The impact of formal finance on the
            rural economy of India
India has systematically pursued a
            supply-led approach to increasing agricultural credit.  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 investment has been more important in substituting
            for agriclutural labor than in increasing crop output.  But
            overall, rural credit and expansion of the rural financial
            system have had a positive effect on rural wages.  Creating
            nonfarm jobs has apparently added more to total employment
            than the substitution of capital for labor has subtracted it
            in agriculture.  So, wages have risen even for agricultural
            workers, albeit modestly.  The supply-led approach to
            agricultural credit that has been pursued for three decades
            has clearly benefited current borrowers and farm households
            formerly indebted to moneylenders.  It has also spurred
            fertilizer use and investment in agriculture.  It has been
            less successful in generating viable institutions - and has
            failed to generate agricultural employment.  The
            policy's costs to India's government have been
            high as portfolio losses associated with poor repayment
            ultimately have to be borne by the government or one of its
            institutions under optimistic assumptions.  The benefits of
            the agricultural income are at best no more than 13 percent
            higher than the cost to the government of the extra
            agricultural credit.  If assumptions about the cost of
            supplying the credit and about repayment rates are less
            optimistic, the social costs - and the costs to the
            government of providing the credit - would have exceeded the
            benefits in agricultural income.  The expansion of
            commercial banks to rural areas paid off in nonfarm growth,
            employment, and rural wages.  The question is:  Could these
            benefits have been achieved without imposing agricultural
            credit targets on the commercial banks and credit
            cooperatives?  Or did the commercial banks expand only
            because they were forced to lend to agriculture?  The
            authors could not answer these questions with the data at hand.