The Real Cost of Credit Constraints: Evidence from Micro-Finance

Abstract

In October 2010, the Indian state of Andhra Pradesh passed a law that severely restricted the operations of micro-finance institutions and abruptly brought the micro-finance industry to a halt. We measure the impact of the withdrawal of credit in this unique natural experiment. Average household expenditure in the state dropped by 19 percent when compared with controls over four quarters after the ban. The largest decrease was observed in expenditure on food, while expenditure on education saw increased volatility. The average consumption of all households were affected and not just the lower income households, which may suggest general equilibrium effects.

Keywords: micro-credit, micro-finance ban, natural experiment, Andhra Pradesh

JEL Classification: D14, G21, G28