The impact of formal finance on the rural economy of India

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Abstract
India has systematically pursued a supply-led approach to increasing agriculturalcredit. Its objectives have been to replace moneylenders, to relieve farmers of indebtedness, and to achieve higher levels of agricultural credit, investment, and output. India's success in replacing moneylenders has been outstanding. Between 1951 and 1971 their share of rural credit appears to have dropped from more than 80 percent to 36 percent. (It may have dropped to as low as 16 percent by 1981, but that estimate is disputed). Still, institutional credit is far from reaching all farmers. Only about a quarter of cultivators borrow, and no more than 2 percent take out long-term loans. Most small farmers have little access to credit, and long-term credit goes mostly to large farmers. Overall, farm debt has probably not increased sharply in real terms, as formal credit has primarily substituted for credit from other sources. Moreover, with the rapid growth of commercial banks in the 1970s, the system mobilized more deposits than it lent in rural areas in 1981. Of course, enhanced deposit services are a useful service of the rural population, but one must ask what has been the impact of heavy rural credit and better financial services on agricultural investment, production, and rural incomes. The authors'econometric results suggest that the rapid expansion of commercial banks in rural areas has had a substantially positive effect on rural nonfarm employment and output. The availability of better banking facilities appears to have overcome one of the obstacles to locating nonfarm activities in rural areas. Expanded rural finance has had less of an effect on output and employment in agriculture than in the nonfarm sector. The effect on crop output has not been great, despite the fact that credit to agricluture has greatly increased the use of fertilizer and private investment in machines and livestock. There has been more impact on inputs than on output, so the additional capital investme
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