The Impact of Farm Credit in Pakistan

Abstract

Both informal and formal loans matter in agriculture. However, formal lenders provide many more production loans than informal lenders, often at a cost (mostly loan default cost) higher than what they can recover. For example, the Agricultural Development Bank of Pakistan (ADBP), providing about 90% of formal loans in rural areas, incurs high loan default costs. Yet, like other governments, the Government of Pakistan supports the formal scheme on the grounds that lending to agriculture is a high risk activity because of covariate risk. Hence, such policies are often based on a market failure argument. As farm credit schemes are subsidised, policy makers must know if these schemes are worth supporting. Using a recent large household survey data from rural Pakistan (Rural Financial Market Studies or RFMS), we have attempted to estimate the effectiveness of the ADBP as a credit delivery institution. A two-stage method that takes the endogeneity of borrowing into account is used to estimate credit impact. Results reveal that ADBP contributes to household welfare and that its impact is higher for smallholders than for large holders. Nevertheless, large holders receive the bulk of ADBP finance. The ADBP is, thus, not a cost-effective institution in delivering rural finance. Its cost-effectiveness can be improved by reducing its loan default cost and partially by targeting smallholders in agriculture where credit yields better results.

Estimating the effects of formal and informal credit on farm household welfare: A hierarchical competitive welfare model approach

“…The choice of the IV approach is in conformity with the assertion that the models for selection bias are only as good as the assumptions of the way it occurs (Arabmazar and Schmidt, 1982;Goldberger, 1981;Lee, 1982). This approach has been used by a number of researchers in related studies (Campa and Kedia, 2002;Villalonga, 2004;Khandker and Faruqee, 2003). This is further supported by the view expressed by Chmelarova and Hill (2010) that if independent variables are endogenous and there are valid IV available, then it is better to use the IV approach since OLS will yield inconsistent estimates.…”

“…It follows the work of Khandker and Faruqee (2003) who used similar approach to estimate the impact of farm credit in Pakistan. A detailed discussion of how the model works is provided in the proceeding paragraphs.…”

“…Unfortunately, factors contained in and cannot be observed by the researcher and may correlate with and which results in selectivity bias that occurs when there is a correlation between the error term and the independent variables (Heckman, 1976(Heckman, , 1979(Heckman, , 1990Heckman and Li, 2003;Heckman and Sedlacek, 1990;Hausman andWise, 1976, 1977;Lee, 1982Lee, , 1983Lee, , 1994Das and Vella, 2003;Vella, 1998;Winship and Mare, 1992;Khandker and Faruqee, 2003). Some of the unobserved variables contained in may be used by lenders to determine, which borrower to grant credit to.…”

“…These included community and district level average years of formal schooling, community and district level average household savings and the average amounts of formal and informal credit borrowed by computing households at the community and district levels. The selection of these factors were partly informed by the empirical literature that years of formal schooling and savings significantly influence the amounts of credit individuals are able to borrow from credit markets (Khandker and Faruqee, 2003;Ayamga et al, 2006). The community level average characteristics were computed as sampled households excluding household i, and that of the district level computed as sampled households across k districts excluding those in community j.…”

o del crédito sobre el Agro en Colombia: Evidencia del nuevo Censo Nacional Agropecuario

“…Ahora bien, en comparación con resultados encontrados por la literatura internacional, Khandker y Faruqee (2003), para el caso pakistaní, hallan que un incremento del 10% en los préstamos de una fuente formal tiene el efecto de aumentar el consumo en 0.04%. No encuentran un efecto para las fuentes de crédito informales, que en nuestro trabajo serían particulares y prestamistas.…”