favour Politically Connected Firms? Rent Provision in an Emerging Financial Market”, Quarterly Journal of Economics, 120 (4): 1371-411.

Rutherford, Stuart (2000): The Poor and Their Money (Rugby: Practical Action Publishing).

Visaria, Sujata (2009): “Legal Reform and Loan Payment: The Microeconomics Impact of Debt Recovery Tribunals in India”, American Economic Journal: Applied Economics, 1(3): 59-81.

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may 5, 2012 vol xlvii no 18