The Productivity of Agricultural Credit
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A recent paper in Agricultural Economics investigates the relationship between institutional credit to agriculture, the use of agricultural inputs and agricultural Gross Domestic Product (GDP). The study highlights that since 1990 Indian agriculture has faced many challenges, overall agricultural GDP has grown slowly and the traditional crop sectors have seen declining profitability. This has pushed policy makers to direct special attention to addressing some of the pressing concerns confronting Indian agriculture. Institutional (formal) credit has been an important lever in this effort.

The study notes that the fundamental attribute of credit is that it serves as an intermediate/enabling input that does not directly enter as an input into agricultural production. Due to this, it is likely that it plays a complex role in farmers’ production decisions. The impact of agricultural credit on agricultural production, efficiency and productivity could potentially occur through multiple channels. For example, formal credit can be used to purchase inputs over the cropping season, enabling a farmer to maximize the yield from the cultivated area. Formal credit can be used to make productive investments that support agricultural production, for instance, in irrigation facilities and machines. In addition, formal credit can be used to replace informal credit associated with higher interest burdens, relieving credit constraints, potentially reducing interest burdens and indebtedness.

The study summarizes how the nature and extent of agricultural credit in India started growing significantly around 2000 and has been supported by three many policy initiatives. The first policy initiative, introduced in 2004-05, aimed to double the volume of credit to agriculture over a period of three years. The second policy initiative in 2008, ‘the Agricultural Debt Waiver and Debt Relief Scheme,’ aimed to deal with the persistent problem of indebtedness and to alleviate financial pressures faced by farmers. The third policy initiative was an interest subvention scheme that rewards the prompt repayment of loans. Together, these interventions have transferred large amounts of credit to the agricultural sector. The amount of agricultural credit disbursed grew slowly in the 1990’s until 2004; from 2004 it increased rapidly from 86,981 crore rupees annually to 711,621 crore rupees annually in 2014.  Similarly, the ratio of institutional credit to the value of agricultural inputs used annually has increased from 15 percent in 1995 to 85 percent in 2011. This suggests that credit growth is outstripping the increasing costs and investments in agricultural inputs in India. This ratio also suggests that formal agricultural credit is perhaps crowding out informal borrowing.

Regarding methodology, the study uses state-level data covering information for all major states in India regarding credit, agricultural GDP, variables related to land under cultivation, inputs, and composition of agricultural output value. The study covers the time period from 1995-2012 and maps the pathways through which institutional credit relates to agricultural GDP through measurement of the credit elasticity of agricultural GDP and the impact of institutional credit on the use and consumption of agricultural inputs.

Significantly, the study finds a statistically-insignificant relationship between institutional credit and agricultural GDP for India as a whole. At the state level, the study finds that this statistically insignificant relationship between credit flow and agricultural GDP holds largely true across states. Punjab, is an exception and shows a consistently strong relationship between agricultural GDP and institutional credit. By contrast, the study finds that institutional credit has a strong relationship with all inputs except pump sets in India as a whole. More specifically, the study finds that a 10 percent increase in credit flow leads to: an increase by 1.7 percent in fertilizers consumption and a 10.8 percent increase in tractor purchases. The study finds that before 2004, institutional credit seems to have been channelled into purchase of variable inputs such as fertilizers, while after 2004, credit seems to be directed to investments in tractors. This is consistent with the popular perception that rising labour costs and a shortage of farm hands is prompting mechanization in India and it appears that credit is aiding and enabling this transition.

In conclusion, the paper highlights that these results indicate that institutional credit has a strong relationship with agricultural inputs but a weak direct relationship with agricultural GDP. There is strong evidence that credit is indeed playing its part of supporting the purchase of inputs and perhaps even aiding the agricultural sector respond to its contextual constraints. These results suggests that credit seems to be an enabling input supporting the increase use and purchase of inputs for Indian agriculture  but has not supported agricultural GDP growth directly. It should be noted, however, that this study does not cover the effects of increased credit on the rural non-farm sector.  While this is an important component to evaluate in future research, the paper speculates that credit can be interpreted as performing two roles: the preservation of productivity levels by supporting mechanization of certain kinds and contributing, indirectly, to the growth of agricultural GDP through the purchase of variable inputs.

The full study can be accessed here.

By: Bas Paris

Photo credit:Flickr, IFPRI