Macroeconomics - role of institutional credit for economic growth - 2008

Macroeconomics Assignment Macroeconomics Assignment GMP 2008-09, XLRIGMP 2008-09, XLRI

Role of institutional credit for economic growth


India: An agrarian economy

Percentage of total workforce depending on agricultural sector for livelihood : 70%

Growth rate of agriculture over the last 10 years : Less than 1.5% per annum Contribution of agricultural sector towards GDP : 19.9% To achieve a GDP growth of more than 8% , agricultural should exhibit a

commensurate growth Growth of Industry and services sectors are directly linked to agricultural

growth. Many farmers have been committing suicides in several parts of our country

due to o Crop failureo Low productiono Increasing indebtedness

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Need for institutional credit…….???

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To give a boost to agricultural sectoro Farmers can acquire inputs and equipment – such as fertilizers,

tractors, farming equipment and livestock – that make them more productive and enhance overall agricultural productivity.

o Increased food output, improved household incomes, and lower food prices. Thus reducing undernourishment.

Informal Sources of Finance – local money lenders, landlords, traderso Charge more than 20% interest rate – generally compoundedo Keep land as collateralo Very High recovery rateo Moneylender financing has increased from 17% in 1991 to 29%

in 2000

Inability of Loan waivers to improve the condition of marginal farmers

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Need for institutional credit


Birth of Institutional Credit for agriculture

It is now widely recognised that access to credit is critical for cultivators operating in a market setting. In order to fully exploit natural, material and human resources in the most efficient and effective way it is necessary for any country to have a sound financial or banking system.

One of the important - and moderately successful - aims of bank nationalisation more than 30 years ago, was to provide institutional credit to agriculture, which until then had been severely neglected by bankers.

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Pre reforms credit situation and Narasimhan Committee report

Among the directed credit programmes followed by the banks, priority sector lending has been perhaps one of the most effective. In 1969, banks provided only 14.6 per cent of their total credit to the priority sectors, with the percentage of credit disbursed to agriculture being only 5.4 per cent. In 1991, 40.9 per cent of net bank credit was advanced to priority sectors, and total credit to agriculture, even though remaining below the prescribed level of 18 per cent, was 16.4 per cent by 1991.

The Narasimhan Committee Report, on the basis of NPA’s argued that the policy of directing credit towards priority sectors should be reconsidered and that the proportions of such credit should be reduced.

The Committee also suggested that banks should not be pressurised to open rural branches and that banks should be allowed to close non-profitable branches.

These suggestions were based on an assessment of the performance of rural banking, which was not justified by the actual experience. In fact, over the 1990s, the share of the priority sectors in total NPAs of public sector banks was declining. Also, NPAs resulting from small advances (i.e. where outstanding bank loans amounts to Rs. 25,000 or less) have been declining and that too quite sharply in relative terms.

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Apart from this, there were also totally new areas under the umbrella of priority sector for the purpose of bank lending. These included lending to the Rural Infrastructure Development Fund of NABARD as well as to State Financial Corporations. Recently even software and bio-engineering have been included under priority sector. This has allowed banks to include all manner of loans to different sectors, and treat such investments as priority sector advances.

This is the only reason why priority sector lending, which was falling as a share of total bank lending between 1991 and 1996, has subsequently been above the target. While total priority sector lending has increased, loans to agriculture have declined, and are now well below the target of 18 per cent of net bank credit. In the year ending March 2003, direct agricultural advances amounted to only 11 per cent of net public sector bank credit.

Private banks in general and foreign banks in particular have been the worst performers in this regard, and have been very lax in meeting regulatory norms. Once again, the sector most affected was agriculture. Direct agricultural advances were only 6.3 per cent of net private sector bank credit in 2002-03.

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Continued…


The difficulty is that even public sector banks are being forced to respond by cutting costs and trying o improve profitability in competition with private banks. They are trying to trim operating expenses, by reducing the wage bill by reducing employment through retrenchment under the VRS scheme and computerisation. They are also seeking to reduce costs by limiting branch expansion and reducing the number of bank branches.

The latter, which affects the rural areas first, reduces access to credit in rural areas that were well-served by the post-nationalisation branch expansion drive, and worsens the tendency towards reduced provision of credit to the agricultural sector.

In consequence of all this, the formal credit squeeze upon Indian agriculture is now acute. This has led to severe problems of accessing working capital for cultivators, and has also meant the revival of private moneylending in rural areas. Such retrogression has extremely disturbing implications for the current conditions of farmers, as well as for the future of Indian agriculture.

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Continued…


Benefits of Institutional Credit


Issues in Institutional Credit


Flow of Institutional Credit to Agriculture

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Food Grains Production


An IMF Study – From Credit to Crops A case study to find relation between financial development and overall

agricultural productivity; between agricultural productivity and nourishment; between financial sector development and investment in agriculture.

A study which covered more than 50 countries between 1980 and 2003 (using data from World Bank, 2005)

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An IMF Study – From Credit to Crops 1 percent increase in private credit to GDP boosts value added per

agricultural worker by 1.0–1.7 percent. The ratio of private credit to GDP in low-income countries, for example, is

about 16 percent, well below the 88 percent level in high-income countries Findings suggest that increased agricultural productivity and investments in

agricultural equipment hold the key.


Few Institutional Credit providers

Cooperative agricultural and rural development bank of India

Apex development bank NABARD SKS Microfinance Primary Agricultural Cooperative Societies (PACS) in

Maharashtra Mutually Aided Cooperative Societies (MACS) in Andhra

Pradesh SHGs – Self Help Groups


Future Ahead…… Microfinance

o Microfinance schemes on the lines of the Grameen Bank of Bangladesh

Easy/Pre-approved credit – e.g. Kisan Credit Card Schemeo Introduced in 1998-99, started by Govt Of India in consultation

with RBI & NABARDo Implemented by 27 commercial banks, 373 District Central

Cooperative banks/State Cooperative banks and 196 Rural banks so far.

o 204 mn Kisan credit cards involving credit sanctions of 43,392 crores

Technologyo Technology such as mobile phone banking, smart cards and

simple scoring models can facilitate delivery of financial services to many farmers at lower cost.

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Thank you

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Macroeconomics - role of institutional credit for economic growth - 2008

Economy & Finance