Subsidized credit programs : the theory, the record, the alternatives

The opening sections of this paper describe the credit subsidization approach first adopted in the 1950s, and contrast the theory behind it with the MacKinnon-Shaw counter-theory of financial liberalization. The study"s central section reviews analyses made over the last 20 years of both subsidized credit and financial liberalization programs, especially those of USAID, in terms of their financial sustainability, economic impact, effects on the poor, and the experience of microenterprise credit programs; case studies of credit programs in the United States and Asia are also provided. Key conclusions are as follows. (1) Subsidized credit has done more harm than good, and has hindered development of the financial sector. (2) In general, lenders that provide cheap capital are not financially viable, and projects that support such lenders have little development impact. By contrast, projects that lend funds at free-market rates and pay market rates to savers can be financially viable and successful. (3) The effect of credit projects on poor farmers has not been encouraging. The nonpoor have benefited the most from credit projects. (4) There is little justification for credit subsidies: market-rate credit has not been the major constraint to agricultural development it was presumed to be. Farmers can increase output profitably while paying market rates of interest. (5) Subsidized credit hinders savings mobilization and generally fails to compensate for distortions in both nonfinancial and financial markets. (6) Financial liberalization is a prerequisite if donor-supported financial services programs are to effective in reaching the poor, especially microentrepreneurs. (7) Through their local knowledge, NGOs have advantages over government agencies in lending to small enterprises, provided they operate as lending rather than philanthropic agencies. (8) For viable microenterprises, access to credit is more important than credit price. Interest rate subsidies are not needed; financial services are. A bibliography is appended.