Interest rates and rural credit: subsidise or liberalise?

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 agriculture input subsidies as well as those for agricultural credit have been reduced or eliminated. As subsidies on credit are reduced the cost of credit increases, and as subsidies on inputs are reduced the amount of credit needed rises. Traditional credit subsidies have usually taken two forms: concessionary, often below the rates of inflation, interest rates on loans and acceptance of loan defaults. Both types erode the value of loan portfolios and may also endanger the viability of the financial institution involved. Unfortunately, neither the interest nor default subsidy have proven to be an efficient tool for alleviation poverty, mainly since access to loans is usually correlated with borrower wealth. This has led a number of policy makers to experiment with more direct avenues for addressing poverty such as programmes in health, education, nutrition, and welfare assistance.

The present document, prepared by Mr. J-L Pizarro, aims at giving a panoramic vision of the main characteristics of the financial liberalization process, its possible consequences for rural financial intermediation, and the conditions that could contribute to improved financial deepening in rural areas. It describes the context and justification of the financial liberalization policy in contrast with that of interest subsidies and, in doing so, focuses on their respective effects, beneficial and detrimental, on rural financial markets and their clients. It also analyses the framework for the implementation of a financial liberalization policy in the field of rural finance and discusses the reasons why subsidized agricultural credit projects or programmes still continue. Finally, it makes an attempt to systematize rural development projects having a financial component, in relation to the degree of the financial development of the region or country where they operate.

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