Rural Finance for Growth and Poverty Alleviation
76 Pages Posted: 20 Apr 2016
Date Written: April 1996
To promote agricultural - and hence economic - growth, Pakistan must make more credit available to agricultural smallholders, the rural nonfarm sector, and women. Subsidizing interest rates is not the way to help marginal borrowers. Instead, they can be helped through fixed-cost subsidies and self-selected targeting.
Pakistan's rural sector accounts for more than 70 percent of employment, and roughly two-thirds of rural employment is in agriculture. Less than a third of rural households get loans, only 10 percent of which are from institutional sources. Pakistan's credit institutions are not helping the country accelerate agricultural growth and reduce poverty.
To improve performance in the rural economy and efficiency in financial institutions, rural credit markets must be liberalized. The government needs to initiate the following reforms:
° Produce and price controls must be replaced by prudent regulation and supervision, combined with policies to stabilize the economy.
° Commercial banks must operate in a competitive environment. They must be allowed to set interest rates for rural lending that cover their transaction costs.
° Credit must be made available to support productivity growth for agricultural smallholders and small producers of the rural nonfarm sector, where Pakistan`s growth potential lies.
° Credit must be made available to women and to the rural poor for consumption-smoothing and for sustainable income-generating activities.
Policy should be directed at developing a market-based financial system for rural finance, but because of market failures to support disadvantaged groups, a special-priority program may be needed to get credit to women, smallholders (with 10 acres or less), and the rural nonfarm sector (small-scale nonfarm activities such as livestock, fishery, forestry, and rangelands, and industrial microenterprises).
Subsidizing interest rates is not the way to help marginal borrowers. Instead, they can be helped through fixed-cost subsidies and self-selected targeting. Nongovernmental organizations (NGOs) should be encouraged to help, keeping in mind such NGO success stories as the Grameen Bank in Bangladesh and Badan Kredit Kecaratan (BKK) in Indonesia.
Commercial banks should be encouraged to lend on other bases than the mortgage and passbook system. They could experiment with wholesaling credit through input suppliers, marketing agents, and NGOs. They should consider lending for such downstream agricultural activities as agroprocessing.
The biggest challenge facing rural finance is the restructuring of cooperatives. The next important step for the Agricultural Development Bank of Pakistan would be a portfolio audit - the results of which will determine next steps, such as major restructuring of its portfolio and changing its ownership. To improve rural financing, the system of property rights, title, and default enforcement must also be strengthened, among other reforms.
This paper - a product of the Agricultural and Natural Resources Division, South Asia, Country Department I - is part of a larger effort in the region to analyze major issues of agricultural growth and rural development in Pakistan and working with the government in developing a strategy to address those issues.
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