impact on the incomes or spending patterns of these households; however, this is not an innocuous assumption, because the very availability of easier credit may reduce the incentive for precautionary (“buffer stock”) savings, and allow even non-borrowers to spend more than they otherwise would have.

Of those who did borrow, some may not have been credit-constrained, meaning that they had access to as much credit as they wanted, given the available price. They would then only have taken on VRF loans because they were cheaper. In part this would produce an income effect – substituting cheap for expensive credit – but the lower price of credit would also provide an incentive to borrow more overall. The effect could be large; one in six VRF borrowers said that they borrowed from another source to repay the VRF loan, and the average annual interest rate paid on those sources was 46.0%; given an average VRF interest rate of 6.0%, this represents a gain of 40%; given the mean loan size of 16,183 baht, the interest saving would be equivalent to 4.9% of an average borrowing household’s annual income. While this probably an upper bound on the cost savings from VRF borrowing, it is enough to allow non-interest consumption for borrowers to rise by at least 6.1%, with no change in household income.

Other VRF borrowers may have been credit-constrained, in the sense that they already wanted to borrow more at the available price of credit. Presumably existing lenders were reluctant to lend more due to prudential concerns, which in turn may have been justified, or may have resulted from asymmetric information. It is entirely possible that the village-level VRF would, in many cases, have better knowledge about the ability of village households to service loans than most outside lenders, and thus improve the efficiency with which credit is allocated.

We do not have direct evidence on whether VRF loans substituted for other credit, or supplemented other borrowing. Kaboski and Townsend (2009), based on a rural sample of 800 households, find evidence that in 2003, households took on VRF loans without reducing their other borrowing. This sits well with the view that many households are credit-constrained, but of course is not inconsistent with the case of nonconstrained households responding to lower borrowing costs.

Much microlending is seen as desirable because it allows households to invest more, and so raise their earnings, and certainly the VRF was originally viewed as a vehicle for promoting the development of non-farm enterprise. In this case the impact goes from loan to more investment to more income to more consumption. On the other hand, many households use credit for consumption purposes – to smooth consumer spending over the course of a year, or make a lumpy purchases (including durable goods), or increase consumer spending now relative to in the future. In this case one would observe an increase in consumer spending without a corresponding rise in income. Given that households are heterogeneous, and only some would borrow from the VRF for productive purposes, our presumption is that the VRF will have a stronger impact on consumption spending than on income.

Whether VRF loans were used for investment or for consumer spending, the effect is likely to be complicated by the fact that a number of credit schemes are already in place. In rural areas, the most _Village Fund, draft of June 29, 2009_ _Page 5 of 34_